Is Your Restaurant's Payroll Ready for Tip and Overtime Reporting?
Your servers and bartenders have probably heard about "no tax on tips." Your cooks and dishwashers may have heard about "no tax on overtime." What fewer people have heard about is the part that lands on the employer: the reporting.
Under the new tax law, eligible employees can deduct up to $25,000 in qualified tips and up to $12,500 in qualified overtime pay ($25,000 for joint filers) on their individual returns. Those deductions depend on numbers that only your payroll records can provide. For 2025, the IRS offered penalty relief while employers adjusted. For 2026, the new reporting is required, and the first W-2s that must include it are due to employees by February 1, 2027.
That makes the next few months a good time to check that the numbers you've been tracking since January will hold up.
What counts as a qualified tip, and what doesn't
Not every dollar that looks like a tip counts as one for this deduction. A qualified tip is generally:
Voluntary. The customer chooses whether to tip and how much. It isn't required or negotiated.
Paid in cash or a cash equivalent. That includes cash, checks, credit and debit cards, and payment apps.
Earned in an occupation where tipping is customary. Treasury has published a list of tipped occupations, each with its own occupation code. Servers, bartenders, and many other food and beverage roles are on it.
Paid to employees through a tip pool counts, too. Tips shared through a tip pool or tip-sharing arrangement can qualify.
For more on how Treasury defined which occupations qualify, see our earlier post, New Treasury Guidance on "No Tax on Tips".
What generally doesn't count is a mandatory charge set by the business. Consider a restaurant owner who adds an automatic 20% "gratuity" to private parties of eight or more. Because the guest doesn't choose the amount, that charge is a service charge, not a tip. It still goes to staff as wages, but it isn't a qualified tip, and it needs to be tracked separately from the voluntary tips those same servers earn on a regular Tuesday night.
Qualified overtime is narrower than total overtime pay
The overtime deduction covers only the extra pay that federal law requires. When an hourly employee works more than 40 hours in a week and earns time-and-a-half, only the "half" counts as qualified overtime. Their regular rate for those hours doesn't.
Overtime paid for other reasons, such as a company policy of double time on holidays, generally doesn't qualify for the portion above what federal law requires. Neither does overtime paid to employees who are exempt from federal overtime rules, like many salaried managers. Your payroll records need to show the federally required premium on its own.
We covered the IRS's latest overtime guidance in more detail in What the Updated Overtime Deduction Rules Mean for Your Payroll, including how owner-employees are treated.
What your 2026 W-2s will show
The 2026 Form W-2 has new places for this information:
Box 12, code TP: cash tips the employee reported to you
Box 14b: the employee's tipped occupation code
Box 12, code TT: qualified overtime compensation
One thing hasn't changed: withholding. Tips and overtime are still subject to federal income tax withholding, Social Security, and Medicare, just as before. The deductions show up when your employees file their own returns, not in your payroll tax calculations.
Getting these amounts right the first time matters. Employees generally can claim only what appears on their W-2, and an employee can't fix an understated overtime amount on their own. The fix is a corrected W-2 (Form W-2c) from you, usually in the middle of filing season.
Getting ready before year-end
For most restaurants, the work comes down to a few practical steps:
Check your payroll system. Confirm it can capture tips, service charges, and overtime premiums separately, and that it will produce W-2s with the new codes.
Reconcile what you've tracked since January. If voluntary tips and service charges have been running through the same pay code, now is the time to separate them, not in late January.
Assign occupation codes by role. Match each tipped position to its occupation code so the right code lands in Box 14b.
Review how you calculate overtime. Make sure your records isolate the federally required premium from regular pay and from any extra overtime you pay by policy.
Let your team know what's coming. Employees will see new entries on their W-2s. A short note explaining what they mean can save a lot of questions in February.
How HFM can help
The new deductions are good news for your employees. Getting the reporting right is what lets them use those deductions. HFM's Client Accounting & Advisory team works with restaurants and hospitality businesses across Connecticut and Rhode Island to set up payroll categories, reconcile tip and overtime records, and prepare for year-end reporting. Our tax team can help with the employee-side questions that follow.
To work through it step by step, use our Tip & Overtime Reporting Guide below. You can bookmark this page to save your results and update them as you complete the steps.
HFM CPAs provides specialized accounting, tax, and assurance services to individuals and businesses across Connecticut and Rhode Island.
