Written By: Mark S. Gallegos, CPA, MST | Tax & Advisory Partner, Porte Brown LLC
On August 6, 2026, the IRS released Fact Sheet FS-2026-13, a substantially revised set of frequently asked questions on the deduction for qualified overtime compensation. The update supersedes the guidance issued in January 2026 and adds meaningful detail on reporting, withholding, eligibility, and federal employee issues.
If you have been waiting for the practical mechanics of this deduction to come into focus, this is the guidance that does it. It also contains at least one provision that will surprise a number of business owners.
The deduction applies to qualified overtime compensation required under the Fair Labor Standards Act (FLSA). It is not a deduction for your entire overtime paycheck.
In most cases, only the premium portion qualifies - the amount paid above the employee’s regular rate of pay. If an employee earns $20 per hour and receives time-and-a-half for overtime, the qualifying amount is generally the extra $10 per hour, not the full $30.
Two related points that generate a disproportionate number of questions:
Equally important is what the deduction does not do. The IRS was explicit on this point: the deduction does not exclude overtime compensation from gross income. Overtime remains fully taxable wages, subject to income tax withholding, Social Security, Medicare, and federal unemployment taxes. The relief comes as a deduction on the return, not as tax-free pay.
Eligible taxpayers may deduct up to:
The deduction begins to phase out once modified adjusted gross income exceeds $150,000 for single filers or $300,000 for joint filers and is reduced as income rises above those thresholds.
Two mechanical points worth noting: the deduction is available to taxpayers who do not itemize, and married taxpayers must file jointly to claim it. A valid Social Security number is required.
The most consequential addition in the updated FAQs is a new provision addressing employee-owners.
An employee who owns at least a bona fide 20% equity interest in a business and is actively engaged in managing that business is generally exempt from the FLSA’s overtime requirements. Because the deduction reaches only FLSA-required overtime, that individual is not eligible for the deduction.
For closely held businesses, this is the headline. S corporation shareholder-employees, LLC member-managers, and family business owners who assumed this deduction was available to them should revisit that assumption now rather than at filing time.
Beginning with tax year 2026, employers must separately report qualified overtime compensation on Form W-2, box 12, using code TT. In limited circumstances - where a worker is an employee for FLSA purposes but treated as an independent contractor for tax purposes - reporting instead appears on Form 1099-MISC (box 14) or Form 1099-NEC (box 1d).
Three consequences follow, and each one matters:
Report the full amount of qualified overtime compensation paid, even where the employee will not be able to deduct all of it because of the dollar limits or the income phaseout. An employee paid $30,000 in qualified overtime still gets $30,000 reported in box 12, code TT.
Employers must continue withholding federal income tax from overtime wages and may not reduce withholding on their own initiative because an employee expects to qualify for the deduction.
Employees who want their withholding to reflect the anticipated deduction should submit an updated Form W-4. That is the appropriate mechanism, and it is a conversation worth having with your payroll team now rather than in the spring.
To qualify, an employee must be covered by the FLSA and not exempt from its overtime rules. The updated FAQs expand the discussion of exempt categories, which commonly include certain executive, administrative, professional, outside sales, computer, agricultural, transportation, and seasonal employees, along with railroad and airline employees subject to separate rules.
Many hourly workers - including police officers, firefighters, and a range of healthcare employees - generally do qualify.
Federal employees received an expanded section of their own, developed in coordination with the Department of Labor and the Office of Personnel Management, covering FLSA overtime eligibility, compensatory time, work periods, hours worked, and regular-rate calculations under OPM regulations. A practical marker: FLSA status is typically documented on Standard Form 50, Notification of Personnel Action, at block 35. An “E” indicates exempt and ineligible; an “N” indicates nonexempt and overtime-eligible.
The IRS also added detail on how employers should calculate qualified overtime compensation, including workweek definitions, hours worked, regular-rate calculations, alternative overtime computation methods, and compensatory time arrangements available to certain state and local government employees.
Employers should:
Employees should:
These are FAQs, not regulations. They provide reasonable-cause penalty protection for taxpayers who rely on them, but they are not precedential authority, and the IRS can revise them - as it just did to the January version. Positions built on this guidance should be documented with that in mind.
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