8522.2 / What is the temporary deduction for overtime income?
Editor's Note: The IRS has confirmed that 2025 will be treated as a transition year with respect to employer reporting obligations. Pursuant to Notice 2025-62, employers will not face penalties for failing to separately provide the total amount of qualified overtime compensation for qualifying employees. The relief applies only for the 2025 tax year, in recognition that employers may not have the necessary information or systems in place to comply with the OBBBA reporting obligations. The IRS has also announced that Forms W-2 and 1099 for the 2025 tax year will not be updated to account for the OBBBA-related changes. The IRS has, however, released a Schedule 1-A that will be used to calculate the deduction.
The OBBBA created a temporary deduction for overtime pay mandated by the Fair Labor Standards Act (FLSA) (overtime compensation paid above the taxpayer's normal rate).[1] The deduction amount is limited to $12,500 for individual returns and $25,000 for joint returns. The deduction is allowable regardless of whether the taxpayer itemizes or takes the standard deduction.
The IRS has released a set of frequently asked questions to help taxpayers understand the new deduction for qualified overtime compensation under the 2025 OBBBA. The FAQ clarified that qualified overtime compensation is compensation that is required under Section 7 of the Fair Labor Standards Act (FLSA). When an employee must be paid "time and a half", under the FLSA for hours worked in excess of the regular 40-hour work week the "half" is what counts for purposes of the deduction. An individual who is not qualified for FLSA purposes does not receive deductible overtime compensation even if overtime compensation is paid as required under some other law or agreement (including collective bargaining agreements).
Only amounts required to be paid under the FLSA qualify. If an employer elects to pay 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 OBBBA deduction.[2]
Planning Point: Employers are required to report the amount of overtime income paid to an employee on Form W-2, box 12, using the code TT. The amount that must be reported as qualified overtime income is the amount that the employer is required to pay the employee in excess of the employee's regular rate of pay. It's important for employees to remember that the amount that is reported on Form W-2 may ultimately not be the same as the amount that the employee is entitled to deduct.
Example: ABC Company paid Joe, an employee, qualified overtime compensation of $30,000 in 2026. ABC Company must include $30,000 on Joe's Form W-2 using box 12, code TT even though the overall limit on the deduction for qualified overtime compensation is $12,500 ($25,000 in the case of a joint return).
Pursuant to the IRS FAQ, employers do not reduce wages subject to income tax withholding to account for the new qualified overtime compensation deduction. Employers cannot reduce withholding on a qualifying employee's wages unless the employee provides the employer an updated Form W-4 that accounts for the expected deduction. The 2026 Form W-4 has been updated to allow employees to account for the deduction (in step 4(b)).
Highly compensated employees are not eligible for the deduction. The amount of 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 temporarily available for tax years 2025 through 2028. A Social Security number is required for a taxpayer to claim the deduction. The IRS has released a revised draft Form W-2. Employers must include the total amount of qualified overtime compensation paid to the employee on their Form W-2 (using box 12) beginning in 2026. For 2025, the IRS directed employers to use a reasonable method to approximate the amounts of an employee's qualified overtime.
[1] IRC § 225, as created by the 2025 OBBB
[2] IRS FS 2026-01