IRS Updates Overtime Deduction Rules

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by LICA-National

The Internal Revenue Service (IRS) released on August 6, 2026, updated frequently asked questions (FS-2026-13, FAQs) for employers and employees on how to calculate qualified overtime compensation for purposes of the overtime pay deduction. 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.



Strict Form W-2 Rules

  • Mandatory W-2 Reporting: Employees can now only claim the deduction if their qualified overtime premium is explicitly reported by their employer on Form W-2, Box 12, using Code TT.
  • No Substitute Forms Allowed: If an employer underreports or leaves this box blank, Form 4852 (Substitute for Form W-2) cannot be used to claim the deduction manually. A corrected Form W-2c must be requested from an employer first.
  • Gross Reporting: Employers are required to report all qualified overtime earned in Box 12, Code TT, even if the total amount exceeds the individual $12,500 or joint $25,000 deduction caps.

Tax Withholding & Form W-4 Changes

  • No Automatic Withholding Cuts: Employers are instructed not to automatically reduce federal income tax withholding on overtime pay.
  • Manual Adjustments: If an employee expects to qualify for the deduction and wants the extra cash in their paycheck now rather than waiting for a refund, the employee must manually submit an updated 2026 Form W-4 and claim the deduction on Step 4(b). The online IRS Tax Withholding Estimator has been updated to help you calculate this.

Exacting Labor Law Alignment

  • FLSA Integration: Developed alongside the Department of Labor, the new guidance explicitly stresses that employers must calculate qualified overtime utilizing precise Fair Labor Standards Act (FLSA) regular-rate mechanics. The calculation is defined strictly as hours worked over 40 in a single workweek multiplied by one-half of the employee's regular rate of pay.