IRS updates overtime deduction FAQs, adds reporting details

The IRS on Thursday updated its frequently asked questions (FAQs) on the deduction for qualified overtime compensation, adding extensive guidance for employers and employees and emphasizing that workers generally cannot claim the deduction for overtime amounts that are not separately reported on Form W-2, Wage and Tax Statement.

The revised guidance also addresses what the deduction does not do. “The deduction for qualified overtime compensation does not mean that overtime compensation is excluded or exempt from gross income,” the IRS said.

The updated FAQs supersede guidance issued in January and add information on reporting requirements, withholding, overtime calculations, federal employees, and the circumstances under which workers may claim the deduction created by H.R. 1, P.L. 119-21, commonly referred to as OBBBA.

The deduction is available for certain overtime compensation required under the Fair Labor Standards Act (FLSA). As the IRS explained in FAQs issued in January, the deduction generally applies only to the portion of overtime pay that exceeds an employee’s regular rate of pay, rather than the employee’s entire overtime payment.

Among the most significant additions are new FAQs stating that, beginning in tax year 2026, employees generally may claim the deduction only for qualified overtime compensation reported on Form W-2, box 12, code TT.

If an employer understates the amount of qualified overtime compensation reported on Form W-2, the employee must obtain a corrected Form W-2, Form W-2c, Corrected Wage and Tax Statement, before claiming a larger deduction, the IRS said. The agency also said workers may not use Form 4852, Substitute for Form W-2, to claim additional deductible overtime compensation that was not reported on Form W-2.

The IRS added that overtime compensation generally remains subject to income tax withholding and employment taxes, including Social Security and federal unemployment taxes. Eligible taxpayers instead may claim a deduction on their returns, subject to statutory limits and income-based phaseouts.

Eligible taxpayers may deduct up to $12,500 of qualified overtime compensation annually, or up to $25,000 on a joint return. The deduction begins to phase out when modified adjusted gross income exceeds $150,000 for single filers or $300,000 for joint filers.

Reporting and withholding guidance

The updated FAQs add extensive guidance for employers on reporting qualified overtime compensation.

The IRS said employers must separately report qualified overtime compensation on Form W-2, box 12, code TT, beginning in 2026. The amount reported is the full amount of qualified overtime compensation paid, even if the employee ultimately cannot deduct all of it because of deduction limits or income-based phaseouts.

The agency also added guidance on correcting reporting errors. Employers that discover an error in the amount reported as qualified overtime compensation must file Form W-2c and furnish the corrected form to the employee.

In addition, the FAQs address withholding requirements. The IRS said employers must continue withholding federal income tax from overtime wages and may not automatically reduce withholding because an employee expects to qualify for the deduction.

Employees who want withholding adjusted to account for the deduction may submit an updated Form W-4, Employee’s Withholding Certificate, according to the guidance.

More detail on eligibility

The IRS expanded its discussion of which workers may be eligible for the deduction by adding information on FLSA coverage and overtime exemptions.

The FAQs list several categories of workers who may be exempt from the FLSA’s overtime requirements, including certain executive, administrative, professional, outside sales, computer, agricultural, transportation, and seasonal employees.

A new FAQ also addresses employee-owners, stating that an employee who owns at least a bona fide 20% equity interest in a business and is actively engaged in managing it generally is exempt from the FLSA’s overtime requirements and therefore is not eligible for the deduction.

The agency also detailed how employers should calculate qualified overtime compensation, including guidance on workweeks, hours worked, regular-rate calculations, alternative overtime computation methods, and compensatory time arrangements available to some state and local government employees.

Expanded federal employee section

Another addition is a series of FAQs directed at federal employees.

The revised guidance includes information on determining FLSA overtime eligibility, compensatory time, work periods, hours worked, and regular-rate calculations under Office of Personnel Management (OPM) regulations.

The IRS said the updated FAQs were coordinated with the Department of Labor and OPM.

The revisions removed information that applied only to tax year 2025 and added clarifications on reporting requirements, deduction limits, withholding procedures, and federal employee issues, the IRS said.

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.