What Business Clients Need to Know About the Qualified Overtime Compensation Deduction (OBBBA / FS-2026-13)

A client calls you the week before payroll runs and asks, “Is my team’s overtime tax-free now?” You’ve seen the headlines about “no tax on overtime,” but your client needs a real answer, not a soundbite, and you need to get the payroll and reporting mechanics right the first time. Get this wrong, and you risk a corrected W-2, a penalty notice, or an employee who loses a deduction because the paperwork wasn’t right. We’ve spent over 50 years helping accounting professionals navigate exactly this kind of regulatory change, and this one is very manageable once you separate what the law actually does from what the headlines say it does. 

Quick answer: The qualified overtime compensation deduction, created by OBBBA and clarified in IRS Fact Sheet FS-2026-13Opens in new window, lets eligible employees deduct the FLSA-required overtime premium (the “half” in time-and-a-half) up to $12,500 per return ($25,000 joint), phased out above $150,000 MAGI ($300,000 joint). Employers must separately report it on Form W-2, box 12, code TT, starting tax year 2026. 

The qualified overtime compensation deduction is an income tax deduction, created by OBBBA (P.L. 119–21), for overtime pay that an employer is required to provide under section 7 of the Fair Labor Standards Act (FLSA), 29 U.S.C. § 207. According to IRS Fact Sheet FS–2026–13, qualified overtime compensation is specifically the amount of FLSA-required overtime pay that exceeds an employee’s regular rate — generally, the “half” portion of “time-and-a-half” pay, not the entire overtime paycheck. 

The deduction is available whether the taxpayer itemizes or takes the standard deduction, which makes it accessible to a broad range of employees. But it is a deduction, not an exclusion—FS–2026–13 is explicit that qualified overtime compensation is still included in gross income and remains subject to employment taxes, including income tax withholding, Social Security, and federal unemployment tax. 

The deduction itself is capped at $12,500 per individual tax return and $25,000 for married couples filing jointly. Practitioners should direct clients to the instructions for Form 1040, Schedule 1-A, for the mechanics of claiming it. 

Only employees who are both covered by the FLSA and not exempt from its overtime requirement—what FS–2026–13 calls “FLSA overtime-eligible” employees—can generate qualified overtime compensation. If an employee is FLSA overtime-ineligible, no overtime they receive counts toward the deduction, even if a state law or a collective bargaining agreement requires the employer to pay it. 

Common FLSA overtime exemptions include executive, administrative, and professional employees; outside sales employees; certain computer-related occupations; certain commissioned employees of retail or service establishments; employees of motor carriers, railroads, and air carriers; workers at certain seasonal amusement or recreational establishments; and certain agricultural employees. This is why the deduction is often misunderstood as a blanket overtime benefit—it is not. FS–2026–13 also flags a scenario frequently encountered with small-business clients—an employee-owner who holds a bona fide 20% or greater equity interest in the business and is actively engaged in its management is generally treated as a bona fide executive, which makes that owner FLSA overtime-ineligible regardless of the hours worked. 

One more nuance worth flagging for clients who pay more generous overtime than the FLSA requires—if an employer voluntarily pays a premium beyond what section 7 requires (for example, true “double time”), FS–2026–13 clarifies that only the portion minimally necessary to satisfy the FLSA counts as qualified overtime compensation for deduction purposes. 

Employers and payors must separately report qualified overtime compensation on the correct information return, and getting this right is what allows the employee to claim the deduction at all. Under FS–2026–13, starting with tax year 2026, the amount is reported on Form W–2, box 12, using code TT, for most employees. In the narrower case where a worker is an employee for FLSA purposes but is treated as an independent contractor under the Internal Revenue Code, the amount instead goes on Form 1099-NEC (box 1d) or Form 1099-MISC (box 14). 

FS–2026–13, issued in August 2026, supersedes the earlier FS–2026–01 from January 2026 and reorganizes the qualified overtime compensation FAQs into eight topic areas covering the basics, FLSA eligibility, information return reporting, withholding, employer issues, employee issues, federal employee issues, and other resources. It removes guidance that applied only to the 2025 tax year and adds new details on FLSA coverage and exemptions, the mechanics of Form W–2 and Form 1099 reporting, and withholding procedures—much of what is summarized above. 

Practitioners should also understand the reliance standard that comes with any IRS fact sheet FAQ. The IRS states plainly that because these FAQs have not been published in the Internal Revenue Bulletin, the agency will not rely on them to resolve a case, and the underlying statute controls if an FAQ turns out to misstate the law for a particular taxpayer. That said, a taxpayer who reasonably and in good faith relies on the FAQs is protected from certain accuracy-related and negligence penalties. In practice, that means FS–2026–13 is a trustworthy day-to-day compliance guide, but it is not a substitute for the statute and any forthcoming regulations.  

