Recently, Accounting Today reported that the Internal Revenue Service and Treasury Department issued comprehensive guidance on the new overtime pay deduction under the One Big Beautiful Bill Act just days before tax season opens. The FAQs published in Fact Sheet 2026-01 clarify that for tax years 2025 through 2028, individuals receiving qualified overtime compensation can deduct amounts exceeding their regular hourly rate—typically the “half” premium portion of “time-and-a-half” pay—as reported on Form W-2 or Form 1099.    

Key Implementation Details

Since Forms W-2 and 1099 were not revised following the enactment of OBBBA in July, no withholding changes occurred for 2025. This means taxpayers will claim the deduction when filing rather than seeing reduced withholding throughout the year.

What the Guidance Covers

The FAQs provide:

• Detailed deduction eligibility requirements
• Resources helping employees (including federal workers) determine whether their overtime qualifies under Fair Labor Standards Act definitions
• Critical distinctions between reporting requirements for tax year 2025 versus 2026-2028
• Clarification on what constitutes “qualified overtime compensation.”

Timing Concerns

The late release—mere days before tax season begins—leaves taxpayers and tax preparers little time to understand the new deduction rules. This compressed timeline may create confusion during early filing, particularly for workers unsure whether their overtime compensation qualifies or how to properly calculate and claim the deduction.

The IRS previously issued complementary guidance: Notice 2025-62 (employer penalty relief for reporting) and Notice 2025-69 (worker eligibility and deduction claiming). Reporting occurs on the new Schedule 1-A, which consolidates fields for overtime, tips, senior citizen, and car loan interest deductions.

Qualified Overtime Definition: Only the premium portion of FLSA-required overtime exceeding regular pay rates qualifies. Example: In time-and-a-half pay, only the “half” premium is deductible.

FLSA Eligibility Challenge: While most US employees are FLSA-covered, numerous exemptions exist. Eligibility depends on occupation, job duties, and earnings—requiring fact-specific analysis. Many salaried professionals, managers, and executives remain exempt even though they work overtime.

FLSA Rules Central to Overtime Deduction Complexity

The Fair Labor Standards Act provisions are fundamental to determining allowable overtime deductions, creating significant compliance challenges given the disconnect between FLSA standards and typical employer practices.

“Those FLSA rules apply, and that’s what’s going to determine deductions,” Dan Lewis, vice president of government affairs at payroll giant ADP, recently told Accounting Today. “The challenge is that very few employers pay strictly based on FLSA standards. Employers often provide more generous benefits—counting PTO toward your 40-hour week, providing overtime for holiday work, or paying double-time rates. The challenge will be ensuring employees claim only what qualifies under FLSA, requiring dual accounting: total overtime received versus FLSA-qualifying overtime for deduction purposes. State-level rules add further complexity. California, for example, mandates double-time pay and triggers overtime after eight hours daily, not just 40 hours weekly.”

Simplified Approach Recommended

Tax professionals suggest focusing on core FLSA definitions rather than getting lost in state variations or employer-specific policies.

“How do I figure out qualifying overtime? The easiest approach is identifying hours beyond 40 under the Fair Labor Standards Act,” said Tom O’Saben, director of tax content and government relations at the National Association of Tax Professionals, during an Accounting Today webinar. “Don’t get hung up on state laws or company-specific policies like differential pay or Sunday triple-time. Focus on what constitutes overtime under federal Fair Labor Standards Act rules.”

Critical Guidance Amid Form Update Delays

Friday’s fact sheet provides essential information following the IRS and Treasury’s decision not to update W-2 and 1099 forms before tax season to reflect OBBBA changes. The guidance includes penalty relief for taxpayers relying on the FAQ information.

“FS-2026-01 acts as a vital bridge between the statutory language of the OBBBA and the practical application required for the 2025 tax year,” wrote Ed Zollars of Thomas, Zollars & Lynch in his Current Federal Tax Developments blog. “For tax professionals, the document is essential not only for its general definitions but specifically for its detailed instructions regarding federal employees and its affirmative statement regarding penalty protection for taxpayers relying on these FAQs in good faith.”

The Practical Challenge

The fundamental issue: employees must differentiate between their total overtime compensation (which may include state-mandated premiums, company policies, or holiday pay) and FLSA-qualifying overtime eligible for federal tax deduction. This requires understanding which overtime hours and premium rates meet federal FLSA standards versus more generous employer or state provisions.

Without updated forms providing this breakdown, taxpayers and preparers must perform this analysis manually—increasing complexity and error risk during an already compressed filing season.