No Tax on Overtime: How the Qualified Overtime Compensation Deduction Works

Section 225, added by section 70202 of Public Law 119-21, allows individuals to deduct qualified overtime compensation for taxable years beginning after December 31, 2024. No deduction is allowed for taxable years beginning after December 31, 2028. The deduction looks simple to clients. It is not. The amount that counts is usually a fraction of what the client calls "overtime," and from 2026 on, the amount is capped by what the employer puts on the Form W-2.

What counts as qualified overtime compensation?

The statute defines qualified overtime compensation as 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 at which the individual is employed. Qualified tips are excluded.

Two consequences follow.

Only the premium counts. For a worker paid time and a half, only the "half" is qualified. The 2026 Form W-2 instructions say exactly this: only the "half" portion of "time-and-a-half" compensation is reported with code TT. The straight-time pay for overtime hours is ordinary wages.

Only FLSA-required overtime counts. IRS FAQ FS-2026-13 (August 2026) says an individual who is not eligible for overtime under the FLSA receives no qualified overtime compensation, even if a state law or a collective bargaining agreement requires overtime pay. Where an employer pays more than the FLSA requires, such as double time or a daily overtime premium, only the amount minimally necessary to satisfy 29 USC 207 qualifies.

The FAQ's worked example: an employee earning $20 an hour works 50 hours in a workweek and is paid double time for 10 hours. The employer pays $400 for those hours. The FLSA required $300 ($200 straight time plus a $100 premium). The qualified overtime compensation is $100.

Which clients are not eligible?

FS-2026-13 lists common FLSA overtime exemptions, including executive, administrative and professional employees, outside sales employees, certain computer-related occupations, certain commissioned retail employees, certain transportation workers and certain agricultural employees. Salaried managers who are told they "earn overtime" under company policy are often exempt and get nothing under section 225.

The FAQ also states that an employee who owns at least a bona fide 20 percent equity interest in the enterprise and is actively engaged in its management is generally an exempt executive. That catches many owner-employees of S corporations who are paid extra for long hours. See S corporation reasonable compensation for the separate wage questions those clients raise.

Workers treated as independent contractors can, rarely, qualify. FS-2026-13 says a payor reports qualified overtime on Form 1099-MISC or 1099-NEC only where the worker is an employee for FLSA purposes but a contractor for Internal Revenue Code purposes. When that happens, the classification itself deserves a look; see worker classification.

How much can be deducted?

• Cap. $12,500 per return, or $25,000 on a joint return.
• Phase-out. The allowable amount is reduced by $100 for each $1,000 by which modified adjusted gross income exceeds $150,000 ($300,000 on a joint return). MAGI is AGI plus amounts excluded under sections 911, 931 and 933.
• SSN. The return must include the individual's social security number. FS-2026-13 says the number must be valid for employment and issued by the Social Security Administration before the return due date, including extensions. If both spouses have qualified overtime, both numbers must appear.
• Joint filing. A married individual must file jointly.

The deduction is allowed whether the client itemizes or not, and it is computed on Part III of Schedule 1-A. It is an income tax deduction only. The FAQ is explicit that overtime remains subject to income tax withholding, social security and federal unemployment taxes.

How did 2025 returns work?

The 2025 Form W-2 had no overtime box. Notice 2025-69 let an FLSA-eligible employee use an amount the employer voluntarily reported in box 14 or on a separate statement, or estimate the amount from pay statements using a reasonable method. The notice's methods include:

• Use a year-end statement that shows the FLSA overtime premium separately.
• If the statement shows total time-and-a-half overtime pay, use one-third of it.
• If overtime is paid at double time and the statement shows only the excess over the regular rate, use one-half of that amount; if it shows total double-time pay, use one-fourth.
• Without a statement, use the regular rate and hours over 40 (or reasonable approximations), and the employee may ask the employer for the figures.
• Workers under alternative FLSA rules, such as public safety work periods, hospital 8-and-80 schedules and public sector compensatory time, compute under those rules.

The notice also says individuals with more than one employer may use a different method for each, and that copies of every document relied on must be kept. For 2025 returns already filed, the workpaper should show which method was used and the source document.

What changes for 2026 returns?

This is the point to stress with clients now. Section 225(a) allows the deduction only for qualified overtime included on a statement furnished under section 6051(a)(19), meaning the Form W-2, or the Form 1099 equivalent. Starting in 2026, employers report the amount in box 12 with code TT.

FS-2026-13 makes the consequences plain:

• No relief is available after 2025. An employee may not deduct any amount above what is reported in box 12, code TT.
• If the employer understated or omitted the amount, the employee must obtain a Form W-2c. If the employer will not issue one, the employee is limited to the amount reported.
• A substitute Form W-2 (Form 4852) does not satisfy the statement requirement.
• If the employer overstated code TT, the employee may use only the amount actually paid.
• The code TT amount is the total qualified overtime paid, not the deductible amount. Schedule 1-A applies the cap and the phase-out.

So the review step for 2026 is to compare code TT to the client's own pay records before filing, and to request a W-2c early if they do not agree. Employers' side of this, including payroll setup and correction duties, is covered in employer reporting for tips and overtime.

Withholding and planning

The statute directs Treasury to modify withholding procedures for years after 2025. FS-2026-13 says an employer may not reduce withholding for the expected deduction unless the employee furnishes an updated Form W-4, and that the 2026 Form W-4 lets employees account for the deduction in step 4(b). Clients who work steady overtime and want the benefit during the year should file a new W-4; others will see it as a refund. Where overtime is irregular, a conservative step 4(b) entry avoids a balance due. For clients who pay estimates, see estimated tax payments.

Client checklist

• Confirm FLSA overtime eligibility (for federal employees, FS-2026-13 points to the FLSA category on Standard Form 50).
• Collect Form W-2 box 12 code TT for 2026, or the 2025 method and support.
• Compare code TT with year-end pay statements; request a W-2c where it is short.
• Check MAGI against the phase-out, filing status and SSN.
• Note whether a revised Form W-4 is worth filing for the next year.

CORAA prepares ready-to-review audit files for US CPA firms; see /us.

Sources

• U.S. Government Publishing Office, Public Law 119-21 (section 70202): https://www.govinfo.gov/content/pkg/PLAW-119publ21/html/PLAW-119publ21.htm
• IRS, FS-2026-13, Updates to questions and answers about the new deduction for qualified overtime compensation: https://www.irs.gov/pub/taxpros/fs-2026-13.pdf
• IRS, Notice 2025-69, Guidance for Individual Taxpayers who received Qualified Tips or Qualified Overtime Compensation in 2025: https://www.irs.gov/pub/irs-drop/n-25-69.pdf
• IRS, 2026 General Instructions for Forms W-2 and W-3: https://www.irs.gov/pub/irs-pdf/iw2w3.pdf
• IRS, New Schedule 1-A and Form 1040 instructions show how taxpayers will claim important deductions (IR-2026-28): https://www.irs.gov/newsroom/irs-published-schedule-taxpayers-will-use-to-claim-deductions-on-no-tax-on-tips-no-tax-on-overtime-no-tax-on-car-loans-no-tax-on-seniors

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error