On August 6, 2026, the IRS updated frequently asked questions (FS-2026-13, FAQs) for employees and employers on how to calculate qualified overtime compensation for purposes of the deduction created by the One Big Beautiful Bill Act (OBBBA). The new FAQs, which supersede FS-2026-01, provide definitions, calculations and examples to help comply with the new rules.

Background

The OBBBA created IRC Section 225, which allows a federal income tax deduction for qualified overtime compensation of up to $12,500 ($25,000 for joint filers), which is reported on Form W-2 for tax years 2025 through 2028. Beginning in 2026, employees generally may claim the deduction only for qualified overtime compensation that is separately reported on Form W-2.

The deduction is available to itemizers and non-itemizers and begins to phase out for adjusted gross income over $150,000 ($300,000 joint). Married taxpayers must file jointly, and all taxpayers must include their SSNs to claim the deduction.

Qualified overtime compensation is defined as overtime that is required by Section 7 of the Fair Labor Standards Act of 1938 or FLSA (that is, federal overtime) and exceeds the regular rate (as defined in the FLSA) at which the individual is compensated. For example, if an employee is paid time-and-a-half for overtime hours, generally only the "half-time premium" portion constitutes qualified overtime compensation. Employees who are exempt from the FLSA's overtime requirements cannot claim the deduction.

The OBBBA did not include any guidance on how to report or deduct qualified overtime compensation. In August 2025, the IRS announced that it would not update 2025 individual information returns/statements (Forms W-2/1099) or withholding tables to reflect those changes (see Tax Alert 2025-1671). The IRS also released Draft Form W-2 for employers to report cash tips and overtime starting with calendar year 2026 (see Tax Alert 2025-1745). Notice 2025-69 then followed with guidance for employees on how to calculate these amounts for 2025 absent a separate accounting from their employer (see Tax Alert 2025-2395).

Employers

Starting in tax year 2026, payors and employers must separately report qualified overtime compensation on Form 1099-MISC (box 14), Form 1099-NEC (box 1d), or, more commonly, Form W-2 (box 12, code TT). (Form 1099 reporting would only arise in the unlikely event an individual is an employee under the FLSA but is an independent contractor under the common-law test used for federal employment tax purposes.) The employer must separately report all of an employee's qualified overtime compensation, even if it exceeds the allowable deduction.

Qualified overtime compensation is generally calculated weekly. For most FLSA overtime-eligible employees, the qualified amount equals the number of hours over 40 in the workweek multiplied by one-half of the employee's regular rate of pay. The "regular rate" includes all remuneration for employment — whether determined on a piece-rate, salary, commission or some other basis — except certain payments excluded by the FLSA.

If an employer pays more overtime than required by the FLSA, only the amount necessary to satisfy 29 USC Section 207 is qualified overtime compensation for purposes of the tax deduction. The new FAQs emphasize that overtime premiums paid solely under state law, collective bargaining agreements, employment agreements, or other employer policies do not constitute qualified overtime compensation unless they are required to satisfy the FLSA overtime requirements.

For employees whose overtime is not calculated under the 29 USC Section 207(a) "general method" — for example, certain hospital or public safety employees — qualified overtime compensation is based on the overtime premium actually paid in compliance with that provision, not on what would have been paid under the general method.

Overtime compensation remains subject to federal income tax withholding. Employers may not reduce wage withholding for the qualified overtime deduction unless the employee provides a valid, updated Form W-4 reflecting the anticipated deduction.

Residents of a US territory may not claim an overtime deduction on a US tax return if all of the overtime compensation is excluded from their US gross income.

Employees

Employees should use Schedule 1-A (Form 1040) to calculate the deductible amount of qualified overtime compensation. For 2026, employees may only include the qualified overtime compensation reported on Form(s) W-2, box 12, code TT in determining their deduction. Employees who believe the reported amount is too low must request a corrected Form W-2 from the employer to claim the full amount. Employees may not use Form 4852 (Substitute for Form W-2) to claim additional qualified overtime compensation that was not reported on Form W-2. For qualified overtime compensation that is too high, employees may use only the correct amount in calculating the deduction.

The new FAQs include detailed guidance for governmental employees.

Implications

The new FAQs confirm that the 2025 transition relief will not be extended and emphasize the need for extremely thorough federal overtime analysis when calculating qualified overtime compensation for 2026. Employers must identify the portion of compensation that satisfies the FLSA overtime requirements, calculate the applicable overtime premium using the FLSA regular-rate rules and separately report qualifying amounts on Forms W-2.

Employers should review the new FAQs to confirm whether they are on track to comply with the new reporting requirements for 2026. Very little time is left to make any necessary changes, so employers may need to act quickly.

Many employers implemented systems that have been gathering what was believed to be relevant overtime compensation data since the beginning of the year. Given the new FAQs' emphasis on numerous intricacies under federal overtime law, employers may wish to consult with external legal counsel specializing in federal labor law, just as the IRS and Treasury Department consulted with the Department of Labor when drafting the new FAQs.