IRS Clarifies Overtime Deduction and 2026 Reporting Requirements
November 4, 2026
Recent IRS guidance has brought important clarity to the qualified overtime deduction, introducing new payroll reporting obligations that employers need to understand and prepare for now. With the 2026 tax year deadline approaching faster than it may seem, taking action early will help businesses avoid compliance headaches and ensure their employees receive the full benefit of this deduction.
What Is the Qualified Overtime Deduction?
Not all overtime pay qualifies for this deduction – and understanding the distinction is critical. The qualified overtime deduction applies only to the additional “half” portion of time-and-a-half overtime pay required under the Fair Labor Standards Act (FLSA). In other words, if an employee earns $20 per hour and receives $30 per hour for overtime, only the extra $10 — the “half” above their regular rate — is considered qualified overtime compensation for purposes of this deduction.
This distinction matters both for employees claiming the deduction and for employers who must accurately track and report qualified amounts. Overtime compensation that falls outside FLSA requirements, such as voluntary overtime pay above the statutory minimum, may not qualify.
New Form W-2 Reporting Requirements Starting in 2026
Beginning with tax year 2026, employers are required to separately report qualified overtime compensation on Form W-2, Box 12, using code TT. This is a new reporting requirement, and payroll systems will need to be configured to capture and distinguish qualified overtime from total overtime compensation well in advance of the reporting deadline.
Importantly, employers must report the full qualifying amount of overtime compensation — even if that amount exceeds the employee’s individual deduction limit. The reporting obligation is not capped to the deduction threshold; it reflects the total qualified overtime paid during the year.
Deduction Limits and Phase-Out Thresholds
For eligible taxpayers, the qualified overtime deduction is available at the following levels:
- Up to $12,500 for individual filers
- Up to $25,000 for married filing jointly
However, the deduction begins to phase out once a taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 for individual filers or $300,000 for joint filers. Employees who earn significant overtime but have higher overall income may see a reduced — or eliminated — deduction benefit.
Withholding Remains Unchanged (Without a New W-4)
One area where employers must proceed carefully is payroll tax withholding. Overtime compensation — qualified or not — remains subject to payroll taxes and federal income tax withholding. Employers are not permitted to adjust an employee’s withholding to account for the qualified overtime deduction on their own initiative.
The only mechanism for adjusting withholding is through the employee submitting an updated, valid Form W-4 that reflects the deduction. Employers should communicate this process to employees who may want to take advantage of reduced withholding based on their anticipated deduction. Without a properly submitted Form W-4, withholding must continue as usual.
What Employers Should Do Now
While 2026 may feel like a distant deadline, the operational steps required to comply are best undertaken well in advance. Here is where to start:
- Audit your payroll system. Confirm whether your current payroll software can distinguish qualified FLSA overtime from total overtime compensation and separately track the qualifying “half” amount.
- Coordinate with your payroll provider. If you use a third-party payroll service, ask whether they are prepared to report qualified overtime in Box 12 with code TT beginning in tax year 2026.
- Communicate with employees. Inform workers who regularly earn overtime about this deduction and remind them that submitting an updated Form W-4 is the only way to adjust withholding to reflect it.
- Consult your tax advisor. Every employer’s situation is different. A proactive conversation with your CPA or payroll advisor can help you identify any gaps in your current processes and address them before they become problems.