Overtime Deduction: Reporting Obligations Employers Should Know

August 10, 2026

Recent IRS guidance on the overtime deduction does not make overtime pay itself tax-exempt. Overtime remains taxable income, but a separate income deduction is available for qualifying amounts. Social Security and Medicare taxes continue to apply as before. Taxpayers choosing the standard deduction can also claim the overtime deduction. It began with 2025 income, and employers’ separate reporting of qualified overtime is fully implemented beginning in 2026.

Deduction Limits and Income Thresholds

The annual limit is $12,500 per return or $25,000 for married filing jointly. The deduction phases out when modified adjusted gross income (MAGI) exceeds $150,000 for individuals or $300,000 for joint filers. The limit applies per return, not per worker. The actual deduction is calculated on the new Schedule 1-A, Part III.

Not All Overtime Pay Qualifies

A pay stub labeled “Overtime” does not make the entire amount deductible. Only the premium above regular pay required by the federal Fair Labor Standards Act (FLSA) for work exceeding 40 hours in a week qualifies. With ordinary time-and-a-half pay, this is only the additional half-time portion. For example, an employee earning $20 per hour who works 50 hours in a week receives a qualifying premium of $10 for each of the 10 overtime hours, totaling $100.

Overtime must be calculated separately for each consecutive 168-hour workweek; hours cannot be averaged across two or more weeks.

Occupations exempt from FLSA overtime, such as certain managers or professionals, generally do not qualify. Amounts beyond federal requirements, such as daily overtime under California law, are also generally excluded.

Separate W-2 Code TT Reporting Beginning in 2026

Starting in 2026, employers must separately report qualified overtime in Form W-2, Box 12, using Code TT. Depending on the circumstances, reporting may instead occur in Form 1099-MISC, Box 14, or Form 1099-NEC, Box 1d.

The temporary employer reporting relief for 2025 has ended, making accurate identification of qualified overtime important from 2026 onward. If a W-2 omits or understates it, request a corrected Form W-2c from the employer. Form 4852 cannot be used to independently add omitted qualified overtime for this deduction.

If the employer does not correct the W-2, the deduction is generally limited to the reported amount even if more qualified overtime was actually received. If the reported amount is too high, only the qualified amount actually received is deductible.

What Employees and Employers Should Check

Employees need a valid Social Security number authorizing employment; an ITIN alone is insufficient. The SSN must be issued by the filing deadline, including extensions.

Married taxpayers must file jointly to claim the deduction. If both spouses receive qualified overtime, both SSNs must be listed.

An employee owning at least 20% of the company and actively participating in management may qualify for the FLSA executive exemption and requires separate review. Such an employee may have no FLSA-required overtime eligible for the deduction. Employers should review payroll systems in advance because incorrect reporting of qualified overtime on W-2s can create information-return issues.

What to Prepare During the Rest of 2026

Employees should keep pay stubs showing overtime and compare them with the amount in W-2 Box 12, Code TT at year-end. Employers should confirm that their payroll provider or software separately identifies and totals regular overtime pay and the qualified overtime amount deductible for tax purposes.

The 2026 Form W-4 has also been revised so employees can adjust withholding for the overtime deduction. The employer should not reduce withholding on its own; the employee must submit a new W-4.

Restaurants, retailers, manufacturers, logistics businesses, and other industries with substantial overtime should review their payroll systems and qualified-overtime calculations now rather than waiting until year-end.

The key point is that overtime is not entirely tax-exempt. Employees should check the actual qualifying amount and W-2 Code TT, while employers must prepare payroll systems for the separate reporting requirement beginning in 2026.