The IRS has moved into a new phase of its “No Tax on Overtime” rules, putting a greater reporting responsibility on restaurant employers ahead of the 2026 tax season.
The rules stem from the One Big Beautiful Bill Act, enacted in July 2025. The legislation created a new federal income-tax deduction for qualified overtime compensation for tax years 2025 through 2028. Workers can deduct up to $12,500 in qualified overtime compensation, or $25,000 for married couples filing jointly. The benefit begins phasing out at modified adjusted gross income of $150,000 for individual filers and $300,000 for joint filers.
For restaurants, the key change is not a new overtime pay requirement. Rather, it is how qualifying overtime must be tracked and reported.
Under the IRS definition, qualified overtime is the portion of overtime compensation that exceeds an employee’s regular rate under the Fair Labor Standards Act. For a worker receiving time-and-a-half, for example, only the additional half-rate premium qualifies for the deduction, and not the employee’s entire overtime paycheck.
The reporting rules were more flexible during 2025, which the IRS treated as a transition year. For 2026 and subsequent years, employers and other payers must separately report qualified overtime compensation. The IRS has introduced Code TT in Box 12 of Form W-2 for this purpose.
That distinction matters for restaurant operators because payroll systems must now identify the qualifying portion of overtime rather than simply recording total overtime wages.
The tax change also does not eliminate payroll taxes on overtime. Qualified overtime remains generally subject to federal income-tax withholding as well as Social Security and Medicare taxes for both employees and employers. The new deduction affects the worker’s federal income-tax liability rather than removing the underlying wage or payroll-tax obligations.
The IRS says employers should use an employee’s updated Form W-4 when submitted so workers can account for their expected deduction through withholding rather than waiting until they file their tax returns.
Operators should therefore be reviewing three areas now: timekeeping, payroll configuration and W-2 reporting. Payroll and HR teams also need a clear understanding of which employees and overtime payments fall within the federal definition, particularly where restaurants use different pay structures or have employees working across multiple locations.
