By Charles Peery, CPA | Business Tax Practice Leader
Background
A new federal tax deduction could put meaningful dollars back in the pockets of workers who earn overtime. For tax years beginning after December 31, 2024, and before January 1, 2029, individuals (including employees and certain non-employees) may deduct up to $12,500 ($25,000 if married filing jointly) of “qualified overtime compensation” on their federal income tax returns. This deduction was created by section 225 of the Internal Revenue Code, as added by the One Big Beautiful Bill Act (OBBBA), and introduces new planning and reporting considerations for both taxpayers and employers.
What Counts as “Qualified Overtime Compensation”
- Qualified overtime compensation is only the overtime premium required under federal law (the Fair Labor Standards Act).
- This includes pay for hours worked over 40 in a workweek at time-and-a-half.
- Only the “extra half” portion of time-and-a-half pay is deductible.
- Overtime that goes beyond federal requirement, such as double time, overtime required solely by state law, or pay under a collective bargaining agreement, does not qualify.
- Overtime pay that is effectively a tip does not qualify for the deduction.
Deduction Limits and Income Phaseouts
- The maximum annual deduction is $12,500 per individual ($25,000 for married couples filing jointly).
- The deduction phases out as income increases:
- Reduced by $100 for every $1,000 of modified adjusted gross income (MAGI) above $150,000 ($300,000 for joint filers).
- MAGI includes certain foreign income exclusions added back to adjusted gross income.
Eligibility Requirements
To claim the deduction, taxpayers must include a valid Social Security number on their federal income tax return, and married individuals are required to file jointly in order to qualify.
New Employer Reporting Requirements (Effective 2026)
- Employers must separately report qualified overtime compensation on Form W-2, box 19.
- This information must be provided to employees and the IRS by January 31 of the following year.
- For non-employees, qualified overtime compensation must be reported on Form 1099-MISC or Form 1099-NEC, as applicable.
- Payroll and reporting systems should be updated now to capture this information accurately for 2026.
How the Deduction is Calculated
- Employees will generally use the amount reported in box 19 of Form W-2.
- If a separate total is not provided, employees may rely on pay stubs, payroll summaries, or other records to calculate the qualifying overtime premium.
- Non-employees should use earnings statements, invoices, or similar documentation to support the deduction.
Practical Steps for Employers
Employers should update payroll systems to separately track FLSA-mandated overtime premiums, communicate with employees about the new deduction and related reporting changes, and maintain detailed records of overtime hours, pay rates, and premiums paid. In addition, employers should prepare information return processes to ensure accurate W-2 and 1099 reporting for 2026 and consider whether employees may need to adjust withholding to reflect the anticipated deduction.
Practical Steps for Employees
Employees should regularly review their pay stubs to confirm overtime is properly calculated and classified, maintain copies of overtime pay records and any related employer communications, and verify that the amount reported in box 19 of Form W-2 matches their records.
Married taxpayers must file jointly to qualify for the deduction, and all taxpayers should monitor their income levels to understand how phaseout thresholds may affect eligibility.
Key Compliance Dates
- January 31, 2027 – Employers must furnish 2026 Forms W-2 and 1099s.
- April 15, 2027 – Deadline to file 2026 federal income tax returns and claim the deduction.
Summary
The new overtime deduction offers a significant tax benefit for eligible workers, but both employers and employees must ensure proper tracking, reporting, and substantiation of qualified overtime compensation. Employers should act now to update systems and procedures for 2026 compliance.
Contact your ATA representative today for more information.