The IRS has issued detailed guidance on a new federal income tax deduction for qualified overtime compensation. This measure, effective for tax years 2025 through 2028, provides a federal income tax deduction that allows eligible individuals to deduct certain qualified overtime compensation.
What is qualified overtime compensation?
Under the new rules, qualified overtime compensation is defined as the portion of overtime pay that exceeds an employee’s regular rate of pay and is required under the Fair Labor Standards Act (FLSA). Essentially, this is the extra half-time in a time-and-a-half overtime wage, rather than the entire overtime payment.
For example, if an employee’s regular rate of pay is $20 per hour and they receive $30 per hour for overtime hours worked, the $10 premium above the regular rate constitutes qualified overtime compensation eligible for the deduction.
Notably, only FLSA-required overtime qualifies. Amounts paid as overtime for other reasons (e.g., solely under state law or employer policy) may not qualify unless they are FLSA-required overtime premium.
Who is eligible?
Eligibility for this deduction hinges on several key factors:
- FLSA overtime eligibility: the taxpayer must be covered by and not exempt from the FLSA’s overtime rules (29 USC §207). Coverage depends on job duties, earnings level, and employer size.
- Valid Social Security number: the employee must have a Social Security number that’s valid for employment.
- Filing status: married taxpayers must file a joint return to claim the deduction. Both spouses, if they received qualified overtime compensation, must include valid SSNs on the return.
How much can you deduct?
For tax year 2025 (and continuing through 2028), the deduction limits are:
- Up to $12,500 of qualified overtime compensation per individual tax return, and
- Up to $25,000 on a joint return.
The deduction is claimed on the individual income tax return in computing taxable income, rather than as an adjustment to gross income. As a result, the deduction does not reduce AGI.
Importantly, taxpayers do not need to itemize deductions to claim the qualified overtime compensation deduction. It may be claimed in addition to the standard deduction, subject to the applicable dollar limits and income phase-outs.
Income phase-out rules
The threshold for the phase-out begins at $150,000 modified adjusted gross income (MAGI) for single filers and $300,000 for joint filers.
Detailed phase-out computations and definitions of MAGI are provided in IRS Notice 2025-69, which should be consulted for precise planning and compliance.
Reporting and compliance
For the 2025 tax year, employers are not required to separately report qualified overtime compensation on Forms W-2, 1099-NEC, or 1099-MISC. Taxpayers should therefore use their payroll records and the guidance in Notice 2025-69 to calculate the deduction.
Beginning tax year 2026, employers will be required to separately report qualified overtime compensation on updated tax forms.
Looking ahead
The IRS’s qualified overtime compensation deduction represents a significant tax change for workers who earn overtime pay and meet specific eligibility requirements. Taxpayers should carefully review the IRS FAQs, Notice 2025-69, and supporting FLSA guidance to ensure accurate calculation and compliance, while incorporating this planning opportunity into broader tax strategy discussions.
For more personalized guidance, please contact our office.
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