IRS Guidance Clarifies Overtime Deduction Limits and W-2 Reporting Rules
The Internal Revenue Service published updated frequently asked questions regarding the federal income tax deduction for qualified overtime compensation enacted under Public Law 119-21, also known as the OBBBA. Superseding preliminary guidance released in January, the updated directives outline reporting requirements for employers and eligibility constraints for taxpayers. The agency emphasized that overtime pay remains part of gross income and remains subject to standard federal income tax withholding, Social Security, and unemployment taxes, rather than being fully tax-exempt at the payroll level.
For tax years beginning in 2026, employees may only claim the deduction if their qualified overtime pay is explicitly reported on Form W-2, Box 12, using Code TT. If an employer understates or omits this amount, the employee cannot use Form 4852 (Substitute for Form W-2) to claim a higher deduction; instead, the taxpayer must obtain a corrected Form W-2c from the employer before filing. The deduction applies exclusively to the premium portion of overtime required under the Fair Labor Standards Act—meaning the portion that exceeds the worker's regular hourly rate. Subject to statutory caps, eligible individuals can deduct up to $12,500 annually, or up to $25,000 on a joint return, with phaseouts beginning at modified adjusted gross income levels of $150,000 for single filers and $300,000 for joint filers.
Employers face specific new administrative directives starting in 2026, requiring them to calculate and report the full amount of qualified FLSA overtime paid in Box 12 under Code TT. Businesses must report the total qualified overtime paid regardless of whether an individual employee will eventually be capped by the annual dollar limits or income phaseouts. The IRS noted that employers cannot automatically reduce federal tax withholding on overtime wages in anticipation of the employee's deduction. However, employees who expect to lower their annual tax liability through the deduction may adjust their tax withholding by submitting a revised Form W-4.
The updated guidance clarifies FLSA coverage rules to help workers and payroll departments determine who qualifies for the tax benefit. Certain worker categories exempt from FLSA overtime rules—including specific executive, administrative, professional, computer, outside sales, agricultural, seasonal, and transportation personnel—are ineligible for the deduction. Additionally, the IRS specified that employee-owners holding a bona fide equity stake of 20 percent or more who actively manage the business are treated as FLSA-exempt and cannot claim the deduction. The agency also detailed calculation methods for regular rates, workweeks, alternative computation models, and public-sector compensatory time arrangements.
Source: Journal of Accountancy
