The phrase sounds as if overtime hours stop being taxed. They don't. The law signed in July 2025 (Public Law 119-21, which the IRS now calls the Working Families Tax Cuts) created a deduction that an eligible employee claims when filing their federal return. Payroll keeps working the way it did, with one new reporting job for employers. This post covers what the deduction is, which dollars count, what changes on a pay stub and on the 2026 Form W-2, and what a small employer has to do.
What the overtime deduction is
The IRS describes it as an income tax deduction for individuals who are paid qualified overtime compensation required under section 7 of the Fair Labor Standards Act (FLSA). It applies to tax years 2025 through 2028 and is available whether the employee itemizes or takes the standard deduction. It is figured on the new Schedule 1-A of Form 1040.
| Rule | What the IRS says |
|---|---|
| Years | Tax years 2025 through 2028 |
| Maximum deduction | $12,500 per return; $25,000 on a joint return |
| Income limit | Reduced when modified adjusted gross income is over $150,000 ($300,000 joint) |
| Who can claim it | Employees paid FLSA-required overtime, with a valid Social Security number; married couples must file jointly |
| Where it is claimed | Schedule 1-A of Form 1040, itemizing or not |
| Payroll taxes | Unchanged: overtime is still subject to income tax withholding, Social Security, Medicare and federal unemployment tax |
IRS Fact Sheet 2026-13 is blunt about the last row: the deduction does not mean overtime is excluded from gross income, and overtime is generally not exempt from wages for employment taxes. So the 6.2% Social Security and 1.45% Medicare on every overtime dollar stay exactly where they were.
Which part of overtime counts
Only the premium that the FLSA requires counts. The FLSA requires at least one and one-half times the regular rate for hours over 40 in a workweek. The straight-time part of those hours is ordinary pay; the extra half is the qualified overtime compensation. For most employees the IRS gives this formula for each workweek:
- Take the FLSA hours worked over 40 in the workweek.
- Multiply by one-half.
- Multiply by the employee's FLSA regular rate of pay for that workweek.
| Line | Amount |
|---|---|
| Regular pay: 40 hours × $20 | $800 |
| Straight time for 10 overtime hours: 10 × $20 | $200 |
| FLSA premium: 10 × $10 (half of $20) | $100 |
| Gross pay for the week at time-and-a-half | $1,100 |
| Qualified overtime compensation for the deduction | $100 |
If the employer pays double time instead, the employee earns more, but the qualified amount stays $100: only what the FLSA minimally requires counts. The same goes for overtime paid under a state law, a union contract or company policy for hours the FLSA does not cover, such as daily overtime after 8 hours or weekend premiums. The employer has to work out how much of such pay the FLSA itself would have required.
The regular rate is not always the hourly rate. Under the FLSA it includes all pay for employment, such as non-discretionary bonuses and shift differentials, apart from specific exclusions. The Department of Labor also says overtime is figured week by week: averaging hours over two or more weeks is not allowed. Salaried employees who are exempt from FLSA overtime (for example under the executive, administrative or professional exemptions) don't receive FLSA overtime, so they have nothing to deduct.
What changes on the pay stub
Nothing changes in the tax lines. The IRS says employers may not reduce withholding to account for the deduction unless the employee hands in an updated Form W-4. The 2026 Form W-4 lets an employee include the expected overtime deduction in Step 4(b), and the IRS Tax Withholding Estimator accounts for it. If nobody files a new W-4, federal income tax on an overtime-heavy paycheck is worked out the same way as before the law changed.
What helps is a pay stub that shows overtime on its own line, with hours and rate, rather than folded into one gross figure. Then the employee can see how the premium was reached, and the employer has a clean record to total for the W-2. Some employers also keep a running year-to-date total of the premium in their payroll records. Federal law doesn't require that figure on the stub, but the employer will need the annual total in January.
| Earnings line | Hours | Rate | Amount |
|---|---|---|---|
| Regular | 40 | $20.00 | $800.00 |
| Overtime | 10 | $30.00 | $300.00 |
| Gross pay | $1,100.00 |
Federal income tax withholding, Social Security and Medicare are figured on the full $1,100, as before. The $100 premium only matters when the employee files their return.
