09.10.2026

Key Takeaways for Employers

• Only FLSA-required overtime qualifies for the federal income tax deduction. The deduction generally applies only to the additional “half” of time-and-a-half overtime required by the FLSA and excludes overtime or premium pay required solely by state law, contract, or employer policy. 
• Continue normal tax withholding, rather than adjusting for anticipated overtime deductions. Qualified overtime remains subject to federal income tax withholding, Social Security, and Medicare taxes. Employers should not automatically reduce the withholding because an employee may qualify for the deduction. 
• Prepare for new 2026 reporting requirements. Employers must separately report qualified overtime compensation on Form W-2 using Box 12, Code TT and qualified tips using Code TP. 
• Review payroll systems now. Employers should ensure their systems can accurately identify and separately track FLSA-qualified overtime and coordinate with payroll providers on the new reporting requirements. 

On Aug. 6, 2026, the Internal Revenue Service issued updated Frequently Asked Questions concerning the new federal income tax deduction for qualified overtime compensation under the One, Big, Beautiful Bill Act.

This deduction is only available for tax years 2025 through 2028.

The FAQs supersede the previously released FAQs and provide important clarification concerning what qualifies for the deduction and employers’ payroll and reporting obligations.

‘No Tax on Overtime’ Does Not Mean Overtime Is Tax-Free

For tax years 2025 through 2028, eligible employees may claim a federal income tax deduction for “qualified overtime compensation.”

This deduction applies only to the portion of overtime compensation required under the Fair Labor Standards Act that exceeds the employee’s regular rate of pay—that is, the “half” portion of the “time and one half” amount they receive as overtime pay. 

The FAQs underscore that overtime pay that is not required under the federal FLSA is not eligible for deduction.

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Source: CBIA

https://www.cbia.com/news/hr-safety/irs-new-guidance-qualified-overtime-compensation-deductions/