Many deductions created by the tax and spending megabill in 2025 have created significant questions for taxpayers — especially now that we've entered the filing season for 2025 federal income tax returns.
In response, the Internal Revenue Service has released answers to frequently asked questions on the deduction for qualified overtime compensation.
Since employers may not have implemented a system to separately calculate and report the amounts that can be treated as "qualified" overtime, advisors and taxpayers are likely to face challenges in getting this deduction right. While the IRS FAQ does not address all potential issues that taxpayers may encounter, it does provide insight into qualification requirements and how to claim the deduction.
Advisors and taxpayers should also review IRS Notice 2025-69 for detailed examples on properly calculating the new deduction.
Deduction for Overtime Compensation: Background
The 2025 legislation created a temporary deduction for overtime pay mandated by the Fair Labor Standards Act. The deduction amount for overtime compensation paid above the taxpayer's normal rate is limited to $12,500 for individual returns and $25,000 for joint returns.
Highly compensated employees are not eligible for the deduction. A phaseout applies so that the deduction is reduced by $100 for every $1,000 by which the taxpayer's modified adjusted gross income exceeds $150,000 ($300,000 for joint returns).
The deduction is available for tax years 2025 through 2028, and a Social Security number is required for a taxpayer to claim it.
IRS Answers to FAQ
The IRS' frequently asked questions clarified that qualified overtime compensation includes only compensation that is required under Section 7 of the Fair Labor Standards Act. The individual, then, must be covered by FLSA and not exempt from the FLSA overtime requirement.
Whether an employee is exempt depends on the nature of the employee's work, earnings and the business itself.
Covered employees must generally be paid at least 1 1/2 times their regular pay for hours worked over 40 hours per week. When an employee must be paid time and a half, it is the "half" pay that counts for purposes of the deduction. An individual not qualified for FLSA purposes does not receive deductible overtime compensation even if such compensation is paid as required under another law or agreement, including collective bargaining agreements.
If an employer pays more than the time and a half required to comply with the FLSA, the excess amount is not qualified overtime compensation for purposes of the deduction.
Married taxpayers must file joint tax returns to claim the deduction. If both spouses receive qualified overtime compensation, each spouse must include a Social Security number on the return.
FAQ on Overtime Reporting Requirements
The IRS previously provided transition relief for the 2025 tax year, so employers were not required to report qualified overtime compensation on employees' Forms W-2 or 1099. If the employer does not voluntarily state the amount of qualified overtime compensation paid, the employee may base the calculation on documentation such as earnings or pay statements, invoices or similar statements.
One IRS example of how to calculate qualified overtime compensation considers a situation where the individual is paid at a rate above the required time and a half. If the individual receives a statement for 2025 that separately accounts for the portion more than the employee's regular rate, the individual should multiply that separate amount by a fraction to calculate the amount of qualified overtime compensation. If the rate is twice the regular rate, the fraction is 1/2.
Employees who do not receive a statement that separately accounts for their overtime can use any reasonable method of determining the amount — including requesting information from their employer to calculate the deduction.
For 2026 and later years, Forms W-2 and 1099 will be updated and employers will be required to separately report qualified overtime compensation.
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