Article | by Andrea Potter

The IRS recently released updated guidance on the federal deduction for qualified overtime compensation, commonly known as the “No Tax on Overtime” provision (IRS Fact Sheet 2026-13). The guidance supersedes prior FAQs and addresses limits and timing, coverage and exemptions, and how employers and payors must report eligible compensation beginning in 2026. The FAQs also address the treatment of qualified overtime under the 1099-MISC for certain limited scenarios.

While the deduction may provide meaningful tax savings for certain workers, the IRS has made clear that proper reporting will be essential beginning in 2026. With year-end approaching, now is the time for businesses and their advisors to evaluate whether this deduction applies to their workforce and whether payroll systems are ready for the new requirements.

What Is the Qualified Overtime Deduction?

The deduction is available to certain individuals who receive overtime pay required under the Fair Labor Standards Act (FLSA). Overtime compensation remains fully taxable income and is still subject to payroll taxes and federal income tax withholding. The provision simply allows qualifying taxpayers to claim an income tax deduction for a portion of eligible overtime compensation when filing their return. When determining eligibility, taxpayers and their advisors should refer to the definition of overtime compensation as defined under Section 7 of the Fair Labor Standards Act (29 U.S.C. Section 207), which establishes the federal overtime requirements that form the basis for the deduction.

For 2025 and future years covered by the legislation, eligible taxpayers may deduct up to:

• $12,500 for individual filers
• $25,000 for married taxpayers filing jointly

The deduction begins to phase out when modified adjusted gross income exceeds:

• $150,000 for single taxpayers
• $300,000 for married taxpayers filing jointly

Not All Overtime Pay Will Qualify

One of the most important clarifications in the IRS guidance is that only overtime compensation required under the FLSA qualifies for the deduction. Overtime pay provided voluntarily by an employer, required by state law, paid pursuant to a collective bargaining agreement, or paid at enhanced rates such as double time may not be fully deductible. In many cases, only the portion required under federal overtime rules qualifies.

Additionally, employees who are exempt from FLSA overtime requirements generally will not qualify. This includes many executive, administrative, professional, outside sales, and certain computer employees. Employee-owners with significant ownership interests may also be excluded.

Simply receiving overtime pay does not automatically mean an employee is eligible for the deduction.

The Biggest Change for 2026: New Form W-2 Reporting

The most significant compliance takeaway from the IRS guidance involves payroll reporting.

Beginning in tax year 2026, employers must separately report qualified overtime compensation on Form W-2 using Box 12, Code TT. The IRS also clarified that employees generally may only claim the deduction for amounts properly reported on their Form W-2. This creates a new compliance responsibility for employers and a new recordkeeping consideration for employees.

Businesses should use the remainder of the year to:

• Review payroll system capabilities
• Confirm overtime calculations align with FLSA requirements
• Work with payroll providers to ensure Box 12, Code TT reporting is properly configured
• Establish procedures for identifying and tracking qualified overtime compensation separately from other premium pay arrangements

Failure to accurately report qualified overtime compensation could require corrected Forms W-2 and expose employers to information return penalties ranging from $60 to $680 per statement. For employers and payors with large workforces, these penalties can accumulate into a significant liability if not addressed correctly and in a timely manner.

What Employers Should Be Doing Now

While much of the public conversation has focused on the tax benefit available to workers, employers face the greater near-term administrative burden. Before year-end, there are four key steps businesses should take:

Review Worker Classifications. The deduction applies only to employees who are eligible for FLSA overtime protections. Businesses should ensure exempt and nonexempt classifications are properly documented and supported.

Evaluate Payroll Processes. Payroll departments should determine whether current systems can separately identify and report qualified overtime compensation and distinguish it from other premium pay arrangements.

Train Human Resources and Payroll Staff. The IRS guidance introduces new terminology, reporting requirements, and correction procedures. Early training will help reduce year-end reporting issues.

Communicate with Employees. Many employees will hear about the “No Tax on Overtime” deduction and assume all overtime pay qualifies. Proactive communication now can manage expectations and reduce confusion during tax season. Employers can direct employees to the IRS Fact Sheet section “Topic F: Information for Employees” or recommend they consult with their personal tax advisor.

Looking Ahead

The IRS guidance provides welcome clarity, but it also confirms that this deduction is more complex than many initially expected. Eligibility depends on FLSA rules, income limitations, and, beginning in 2026, proper Form W-2 reporting. The window for employers to prepare is narrow, and the immediate priority should be payroll readiness, compliance procedures, and proactive employee communication before year-end.

Organizations that begin evaluating their reporting processes now will be far better positioned to avoid surprises when Forms W-2 are issued and employees begin claiming the deduction.

Businesses with questions about how these new rules may affect their workforce or payroll operations are encouraged to reach out to a Geffen Mesher advisor. We are glad to help.

About Geffen Mesher: Geffen Mesher is a Portland-based CPA and advisory firm with nearly a century of experience serving businesses, families, and investors across the Pacific Northwest. We provide ongoing financial strategy, accounting, and tax advisory services for businesses and individuals across a wide range of industries. Learn more at gmco.com.