The IRS Updated Its Overtime Deduction FAQ Again: New Answers to Questions That Are Tripping Workers Up

On August 6, 2026, the IRS released Fact Sheet FS-2026-13, a substantial rewrite of its earlier guidance on the deduction for qualified overtime compensation, commonly called “No Tax on Overtime.” If you worked overtime last year or this year and you are not sure whether your extra pay qualifies, the updated FAQs answer questions that have been tripping workers up since this deduction first took effect in 2025. Read them now, before tax season, so you have time to gather the records the IRS says you need.

What the Deduction Is and How Long It Lasts

The One Big Beautiful Bill Act (OBBBA) added a new deduction for qualified overtime compensation, which is limited to Fair Labor Standards Act (FLSA)-required overtime. The change is retroactive to January 1, 2025, and applies to qualified overtime hours worked through December 31, 2028.

The deduction is up to $12,500 of qualified overtime compensation earned for the year per individual tax return, or $25,000 in the case of a joint return. The deduction is reduced if your modified adjusted gross income (MAGI) for the tax year exceeds $150,000 ($300,000 for joint filers).

One thing many workers miss: the deduction for qualified overtime compensation does not mean that overtime compensation is excluded or exempt from gross income. Generally, overtime compensation is not excluded or exempted from wages for purposes of employment taxes, including income tax withholding, social security, and federal unemployment taxes. In other words, you still see overtime in your Box 1 wages. You claim the deduction separately, on the new Form 1040, Schedule 1-A.

The Biggest Question: Does Your Overtime Actually Qualify?

This is where most confusion starts, and where FS-2026-13 added the most new detail.

You must be FLSA non-exempt

Only overtime required under the FLSA can qualify. Employees exempt from the FLSA’s overtime requirements are ineligible for the deduction, regardless of whether they are eligible for or receive overtime-like payments under employer policy, state law, or collective bargaining agreements.

That last part matters. If your employer pays you extra for working more than 40 hours as a workplace policy, but your job title falls under an FLSA exemption such as executive, administrative, professional, outside sales, or certain computer-employee categories, that extra pay does not count. Overtime compensation not required by the FLSA is not eligible for the deduction.

Only the premium “half” qualifies, not your full overtime paycheck

The IRS confirms that qualified overtime compensation generally equals: (hours worked in excess of 40 during an FLSA workweek) multiplied by one-half, multiplied by the employee’s FLSA regular rate of pay. The guidance stresses that only the overtime premium portion qualifies. Thus, while an employee generally will receive time-and-one-half pay for overtime hours worked, only the additional one-half premium constitutes qualified overtime compensation.

In plain terms: if your regular rate is $20 an hour, your overtime rate is $30. Only the $10 difference counts toward the deduction, not the full $30.

Most independent contractors do not qualify

Under the Act, independent contractors are technically eligible to deduct qualified overtime, but because the Act limits qualified overtime to overtime required under Section 7 of the FLSA, which generally does not apply to independent contractors, the FAQs clarify that independent contractors would only receive qualified overtime if they are considered employees under the FLSA while being classified as an independent contractor under the Internal Revenue Code, a circumstance the FAQs note would be “rare.”

Most independent contractors, gig workers, and self-employed individuals won’t qualify. Working extra hours or charging a higher “overtime” rate doesn’t make independent-contractor income eligible for the deduction.

Business owners face an additional hurdle

The FAQs clarify that business owners who own at least 20% of their business and actively participate in its management generally are not eligible to deduct qualified overtime because they are treated as exempt executive employees under the FLSA. Individuals who own less than 20% of their business could be eligible for the overtime deduction, assuming they are not covered by a separate FLSA exemption.

The Reporting Rules Changed for 2026, and That Changes What You Need to Do

This is the most practically important shift in FS-2026-13, because it affects the records you need to collect right now.

For tax year 2025, employers were not required to break out qualified overtime separately on your W-2 or 1099. Notice 2025-69 clarified for workers how to determine the amount of their deduction without receiving a separate accounting from their employer for cash tips or qualified overtime on information returns such as Form W-2 or Form 1099, as those forms remained unchanged for the 2025 tax year. For 2025, you could use any of the methods described in Notice 2025-69 and the Instructions to Form 1040, Schedule 1-A to calculate the amount of qualified overtime compensation. Generally, this requires isolating all overtime payments made and dividing the total by three to determine the overtime premium.

For tax year 2026 and beyond, the rules tighten significantly. The IRS emphasizes that beginning in 2026, employees generally may claim the deduction only based on amounts separately reported by employers, increasing the importance of accurate overtime calculations and information reporting. Specifically, beginning in 2026, employers must separately report qualified overtime compensation on Form W-2 in Box 12 using Code TT.

If your employer makes a mistake, it matters too. FS-2026-13 adds a new FAQ addressing correction obligations. If an employer discovers an error in the amount reported in Box 12, Code TT, the employer must issue a Form W-2c and provide the corrected form to the affected employee as soon as possible. If you notice a discrepancy on your W-2, do not ignore it. Ask your employer to issue a corrected form before you file.

What About Withholding? Your Paycheck Will Not Change Automatically

A common question workers have is whether their employer should automatically reduce withholding to reflect the deduction. FS-2026-13 addresses this directly. The IRS answer is no. The deduction does not change how your employer withholds taxes from each paycheck. Overtime pay remains subject to federal income tax withholding, and your employer may not reduce withholding for the deduction unless you file an updated Form W-4. The 2026 Form W-4 lets you account for it in Step 4(b).

If you want less withheld from each check to reflect the deduction you expect to claim, submit an updated Form W-4 to your employer. Otherwise, you will simply receive any resulting refund when you file your return.

Records You Should Be Keeping Right Now

Whether you are still filing your 2025 return or planning ahead for 2026, the records below are what you will need to support the deduction. The IRS has not been vague about this, and FS-2026-13 reinforces it.

• Pay stubs showing hours worked per week. The deduction only applies to hours over 40 in a given workweek. Stubs that show daily or weekly hours are more useful than monthly summaries.
• Overtime rates and regular rates, both. Because only the premium half qualifies, you need enough detail to separate those amounts. If your paystub does not break them out, ask your payroll department for a earnings detail report.
• Your Form W-2 for 2025 and 2026. For 2025 only, check whether your employer voluntarily noted qualified overtime in Box 14. For 2026 and later, look for Box 12, Code TT. If the amount is missing or wrong, request a corrected W-2 before filing.
• Documentation of your FLSA status. If there is any question about whether your position is non-exempt, check your offer letter, your employee handbook, or ask HR in writing. A job title alone does not determine eligibility.
• For 2025 filers still working through their return: Keep copies of any earnings statements, payroll reports, or schedules you used to calculate the premium portion of your overtime under Notice 2025-69. The IRS may ask how you arrived at the number.

If You Are Behind on Filing or Owe the IRS, This Deduction Still Applies to You

If you have unfiled returns going back to 2025, the qualified overtime deduction may reduce what you owe, or increase a refund that offsets a balance due. Getting back into compliance and making sure every available deduction is applied correctly can make a real difference in your total tax liability, depending on your circumstances.

The IRS has collection tools including liens, levies, and wage garnishments that it uses against taxpayers who fall behind. If you are in that situation, or close to it, there may be resolution options available to you. At Clear Start Tax, we work directly with individuals and businesses to evaluate their IRS and state tax situations and help them understand what paths forward may be available. Contact us for a free consultation to find out where you stand.