Clients need payroll and timekeeping systems that can isolate the FLSA overtime premium separately from base pay and from any non-qualifying overtime, on a workweek-by-workweek basis. FS–2026–13 defines a workweek as a fixed, regularly recurring period of 168 hours, or seven consecutive 24-hour periods, and specifies that hours generally cannot be averaged across two or more workweeks for overtime purposes. 

For most employees, qualified overtime compensation for a workweek equals the number of FLSA hours worked beyond 40, multiplied by one-half, multiplied by the employee’s FLSA regular rate of pay. The regular rate itself is broader than a base hourly wage—it includes all payments for employment, whether paid on a piece-rate, salary, or commission basis, except for payments the FLSA specifically excludes, divided by total FLSA hours worked. 

Advise clients to document, in writing, how each employee’s FLSA classification was determined (exempt versus overtime-eligible), since that classification decides whether any of that employee’s overtime can qualify at all. Contemporaneous timekeeping records, a payroll system capable of coding the premium portion separately for box 12, code TT, and a documented process for issuing Form W–2c corrections when errors surface will save your client—and you—significant time at year-end.

The most common misconception is that “qualified overtime compensation” means all of an employee’s overtime pay is deductible, or even tax-free. It is neither. FS–2026–13 is explicit that only the premium portion—the “half” in time-and-a-half that the FLSA requires beyond the regular rate—counts as qualified overtime compensation, and that amount remains fully included in gross income and subject to employment taxes. An employee who works overtime does not get to deduct their entire overtime paycheck—they may deduct only the qualifying premium, up to the applicable cap. 

Another related misconception is that employer reporting and employee deduction-claiming are two separate duties. The employer’s job is to accurately report qualified overtime compensation on Form W–2 (or the applicable Form 1099) using the correct box and code. The employee’s job is to claim the deduction on their own return, using Form 1040, Schedule 1-A. A business that reports the amount correctly has satisfied its obligation—whether and how much the employee ultimately deducts depends on that employee’s own MAGI, filing status, and total qualified overtime compensation for the year. 

Stay current by monitoring IRS Fact Sheets and the Schedule 1-A instructions directly, rather than relying on a single article or a prior version of the guidance. FS–2026–13 itself replaced an earlier fact sheet issued only months before, and the IRS has signaled that further updates and modifications are possible as OBBBA implementation continues. Treat each fact sheet as dated guidance, and confirm you’re working from the most recent version before advising a client. 

Whether you’re an EA focused on individual and business tax compliance or a CPA advising clients across accounting, payroll, and reporting, staying current on legislative shifts like OBBBA is part of the job—and part of what we build into Gleim EA review and Gleim CPA Review System content as the law evolves.  

It is an income tax deduction, created by the One, Big, Beautiful Bill Act, for the FLSA-required overtime premium—generally the “half” portion of “time-and-a-half” pay under 29 U.S.C. § 207. Per IRS Fact Sheet FS–2026–13, the deduction is capped at $12,500 per individual tax return and $25,000 for married couples filing jointly.  

Only employees who are FLSA overtime-eligible—covered by the FLSA and not exempt from its overtime requirement—can generate qualified overtime compensation. Many salaried employees are classified as exempt executive, administrative, or professional employees under the FLSA and therefore do not qualify, regardless of how many hours they work.

Starting with tax year 2026, employers report the total qualified overtime compensation paid on Form W–2, box 12, using code TT. Workers who are FLSA employees but treated as independent contractors under the Internal Revenue Code instead receive the amount on Form 1099-NEC (box 1d) or Form 1099-MISC (box 14). The reported figure is the full amount paid, not the amount ultimately deductible by the employee, per FS–2026–13. 

FS–2026–13 adds operational detail the statute leaves open, including exactly how FLSA eligibility and exemptions apply, the specific Form W–2 and Form 1099 boxes and codes to use, correction procedures via Form W–2c, and how Form W–4 withholding elections interact with the deduction. It replaces the earlier FS–2026–01 and reorganizes guidance into topic areas covering basics, FLSA eligibility, reporting, withholding, and employer and employee issues. 

Employees may claim the deduction starting with qualified overtime compensation they earn, subject to the dollar caps and MAGI phaseout described in FS–2026–13. For employer reporting specifically, FS–2026–13 confirms that separate reporting of qualified overtime compensation on Form W–2, box 12, code TT (or the applicable Form 1099) is required beginning with tax year 2026, so payroll systems need to be ready to capture and code the premium portion accordingly. 

OBBBA provisions like the qualified overtime compensation deduction are the kind of changes we build into our courses as soon as the IRS issues guidance, so EA and CPA candidates study the rules as they actually apply today. If you’re preparing for the EA exam or the CPA Exam, or you simply want to see how we cover current tax law changes, start with a free resource—explore Gleim EA review materials or the Gleim CPA Review System. 

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