IRS updates guidance on overtime deduction

The Internal Revenue Service has updated the questions and answers in its fact sheet on the new overtime deduction under the One Big Beautiful Bill Act, also known as the Working Families Tax Cuts.

The changes include deleting information that was only applicable to tax year 2025. The revised fact sheet, which was updated earlier this month, also clarifies the limits and timing of the qualified overtime compensation deduction and provides more information on coverage and exemptions under the Fair Labor Standards Act.

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It also provides detailed information on the Form W-2, Form 1099-MISC, and Form 1099-NEC requirements applicable to employers and payors of qualified overtime compensation. In addition, it adds information on federal income tax withholding procedures related to qualified overtime compensation. 

The revisions also add information on the requirement that qualified overtime compensation must be separately reported on Form W-2 in order to claim the deduction. The revised fact sheet also provides more detailed information on issues applicable to federal employees. There are other updates as well,  including the addition of an index, the renumbering of certain FAQs, as well as various clarifying revisions to most questions.

The overtime deduction is for up to $12,500 of qualified overtime compensation earned for the year per individual tax return (or $25,000 for joint returns). The deduction is reduced if a taxpayer's modified adjusted gross income for the tax year exceeds $150,000 ($300,000 for joint filers). 

Starting in tax year 2026, payors and employers are required to separately report qualified overtime compensation on Form 1099-MISC (box 14), Form 1099-NEC (box 1d), or, more commonly, Form W-2 (box 12, code TT). 

The IRS noted that overtime compensation (including qualified overtime compensation) is subject to federal income tax withholding. That means an employer can't reduce withholding on wages to account for the qualified overtime deduction unless the employee furnishes the employer an updated and valid Form W-4 accounting for the employee's expected deduction for qualified overtime compensation. 

Employers have to report the amount of qualified overtime compensation paid to an employee beginning in 2026, on Form W-2 in box 12, using code TT. 

Qualified overtime compensation is the amount of overtime compensation in excess of the employee's regular rate. That means the amount that should be reported on Form W-2, box 12, code TT is the total qualified overtime compensation paid, which, due to other limitations, cannot be the amount ultimately deductible by the employee.

If an employer discovers an error on Form W-2, box 12, code TT, the employer must file Form W-2c, Corrected Wage and Tax Statements (Corrected Wage and Tax Statement) with the Social Security Administration and furnish Form W-2c to the employee as soon as possible. An employer that files or furnishes an incorrect Form W-2 may be subject to information reporting penalties under section 6721 or 6722, including reduced penalties for timely corrections.

Generally, qualified overtime compensation is determined each workweek, the IRS noted. In keeping with the guidance provided earlier  for tax year 2025, for most employees, qualified overtime compensation paid to an FLSA overtime-eligible employee for the workweek can determined this way:

Number of FLSA hours worked in excess of 40 hours in a workweek x 
One-half x
Employee's FLSA regular rate of pay  = 
Qualified overtime compensation for workweek

For an employer relying on certain creditable overtime premiums to meet the FLSA overtime requirement, the IRS noted, this formula equals the amount of the portion of the overtime premiums credited (and only that portion) plus any additional FLSA overtime premium paid.