What changes on the 2026 Form W-2
Starting with tax year 2026, employers must report qualified overtime compensation separately. On Form W-2 it goes in box 12 with code TT. Report the full amount paid in the year, even when it is above the deduction limit: the IRS's own example is an employee paid $30,000 of qualified overtime, and the employer reports $30,000 with code TT although the deduction caps at $12,500. If the code TT amount turns out to be wrong, the employer files and furnishes a Form W-2c.
- 2025 forms: employers were not required to report qualified overtime separately. Employees figure the amount themselves using the Schedule 1-A instructions.
- 2026 forms: box 12, code TT on Form W-2. For 2026 Forms W-2 the IRS lists 1 February 2027 as the date to furnish them to employees and to file them with the Social Security Administration.
- Rare 1099 case: the IRS says qualified overtime goes on Form 1099-NEC (box 1d) or 1099-MISC (box 14) only when a worker is an employee under the FLSA but treated as an independent contractor for tax purposes.
A checklist for small employers
- List which employees are FLSA overtime-eligible (non-exempt). Exempt salaried staff are outside this.
- Keep hours by workweek, and work out each week's regular rate, including non-discretionary bonuses.
- Pay at least time-and-a-half for hours over 40, and record the premium part separately from straight time.
- Show regular and overtime hours on separate pay stub lines.
- Accept a new 2026 Form W-4 if an employee wants less withheld, and apply it from the next payroll.
- Total each employee's qualified overtime for 2026 and enter it in W-2 box 12 with code TT.
Two things not to promise employees: that their paycheck will grow (it won't unless they change their W-4), and that they will deduct everything in box 12 code TT (the cap and the income limit may reduce it). The employee's tax return settles the deduction, so employers should stick to reporting the right number.
Where PayDocs fits, and where it doesn't
The PayDocs paycheck calculator estimates one 2026 paycheck: federal income tax withholding, Social Security, Medicare and, in supported states, state income tax. Enter gross pay including overtime and it shows the withholding that comes out of that check. It does not subtract the overtime deduction, because the IRS rule is that withholding stays the same unless the employee files a new W-4.
The PayDocs pay stub generator has a separate line for additional hours at their own rate, so overtime appears next to regular hours instead of inside one total. The W-2 generator makes employee copies of the 2026 Form W-2 and includes box 12 code TT. PayDocs makes documents from your figures. It doesn't run payroll, deposit taxes, file anything with the IRS or the Social Security Administration, or give tax advice.
Questions
Does no tax on overtime mean no Social Security or Medicare on overtime?
No. The IRS says overtime is still subject to income tax withholding, Social Security, Medicare and federal unemployment tax. The deduction only reduces federal taxable income when the employee files their return.
Is all overtime pay tax-free now?
No. Only the FLSA-required premium counts (the extra half in time-and-a-half), the deduction is capped at $12,500 a year ($25,000 joint), and it shrinks once modified adjusted gross income passes $150,000 ($300,000 joint). The straight-time part of overtime hours is taxed as before.
Does the deduction apply to 2025?
Yes, it covers tax years 2025 through 2028. Employers did not have to report the amount separately on 2025 forms, so employees figure it using the Schedule 1-A instructions. From 2026 the amount appears in W-2 box 12 with code TT.
Can an employee get the benefit in each paycheck?
Only by giving the employer a new Form W-4. The 2026 form has room in Step 4(b) for the expected overtime deduction. Without a new W-4, the employer must keep withholding as usual.
Do independent contractors qualify?
Generally no, because the FLSA's overtime rules apply to employees. The IRS describes one rare case: a worker who is an employee under the FLSA but treated as a contractor for tax purposes, whose qualified overtime is reported on Form 1099-NEC or 1099-MISC.
Sources
- IRS: What to know about the No Tax on Overtime deduction
- IRS Fact Sheet FS-2026-13: Questions and answers about the deduction for qualified overtime compensation (August 2026)
- IRS: Working Families Tax Cuts, tax deductions for working Americans and seniors
- IRS: General Instructions for Forms W-2 and W-3 (2026)
- U.S. Department of Labor: Fact Sheet #23, Overtime Pay Requirements of the FLSA
Sources checked October 4, 2026. This article explains how pay documents work; it is not tax or legal advice.
