The RFC 2698 says - "The color is coded in the DS field [RFC2474] of the packet in a PHB specific manner". I am trying to understand how color is encoded like in the IPv4 header - in the TOS field where the color information is encoded. Also, how it knows it is green, yellow or red?

In case, QoS is used for L2 i.e 802.1Q - PCP - Priority Code point, where the color is encoded here.

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On an IP packet there is a field for the Differentiated Services.

IP header field from Wireshark

There are 8 bits in the DS Field, 6 are for DSCP marking and 2 are unused. There is no field specifically for colors.

The colors are just a logical construct of how policing is done.

**green** = conforming = good = transmit the traffic
**yellow** = exceeding = not so good = transmit the traffic but remark to a lower QOS priority.
**red** = violating = bad? = transmit the traffic and lower the QOS priority or discard the packet.

Same as with the 802.1q header, there is no part specifically stating colors.

If you need additional technical details as to how the computation works, you might want to search refer back to RFC2698

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