The IRS has released updated guidance on the new deduction for qualified overtime compensation, commonly referred to as “No Tax on Overtime.” The August 2026 guidance provides important clarification for both employees who may qualify for the deduction and employers responsible for tracking and reporting eligible overtime.
The deduction was created under the One, Big, Beautiful Bill Act and applies to certain overtime compensation required under the Fair Labor Standards Act (FLSA).
What Qualifies as “No Tax on Overtime”?
Despite its commonly used name, the provision does not make all overtime pay tax-free.
The deduction generally applies only to the portion of overtime compensation that exceeds an employee’s regular rate and is required under the FLSA. For an employee receiving the standard time-and-a-half overtime rate, this generally means the additional “half” portion of the overtime rate—not the employee’s entire overtime wages.
For example, if an employee’s regular rate is $20 per hour and the employee receives $30 per hour for FLSA-required overtime, the $10-per-hour overtime premium may qualify for the deduction.
Overtime paid solely because of an employer policy, state law, collective bargaining agreement or other arrangement does not necessarily qualify. If an employer pays more than the amount required under the FLSA, only the amount necessary to satisfy the FLSA overtime requirement is treated as qualified overtime compensation.
How Much Can Employees Deduct?
The deduction is limited to:
- $12,500 per individual tax return
- $25,000 for married couples filing jointly
The deduction begins to phase out when modified adjusted gross income exceeds $150,000 for an individual or $300,000 for joint filers.
Employees do not need to itemize deductions to claim the qualified overtime deduction.
Importantly, overtime compensation remains part of an employee’s gross income and generally remains subject to federal income tax withholding, Social Security and other applicable employment taxes.
New 2026 Reporting Requirements for Employers
Beginning with tax year 2026, employers must separately report qualified overtime compensation on employees’ Forms W-2.
Qualified overtime compensation must be reported in Box 12 using code TT. Employers must report the full amount of qualified overtime compensation paid during the year, even when that amount exceeds the employee’s maximum allowable deduction.
For example, if an employer pays an employee $20,000 of qualified overtime compensation during 2026, the employer reports the full $20,000 on Form W-2. The employee will apply the applicable deduction limits when preparing their individual income tax return.
This makes accurate payroll tracking particularly important during 2026.
Employees Will Need Accurate W-2 Reporting
The IRS guidance also makes the employer reporting requirement especially significant for employees.
For tax years after 2025, employees generally may claim only qualified overtime compensation that is separately reported on Form W-2, Box 12, code TT. If an employer omits or understates qualified overtime compensation, the employee must request a corrected Form W-2c from the employer.
If the employer does not provide the corrected Form W-2c, the employee cannot use the omitted amount when calculating the deduction—even if the employee actually received the qualifying overtime compensation.
Employers that discover an error in the qualified overtime amount reported on an employee’s Form W-2 are required to file Form W-2c and provide the corrected form to the employee.
Can Employees Adjust Their Withholding?
Qualified overtime compensation remains subject to federal income tax withholding when it is paid. Employers should not automatically reduce an employee’s withholding because the employee may qualify for the deduction.
However, employees who expect to claim the deduction may choose to submit a new Form W-4. The 2026 Form W-4 allows employees to account for an expected qualified overtime deduction in Step 4(b).
What Employers Should Do Now
Employers should not wait until year-end to consider these requirements. Payroll and accounting teams should review how overtime is currently calculated and tracked and confirm that their payroll systems can identify qualified overtime compensation separately from other overtime pay.
In particular, employers should understand which employees are eligible for FLSA overtime, determine what portion of their overtime compensation qualifies under the new rules and prepare to report qualified amounts correctly on 2026 Forms W-2.
The IRS guidance includes additional rules and examples for employers with more complex overtime arrangements, including certain state and local government employees, employees receiving compensatory time and employees whose overtime is calculated under alternative FLSA provisions.
Have Questions About the New Overtime Deduction?
The qualified overtime deduction creates new considerations for both employers and employees, particularly as businesses prepare for 2026 year-end payroll reporting.
If you have questions about how the new rules may affect your business or your individual tax situation, contact your Hawkins Ash CPAs representative.
