FAQs clarify the new qualified overtime deduction

The IRS has released updated guidance on the new deduction for qualified overtime compensation through Fact Sheet FS-2026-01. This timely clarification is essential for tax professionals advising clients on the overtime deduction created by the One Big Beautiful Bill Act. While the guidance does not change the law, it helps define key eligibility rules that many taxpayers and preparers may not fully understand.

What counts as qualified overtime compensation

The overtime deduction is limited to the portion of overtime pay that is required under the Fair Labor Standards Act and paid in excess of an employee’s regular rate of pay. The IRS emphasizes that only the FLSA-required premium portion qualifies.

For example, if an employee earning $20 an hour is paid $30 an hour for 10 overtime hours, only $100 (the $10 per hour premium) qualifies for the deduction. The regular $200 does not.

Even if an employer voluntarily pays double time, only the amount needed to reach time and a half qualifies. The IRS makes clear that extra compensation above what the FLSA requires does not count.

NOTE: The deduction is only available if the taxpayer (and spouse, if married) has a valid Social Security Number and files a joint return if married. 

FLSA eligibility is mandatory

The IRS states that if an employee is not eligible for overtime under the FLSA, no amount qualifies, regardless of how the pay is described, whether it is labeled overtime, premium pay or additional compensation.

This rule applies even when overtime is paid under employer policy, state law, or a collective bargaining agreement. For example, a salaried employee who is exempt under the FLSA and receives extra pay for overtime does not qualify for the deduction. Likewise, overtime paid for hours that are not FLSA-required, such as hours 36 through 40 when the FLSA threshold is 40, does not qualify.

Federal employees and FLSA status

For most federal employees, FLSA status is shown on their Standard Form 50, Notice of Personnel Action, in Box 35. An “N” indicates a nonexempt employee who may be eligible for the deduction. An “E” indicates exempt status, meaning the employee does not qualify for the overtime deduction even if overtime pay appears on a pay statement.

Deduction limits and income phaseouts

The deduction is capped at $12,500 per return and $25,000 for married filing jointly taxpayers. It is also subject to an income phaseout. The deduction begins to phase out when modified adjusted gross income exceeds $150,000 for single filers and $300,000 for married filing jointly taxpayers. Once a taxpayer crosses these thresholds, the allowable deduction is reduced and may be partially or fully eliminated depending on income level. 

For example, a single taxpayer has a modified adjusted gross income of $165,000 and otherwise qualifies for $8,000 of qualified overtime compensation. Because the taxpayer’s income exceeds the phaseout threshold, the deduction is reduced under the MAGI limitation and may be partially or fully eliminated based on the final calculation.

Reporting issues for 2025

For tax year 2025, the IRS confirms that employers are not required to separately report qualified overtime compensation on Forms W-2 or 1099. As a result, taxpayers or preparers may need to calculate the deductible amount using payroll records, employer summaries or other documentation. Starting in tax year 2026, separate reporting will be mandatory.

This makes documentation especially important during the initial year of the deduction. Preparers should verify overtime hours, pay rates and FLSA eligibility before claiming the deduction.

Penalty relief for reasonable reliance

Although the IRS FAQs are not published in the Internal Revenue Bulletin, the agency states that taxpayers who reasonably and in good faith rely on this guidance will generally be protected from accuracy-related penalties. If any FAQ later proves incorrect, the statute controls, but penalty relief may still apply.

Why this matters for tax pros

The IRS guidance does not broaden the overtime deduction, but it clarifies its boundaries. The key points are straightforward:

• Only the FLSA-required premium portion of overtime pay qualifies.
• FLSA eligibility is nonnegotiable.
• Voluntary overtime pay, state law overtime pay or contractual overtime that does not align with the FLSA does not qualify.
• For 2025, careful documentation and calculation by the preparer may be necessary.
• Income phaseouts and deduction limits can significantly reduce the benefit for higher-income clients.

With careful documentation and a solid grasp of the requirements, you can help clients take full advantage of this new deduction without surprises during filing season.