IRS offers guidance on overtime deduction ahead of tax season

The Internal Revenue Service and the Treasury Department released a set of questions and answers on the new deduction for overtime pay under the One Big Beautiful Bill Act only a few days before the start of tax season.

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The FAQs in Fact Sheet 2026-01 noted that for tax years 2025 through 2028, individuals who receive qualified overtime compensation can deduct the amount that exceeds their regular rate of pay (generally, the “half” portion of “time-and-a-half” compensation) and is reported on a Form W-2 or Form 1099.

The FAQs include more information about the deduction, provide resources for employees (including federal employees) to assist them in determining whether they received qualified overtime compensation under the Fair Labor Standards Act, and contain useful information regarding the differences in reporting requirements for tax year 2025 and 2026-2028.

The IRS and the Treasury have already offered some previous guidance on the overtime deduction, including penalty relief for reporting overtime pay as well as tips, for which there’s also a new deduction in the OBBBA, and there are various options available for reporting tips and overtime pay on the new Schedule 1-A, which also includes fields for the new deduction for senior and car loan interest. The IRS and the Treasury previously issued Notice 2025-62 offering penalty relief to employers and other payers for tax year 2025 on the new information reporting requirements for qualified overtime compensation. They also issued Notice 2025-69 for workers eligible to claim the deduction for overtime compensation for tax year 2025.  

The questions in the new FAQ page include answers on what is considered to be qualified overtime compensation for purposes of the deduction. The IRS noted that qualified overtime compensation is overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act that exceeds the regular rate at which the individual is employed. “For example, if an individual is paid at ‘one and one-half times’ their regular rate for an hour of overtime work as required by the FLSA, the ‘half’ portion of the ‘one and one-half times’ paid for an hour of overtime work is qualified overtime compensation.”

Another question asks how to determine whether a taxpayer is covered by and not exempt from the FLSA, in other words, how do they determine if they are an FLSA overtime-eligible employee? The FAQ page pointed out that while it is common for employees working in the U.S. to be covered by the FLSA, there are many exemptions from its overtime premium requirement. “Whether an individual is covered by and not exempt under the FLSA is a fact-specific determination that depends on the individual’s occupation, work activities, and/or earnings,” said the fact sheet.

The FLSA rules figure prominently in discussions of the new overtime deduction. “Those FLSA rules apply, and that’s what’s going to be applied in determining what the deductions are,” Dan Lewis, vice president of government affairs at the payroll giant ADP, recently told Accounting Today. “The challenge is going to be that very few employers pay strictly based on FLSA standards. Employers often provide more generous benefits, whether it’s counting PTO toward your 40 hours of work in a week, whether it’s saying you’re going to get overtime because you work on a holiday, whether it’s saying you’re going to get overtime at a rate of two times the regular rate of pay. The challenge will be making sure that what the employees are claiming for deductions is what they’re qualified to claim under FLSA, which is going to be a dual accounting of here’s your aggregate overtime of everything you got and here’s your accounting of overtime for purposes of taking your deduction. There’s also different rules at the state level. California is a great example of that. In California, the standard for overtime is two times the regular rate of pay, and employees are qualified for overtime if they work more than eight hours a day.”

There may be ways to simplify those determinations. “How do I figure out what the overtime is? The easiest takeaway is to look for those hours over 40 as defined under the Fair Labor Standards Act,” said Tom O’Saben, director of tax content and government relations at the National Association of Tax Professionals, during a recent Accounting Today webinar. “Don’t get so hung up in what a state law might be or what a different company may offer, such as differential pay or maybe triple pay on a Sunday, but what really is determined as overtime from tje standpoint of the federal Fair Labor Standards Act?”