The IRS has released new guidance in the form of frequently asked questions (FAQs) to help eligible taxpayers claim the overtime compensation deduction.
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The IRS has released new guidance in the form of frequently asked questions (FAQs) to help eligible taxpayers claim the overtime compensation deduction. The guidance explains how the new deduction for qualified overtime compensation works, who may be eligible, and how it will be reported—at least for now.
(And remember: as with tips, this is a deduction, not an exclusion. That’s important for reporting purposes.)
Here’s what you need to know.
What Is Qualified Overtime Compensation?
The new deduction applies only to qualified overtime compensation. According to the IRS, qualified overtime compensation is the portion of overtime pay that is required under Section 7 of the Fair Labor Standards Act (FLSA) and that exceeds an employee’s regular rate of pay.
In practical terms, if a taxpayer is paid “one and one-half times” their regular rate for an hour of overtime work, the “half” portion of that payment—the amount above the regular rate—is treated as qualified overtime compensation.
If you are paid overtime under state or local law, or for another reason, but are not FLSA overtime-eligible, that pay does not qualify—no matter the circumstances.
What Do You Mean By “Exceeds An Employee’s Regular Rate Of Pay”?
You can’t deduct the entire overtime payment. The deductible amount is the portion that exceeds your regular rate of pay by law—the “half” portion of time-and-a-half compensation.
The IRS clarifies that while the additional half required by the FLSA may qualify, payments in excess of the FLSA-required premium do not. That means only the half is deductible, even if your overtime rate is two or three (or more) times your normal rate.
Who Is Eligible?
Whether you’re eligible to claim the deduction depends on you are FLSA overtime-eligible. Eligibility is facts and circumstances specific and depends on factors such as your occupation, job duties, and earnings. The Department of Labor (DOL) has some resources explaining FLSA coverage and exemptions.
Most employees in the United States are covered by the FLSA, but not everyone is. You’re typically covered if you work for a business engaged in interstate commerce, work for hospitals, schools, government agencies, or large employers, or are hourly or non-supervisory workers. Examples may include retail workers, warehouse employees, factory workers, construction workers, and most clerical and administrative staff. Many federal and state government employees are also covered.
Some workers fall outside of the FLSA, regardless of job duties. These may include independent contractors, certain agricultural workers, some seasonal or recreational workers, some small-farm employees, and certain family businesses employing immediate family members. If you’re not covered by the FLSA, you can’t receive qualified overtime compensation for purposes of the deduction—even if you’re paid extra for long hours.
To qualify under the rules, you have to be both covered by the FLSA and not exempt from the overtime requirement.
Wait, How Could Someone Be Covered By The FLSA But Exempt From Overtime?
This is where things can get tricky. Many employees are covered by the FLSA but are exempt from its overtime requirements.
Common overtime-exempt categories—often referred to as the “white-collar” exemptions—include executive employees (such as retail store managers), administrative employees (such as HR managers or compliance officers), professional employees (such as, sadly, attorneys and certified public accountants), certain computer employees (such as salaried software developers), and outside sales employees (such as pharmaceutical sales representatives who work primarily away from an employer’s place of business).
If you fall into one of these exempt categories, you do not receive FLSA-required overtime, even if you work more than 40 hours. That means there’s no qualified overtime compensation for the deduction.
If you’re not sure about whether you’re exempt, you can take a peek at the DOL website, or ask your HR or payroll department to confirm your status.
What About Federal Employees?
For most federal employees, FLSA eligibility is documented on Standard Form 50, Notification of Personnel Action. Block 35 of the form lists the employee’s FLSA category with “N” indicating nonexempt, meaning the employee is overtime-eligible, while “E” indicates exempt.
The Office of Personnel Management administers the FLSA for most federal employees, though there are exceptions. DOL regulations apply to employees of the Library of Congress, the United States Postal Service, the Postal Regulatory Commission, and the Tennessee Valley Authority. Legislative branch employees are generally covered by rules issued by the Office of Congressional Workplace Rights.
Let’s Assume I Qualify. How Much Is The Deduction?
The deduction for qualified overtime compensation is capped at $12,500 per return, or $25,000 for married taxpayers filing jointly.
The deduction is also subject to income limits. It begins to phase out when your modified adjusted gross income (MAGI) exceeds $150,000 for single filers or $300,000 for joint filers.
Are There Any Other Special Rules?
Yes. To claim the deduction, you must have a Social Security number valid for employment and include that number on the tax return. Married taxpayers must file a joint return to claim the deduction—the deduction is not available to those who file as married filing separately. If both you and your spouse received qualified overtime compensation, you both must have valid Social Security numbers for employment and you must include those numbers on your return.
Can I Also Deduct My Tips?
Only if they are qualified tips and you meet the applicable requirements. But there’s no double-dipping: qualified overtime compensation does not include qualified tips.
How Will Overtime Be Reported On My Tax Return In 2025?
The deduction for qualified overtime compensation is calculated on a new Schedule 1-A at Part II. The actual amount of your deduction (after adjustments) appears on line 13, and is tallied together with deductions for tips, car interest, and the enhanced deduction for seniors, resulting in the sum on line 38. That total is then carried over to Form 1040, line 13b. Easy, right?
Remember, your overtime pay is still reported as income (this isn’t an exclusion), but claimed as an additional deduction. You don’t need to itemize your deductions to claim it (though you may).
How Will Overtime Be Reported By My Employer In 2025?
For tax year 2025, employers and other payers are not required to separately report qualified overtime compensation on Forms W-2, 1099-NEC, or 1099-MISC. Some employers may choose to report the amount voluntarily—such as in Box 14 of Form W-2 or through an online portal—but many will not.
As a result, taxpayers will need to use reasonable methods, such as pay stubs and employer-provided documentation, to determine the overtime portion. That may mean doing a bit of math.
(The guidance to help employers and other payers navigate reporting requirements for qualified overtime compensation under OBBBA can be found here.)
How Will Overtime Be Reported By My Employer In 2026?
Beginning in tax year 2026, employers and other payers will be required to separately report qualified overtime compensation. The IRS says Forms W-2, 1099-NEC, and 1099-MISC will be updated to allow for separate reporting.
How Long Will The Deduction Be Available?
The overtime deduction applies to the tax years 2025 through 2028.
Where Can I Find The Guidance?
You can find the FAQs about the deduction for qualified overtime compensation in Fact Sheet 2026-01.
Treasury and IRS also issued Notice 2025-62, providing penalty relief to employers and other payers for tax year 2025 regarding new information reporting requirements, and Notice 2025-69 for workers eligible to claim the deduction for tax year 2025.
Can I Rely On This Guidance?
Sort of. Guidance found on the IRS website—including FAQs and fact sheets—is not treated as binding legal authority. Because this guidance is not published in the Internal Revenue Bulletin (IRB), it cannot be relied on as precedent or used to support a legal argument in court. Only guidance published in the IRB has precedential value.
That said, the IRS notes that taxpayers who reasonably and in good faith rely on these FAQs generally will not be subject to penalties that provide a reasonable-cause standard for relief, including negligence or other accuracy-related penalties, to the extent that reliance results in an underpayment of tax.
What’s Next For Taxpayers?
The easiest way to make sure you have the information you need? Check back with Forbes. To keep it simple, I recommend subscribing to our free tax newsletter, so the information you need arrives directly in your inbox each Saturday morning.
Source: https://www.forbes.com/sites/kellyphillipserb/2026/01/23/irs-offers-more-info-on-how-the-new-overtime-deduction-works/
