IRS updates “overtime pay tax exemption” deduction rules for 2026

Workers who qualify for federal tax breaks related to overtime pay may find it easier to claim in the 2026 tax year than in the 2025 return.

The IRS has updated its “No Tax on Overtime Pay” deduction FAQ to clarify and expand the information provided. Experts say there was some confusion about deductions when 2025 tax returns were filed earlier this year.

“While the words ‘overtime tax exempt’ fit on a bumper sticker, all the terms and conditions that apply…of course we’ve gotten a lot of questions from workers and employers about what overtime pay is covered and how employers are required to report it,” said Andrew Lautz, senior director of federal policy at the Tax Foundation, a bipartisan research group. “Now more details have come to light.”

Specifically, employers must include information on workers’ W-2s for the 2026 tax year. This means that many taxpayers will not be responsible for determining eligibility or calculating their own deductions, as they would on a 2025 return.

“This filing season has been complicated, but we hope that employer filing will make things less complicated for workers,” Lautz said.

The overtime tax exemption was included in President Donald Trump’s One Big Beautiful Bill Act, which was signed into law in July 2025. This was one of several new one-time deductions taxpayers may be eligible for, along with additional deductions for auto loan interest, tip income, and taxpayers age 65 and older. All four are valid for tax years 2025 through 2028.

Workers who qualify for the overtime tax deduction can deduct a portion of their qualifying overtime hours on their tax returns, up to $12,500 for single taxpayers and $25,000 for married couples filing jointly. The exemption applies to overtime pay under the Fair Labor Standards Act, which states that non-exempt employees must be paid at least 1.5 times their regular wage rate if they work more than 40 hours a week.

However, only the “overtime premium”, or 1/2 of the overtime premium, is deducted. Example: If a covered worker’s regular hourly wage is $40 and overtime pay is $60, only the $20 premium over the regular hourly wage is deductible. The tax relief will phase out starting at $150,000 in income for single taxpayers and $300,000 for joint taxpayers.

The updated IRS FAQ includes a requirement that employers enter the deductible amount on a worker’s W-2 in box 12 using the “TT” code. The IRS says it is possible for independent contractors to receive a 1099-MISC or 1099-NEC that includes eligible overtime pay, but the circumstances in which this occurs are “rare.”

The FAQ also clarifies that if state law or union agreements require overtime pay that differs from the FLSA, only the portion required under the FLSA (usually the additional half of the 1.5x pay rule) is deductible.

More than 29 million taxpayers claimed overtime wage credits between the most recent tax season and the April 15 filing deadline, according to a July 2 announcement from the Treasury Department. The average deduction was more than $3,100, according to the release. Furthermore, 75% of these filers had incomes of less than $100,000 and 96% had incomes of less than $200,000.

For tax year 2025, the Treasury Department and the IRS have waived the requirement for employers to separately report amounts eligible for deductions. That’s because the systems and procedures to capture that information weren’t yet in place, and the required IRS tax forms hadn’t been updated to include it. As a result, many workers had to use their payroll statements or final pay stubs for the year to calculate the amount they were eligible for on their own.

“We had to use people’s pay stubs and make our best guess at what the amount of qualified overtime would be,” said Tom Oseven, director of tax content and government relations at the National Association of Tax Professionals.

“All things being equal, it is quite possible that the amount deducted as overtime pay in 2026 will be less than the amount deducted in 2025 because the calculation may have been incorrect,” Oseven said.

Even if overtime deduction information appears on your W-2, it’s worth checking to make sure it’s accurate.

“We’re still going to ask customers to bring their pay stubs with them. We’ll take a few minutes to (check) that number and make sure it’s accurate,” Oseven said.

If not, the worker should request an amended W-2.

“If a worker believes that the information provided by the employer for overtime pay is incorrect, whether the employer is offering too much or too little, it is the worker’s responsibility to request an updated W-2,” Lautz said.

“If you find a mistake, you can’t say, ‘Oh, I’ll correct it myself,’ and claim another deduction,” he says.