Definition of Comp - Overtime and Tips Deduction

If a plan uses the W-2 definition of compensation, then it is pretty clear that tips and overtime are included in Box 1 of W-2 and thus the exclusion of overtime and tips will not affect comp.  But what about if the definition of comp is based income for purposes of withhdoling?  If the IRS clarifies that qualifying tips and overtime are not subject to withholding, won't that create a problem?  I am hearing that the IRS may do just that for 2026. I haven't seen anything written about this so I am very curious...

I don’t yet know anything about how the Treasury department or its Internal Revenue Service might interpret Internal Revenue Code § 224 (Qualified tips) or § 225 (Qualified overtime compensation).

I.R.C. (26 U.S.C.) § 224 http://uscode.house.gov/view.xhtml?req=(title:26%20section:224%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section224)&f=treesort&edition=prelim&num=0&jumpTo=true

I.R.C. (26 U.S.C.) § 225 http://uscode.house.gov/view.xhtml?req=(title:26%20section:225%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section225)&f=treesort&edition=prelim&num=0&jumpTo=true

Neither provides an exclusion from any measure of wages. Neither provides an exclusion from gross income. Each provides a deduction.

But I see the possibility of a difficulty.

If the IRS might publish a form, instruction, other guidance, or an interpretation that could result in a plan provision some plan sponsors don’t intend, perhaps someone might persuade the Secretary of the Treasury (who now acts as the Commissioner of Internal Revenue) to treat that effect as a “disqualifying provision that [i]s integral to a qualification requirement of the Internal Revenue Code that has been changed”, and so allows a remedial-amendment period.

26 C.F.R. § 1.401(b)-1(b)(3)(ii) https://www.ecfr.gov/current/title-26/part-1/section-1.401(b)-1#p-1.401(b)-1(b)(3)(ii).

This is not advice to anyone.

I did see that the IRS actually did publish a draft W-4 on which employees can estimate their qualifying tips and overtime to adjust their withholding.  Additional research told me that as a technicality, amending the W-4 in this way does not affect the legal definition of wages for withholding--only a change to 3401(a) itself would do that. So the W-4 just allows employees to request lower withholding but does not exclude qualifying tips and overtime from the definition.  I suppose 3401a could be viewed as a starting point, from which the employee can make certain adjustments.  Anyway, that is what I learned from google and AI.  Curious if anyone can validate.

Were you all aware that when they said "overtime is tax free" they meant just the "half" in "time and a half"?  So for example, if the pay is $10 an hour, $15 for over-time, it is just the $5 extra that is eligible for the deduction.  I did not realize that.  I'll bet there are millions of hourly employees who did not realize that.  No one ever clarified (that I ever heard), and now the exclusion from income is 1/3 of what was communicated.  Anyway, I definitely had no idea so figured I would say something to you guys!

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austin3515, your second point shows why we should read the statute.

(c) QUALIFIED OVERTIME COMPENSATION.—

(1) IN GENERAL.—For purposes of this section, the term ‘qualified overtime compensation’ means overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate (as used in such section) at which such individual is employed.

(2) EXCLUSIONS.—Such term shall not include any qualified tip (as defined in section 224(d)).

Internal Revenue Code of 1986 § 225(c), added by An Act to provide for reconciliation pursuant to title II of H. Con. Res. 14, Pub. L. No. 119-21 § 70202(a) (July 4, 2025), 139 Stat. 72, 174 (2025), available at https://www.govinfo.gov/content/pkg/PLAW-119publ21/pdf/PLAW-119publ21.pdf [pdf page 104 of 331].

I read the statutes for SECURE 2.0 but not for payroll matters, LOL.  And my real point in mentioning is on behalf of John Doe manufacturing employee working 20 hours of OT per week, including double time on weekends and triple time on holidays, and coming to find out this is a fraction of what it was billed as.  "We're not taxing overtime" is what I heard.  John Doe did not read the statute, and if he just caught the headlines, this was never mentioned (and I probably watch and read more news then average American, though admittedly others read far more than I do). 

You’re right that politicians’ misleading expressions were deplorable.

3 hours ago, austin3515 said:

John Doe did not read the statute, and if he just caught the headlines

That is what they bank on.

1 hour ago, Peter Gulia said:

politicians’ misleading expressions were deplorable

Meet the new boss, same as the old boss....won't get fooled again - don't count on it. JQ Public duped again.

Imagine what an employee's reaction will be when they prepare their taxes and learn their occupation is not listed by the IRS as an occupation eligible for the employee to take the deduction for tips.

20 hours ago, Paul I said:

Imagine what an employee's reaction will be when they prepare their taxes and learn their occupation is not listed by the IRS as an occupation eligible for the employee to take the deduction for tips.

How many will lie about their occupation?  I remember hearing something about how many "missing" children there were after SSNs were required.

They won't lie, just "creatively describe." 😁

I think the employer is required to add it to the w2.  I think I read that somehwere.

That is correct - but the IRS announced that the W-2 wasn't going to change for 2025. They will probably add it in 2026.