Kaitlyn L. Mariano, CPA, Tax Partner, Dannible & McKee, LLP
The One Big Beautiful Bill Act, signed into law on July 4, 2025, introduced an individual deduction for qualified overtime compensation. Effective for tax years 2025 through 2028, individuals who receive qualified overtime compensation may deduct the portion of pay that exceeds their regular pay, such as the “half” portion of “time-and-a-half” compensation required by the Fair Labor Standards Act (FLSA) and reported on a Form W-2, Form 1099 or other specified statement.
The deduction has both an annual limitation based on the taxpayer’s filing status and a phaseout based on the taxpayer’s modified adjusted gross income. For 2025, employers were not required to separately report qualified overtime compensation. However, beginning in 2026, employers and other payers will be required to separately report qualified overtime compensation to all recipients.
Qualified Overtime Compensation Defined
Qualified overtime compensation is federally recognized as overtime compensation paid to an individual that exceeds their regular rate of pay (and must be at least time-and-a-half) for hours worked beyond 40 hours in a single workweek, as defined by the FLSA. Overtime pay that is not tied to the FLSA 40-hour rule, such as bonuses, daily overtime or contractual premiums, does not qualify for the new tax deduction. When an employee receives FLSA overtime compensation for hours worked over 40 hours per week, the deduction applies only to the premium (the extra half-time pay) portion above the regular hourly rate.
For example, Employee A’s standard hourly wage is $20, and A works 10 hours of overtime, computed at time-and-a-half. With the overtime rate calculated as $30 per hour ($20 x 1.5), the premium portion of A’s pay is $10 per hour. Since the overtime pay meets the definition of qualified overtime compensation, the overtime deduction available to A is $100 ($10 x 10 hours).
If an individual is eligible for overtime under the FLSA and the employer pays more than the required time-and-a-half rate, the qualified overtime compensation is limited to the portion of the overtime that is required. For example, Employee B’s standard hourly wage is $20, and B works 10 hours of overtime, calculated at $40 per hour (double-time). Since only time-and-a-half pay was required, the overtime premium qualifying for the deduction remains $100. The additional $100 received does not qualify.
Deduction Limits and Phaseouts
Beginning in 2025, the maximum deduction is $12,500 for single filers and $25,000 for joint filers. To qualify for the full deduction, the taxpayer’s modified adjusted gross income (MAGI) must be under $150,000 for single taxpayers or $300,000 for joint filers. The deduction is reduced by 10% for every $1,000 above the threshold and is fully phased out once MAGI reaches $275,000 for single taxpayers or $550,000 for those married filing jointly. The deduction is not available to married taxpayers who file separate tax returns. It is reported as an above-the-line deduction on the taxpayer’s personal income tax return and applies only to federal income taxes, while payroll taxes are unaffected.
Reporting Requirements and Best Practices for Employers
For 2025, the IRS provided penalty relief for employers who did not separately report qualified overtime pay on employee W-2 forms or other statements. Employers are encouraged to provide employees with a separate accounting of their qualified overtime compensation to assist them in calculating their deduction for 2025. Employees seeking guidance can also be directed to IRS Notice 2025-69, which provides several methods for calculating the amount of qualified overtime compensation.
Beginning in 2026, employers will be required to separately report qualified overtime compensation on Form W-2, Box 12, using code “TT.” The IRS will update Forms W-2, 1099-NEC, and 1099-MISC to assist employers and other payers in the separate reporting of an individual’s qualified overtime compensation. Employers are encouraged to work with their payroll providers to determine the best reporting practices so that payroll companies can properly furnish the necessary information going forward. Establishing accurate tracking procedures will be key to meeting the new reporting obligations.
If you have questions regarding the qualified overtime deduction discussed above and your business or personal income tax situation, we encourage you to contact us.
Kaitlyn L. Mariano, CPA, is a tax partner at Dannible & McKee, LLP, a public accounting firm with offices in Syracuse, Auburn, Binghamton and Schenectady, NY, and Tampa, FL. She has over 14 years of experience overseeing tax engagements for a variety of clients with a focus on construction, manufacturing and high-net-worth individuals. For more information on this topic, contact our firm at (315) 472-9127 or visit us online at www.dmcpas.com.