The One Big Beautiful Bill Act (OBBBA) introduces changes and new requirements for reporting overtime pay in 2026. The changes are required to enable employees to claim certain overtime deductions on their personal tax return.
The new tax deduction applies only to the ‘Qualified Overtime Compensation’ portion of overtime pay. The Qualified Overtime Compensation is the premium portion of overtime pay, or that extra “half” portion of “time-and-a-half” compensation.
For example, if an employee earns $20/hour and works overtime, the overtime pay is $30/hour. Of the $30/hour, in this example the $10/hour is the Qualified Overtime Compensation that may be deductible under the new rule.
Not all overtime will qualify for the deduction by employees. Only overtime pay required by the Federal law Fair Labor Standards Act (FLSA) is eligible. Overtime Pay required by California regulations will not be included in the tax deduction. This means the California Overtime Pay for working over 8 hours in a day, or double time for over 12 hours, will not be allowed to be deducted.
Starting in 2026, employers may need to make changes to how they track and report overtime. The IRS has recently announced transition relief for 2025, and tax forms for 2025 will not be adjusted. The IRS will provide further guidance on the specifications for the 2026 tax returns later this year.
While these deductions are in effect now, the tax deductions are taken into account on the employee’s individual tax return when it is filed. The new overtime tax deduction is not taken through payroll. Additionally, all overtime is still subject to Social Security, Medicare, unemployment, and state taxes.
Eligibility: The overtime deduction is available for both itemizing and non-itemizing taxpayers.
From 2025 to 2028, employees who qualify can deduct up to $12,500 annually for the Qualified Overtime Compensation’ (or $25,000 for joint filers). To claim the deduction the employee must Include their Social Security number on their return and file jointly if married, to claim the deduction. Employees who make over $150,000 individually (or $300,000 jointly) will have the deduction phase out. Whether the employee itemizes or not, overtime deduction may be available.