Qualified overtime deduction basics for tax pros

Updated Aug. 6, 2026: The IRS issued FS-2026-13, which supersedes FS-2026-01 and adds guidance on 2026 reporting, withholding, corrected information returns and other filing-season issues.

The IRS has released updated guidance on the new deduction for qualified overtime compensation through Fact Sheet FS-2026-13. 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.

For a closer look at the updated reporting and correction rules that could affect the 2027 filing season, see IRS overtime FAQs show where 2027 filing season could stall.

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.

2026 reporting rules

For tax year 2025 only, employers and payers were not required to separately report qualified overtime compensation on Forms W-2 or 1099, so taxpayers or preparers may have needed to calculate the deductible amount using payroll records, employer summaries or other documentation.

Beginning with tax year 2026, employers must separately report qualified overtime compensation on Form W-2, Box 12, using Code TT. Certain payers may report qualified overtime compensation on Form 1099-MISC, Box 14, or Form 1099-NEC, Box 1d. The employer or payer reports the full amount of qualified overtime compensation, while the deduction limits and MAGI phaseout are applied when the individual return is prepared.

Preparers should verify overtime hours, pay rates and FLSA eligibility before claiming the deduction.

Penalty relief for reasonable reliance

IRS FAQs are not published in the Internal Revenue Bulletin and generally cannot be relied on as legal authority. However, reasonable, good-faith reliance may support relief from certain penalties. Learn more in Can tax pros rely on IRS notices and guidance?

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.
• Beginning with 2026 information returns, qualified overtime compensation is separately reported on applicable Forms W-2 and 1099.
• 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.