Overtime tax deduction for union workers hinges on FLSA pay

Limitations on the allowable overtime exemption in the One Big Beautiful Bill Act (OBBBA) have led to confusion about whether overtime paid pursuant to a union collective bargaining agreement qualifies for the tax deduction. Fortunately, Internal Revenue Service (IRS) guidance released earlier this year provides some clarity.

On July 4, 2025, the OBBBA was signed into law. One of the highly publicized features of the legislation was the “no tax on overtime” provision. Generally, this provision allows individuals to deduct up to $12,500 ($25,000 if married filing jointly) of qualified overtime compensation from income subject to federal income tax for tax years 2025 through 2028. The maximum deduction is also subject to income limits and begins to phase out when an individual’s modified adjusted gross income exceeds $150,000 ($300,000 if married filing jointly). Only the overtime premium (the additional one-half of the regular rate of pay in time-and-a-half compensation) required by the Fair Labor Standards Act (FLSA) under §207 is eligible for the tax deduction.

IRS Fact Sheet 2026-13

In August 2026, the IRS released Fact Sheet 2026-13, Updates to questions and answers about the new deduction for qualified overtime compensation, which includes a question and answer directly addressing what happens when an FLSA overtime-eligible employee is paid overtime compensation not required by the FLSA.

Noting that “[s]ome employers may provide overtime pay that is not required by 29 U.S.C. §207 on their own initiative, pursuant to a State law, or under a collective bargaining agreement with a labor union,” the guidance goes on to explain that where an employee is paid more than what is required under the FLSA, “only the amount minimally necessary to satisfy 29 U.S.C. §207 is qualified overtime compensation for purposes of the tax deduction.”

Although the IRS guidance was issued as a fact sheet and does not carry the legal authority of regulations or official notices published in the Internal Revenue Bulletin, it does provide helpful compliance information regarding the ‘no tax on overtime’ provision.

Payroll-identified FLSA overtime pay information

The IRS guidance makes clear that certain employees, including those covered by a collective bargaining agreement, who receive overtime pay in excess of the FLSA-required amounts are eligible for the overtime deduction. However, it puts the onus on employers to calculate both amounts, noting that “the employer must evaluate the payments in accordance with the FLSA’s principles at 29 U.S.C. §207, particularly subsections (e) and (h), to determine the amount required under the FLSA.” This sets up a dual-tracking requirement for employers. Not only must employers track what is due under the collective bargaining agreement; they must also figure the FLSA-required overtime amount. This is similar to employers with employees in states that require overtime pay that exceeds FLSA requirements, such as California’s single-day overtime pay rules.

The IRS guidance provides a helpful example of the dual calculation. In the IRS’s example, an employee works 50 hours during a workweek at an hourly rate of $20. The employer pays overtime at two times the employee’s regular rate of pay, which means the employee is paid $400 for overtime hours worked ($20 per hour x 10 overtime hours = $200 in straight-time compensation, plus $20 per hour premium x 10 overtime hours = $200 in overtime compensation). However, the FLSA-required overtime would be $300 for the 10 overtime hours ($20 per hour x 10 overtime hours = $200 in straight-time compensation, plus $10 per-hour overtime premium x 10 overtime hours = $100 in overtime compensation). The overtime amount eligible for the deduction is limited to the overtime premium, so the qualified overtime compensation is only $100 (the “half” amount in the required 1.5 times the regular rate of pay).

Reporting the FLSA-required overtime pay

Beginning with 2026, employers must report qualified overtime compensation on Form W-2, Wage and Tax Statement, in Box 12 with Code TT. If an employee believes the number reported on their Form W-2 is incorrect, they must request that their employer issue a Form W-2c, Corrected Wage and Tax Statement. The employee may not claim a deduction greater than what is reported on the Form W-2 or W-2c. Employers may be subject to penalties under §6721 and §6722 for failing to timely file or furnish correct information returns if the amount reported on the Form W-2 is incorrect.

For employees with a standard hourly rate, the calculation of qualified overtime is relatively straightforward. For employees with different hourly rates or who receive additional compensation (e.g., a production bonus), determining the regular rate of pay for the FLSA-mandated overtime amount can quickly become complicated.

OBBBA for employees and employers

Employees should review their information each pay period for accuracy and immediately inform their employer’s payroll department if they see errors. This will help to avoid the need for a Form W-2c and ensure that employees are paid accurately and on time.

The overtime deduction provision has received a high level of public attention. Through the most recent IRS guidance, many of the administrative questions concerning the tax deduction, including whether employees working under a collective bargaining agreement are eligible, have been answered. This also has crystallized the need for payroll departments to make sure they are tracking the data necessary to correctly report the qualified overtime pay on Form W-2.

Tax practitioners can help their clients by reviewing employer-provided Forms W-2 to make sure that the information accurately distinguishes between wages paid to employees each pay period and those wages subject to the FLSA-required overtime amount.

Further information

Fact Sheet 2026-13 provides information through 32 questions and answers, many with concrete examples, on the deduction for qualified overtime compensation and can be found on the IRS’s website. In addition, PayrollOrg has a "Hot Topics" web page dedicated to OBBBA that provides information on many of the payroll-related provisions in the OBBBA.

About PayrollOrg

PayrollOrg is a nonprofit and nonpartisan association representing more than 20,000 payroll professionals throughout the United States. PayrollOrg’s primary mission is to educate its members and the payroll industry regarding best practices associated with paying America's workers while complying with applicable federal, state, and local laws. PayrollOrg’s Government Relations Task Force works in partnership with government and other organizations, like the National Association of Tax Professionals, to help payroll professionals with complex compliance requirements, while minimizing the administrative burden on government, employers, and individual workers.