On August 6, 2026, the IRS released Fact Sheet FS-2026-13, substantially revising and replacing FS-2026-01, its January 2026 guidance on the new deduction for qualified overtime compensation enacted by the One Big Beautiful Bill Act (OBBBA). The revised guidance reflects the transition from the temporary 2025 reporting relief period to a more formal compliance regime applicable for tax years 2026 through 2028. As a reminder, the IRS provided transition penalty relief for tax year 2025 to excuse the requirement that employers and other payers report qualified overtime compensation separately on Forms W-2, 1099-NEC, and 1099-MISC. See Notice 2025-62.
While the updated fact sheet includes numerous technical revisions, several changes are particularly significant for employers, payroll providers, and employees seeking to claim the deduction. Most notably, the IRS emphasizes that beginning in 2026 employees generally may claim the deduction only based on amounts separately reported by employers, increasing the importance of accurate overtime calculations and information reporting.
Key Changes in FS-2026-13
The August update to the FAQs:
- Removes guidance applicable solely to the 2025 transition year.
- Clarifies deduction limitations and timing rules, including that the same principles governing when a payment is treated as wages for income tax withholding purposes apply to determine when qualified overtime compensation is paid.
- Expands guidance regarding Fair Labor Standards Act (FLSA) coverage and exemptions.
- Provides detailed Form W-2, Form 1099-NEC, and Form 1099-MISC reporting rules.
- Adds federal income tax withholding guidance.
- Clarifies the requirement that qualified overtime compensation be separately reported to support the deduction.
Notable Guidance: The W-2 Generally Controls the Deduction
One of the most consequential revisions concerns information reporting. FS-2026-13 confirms that, beginning in 2026, employers must separately report qualified overtime compensation on Form W-2, Box 12, Code TT. In the rare circumstance where a worker is an employee for FLSA purposes but is treated as an independent contractor for purposes of the Internal Revenue Code, the payor must report qualified overtime compensation on Form 1099-MISC (Box 14) or Form 1099-NEC (Box 1d) instead of Form W-2.
For tax years beginning in 2026, the IRS has made clear that separate reporting will become the cornerstone of the deduction framework. The practical implication is that employees may be unable to claim deductions in excess of amounts reported by their employers, even where they believe additional overtime compensation qualifies based on their records. However, an employee cannot just rely on the amount reported on Form W-2, Box 12, Code TT to the extent the employer overstates the qualified overtime paid to the employee.
Specifically, FAQs 20, 21, and 22 make clear that, in determining the deductible amount of qualified overtime compensation, the employee is only entitled to consider overtime compensation that is:
(1) actually paid as qualified overtime compensation during the taxable year, and
(2) reported on the Form W-2, Box 12, Code TT.
If the employer overstates the amount reported, the employee is still limited in his or her deduction to the amount actually paid. If the employer understates the amount reported, the employee is stuck with the amount listed in Box 12, Code TT unless and until they receive a Form W-2c, Corrected Wage and Tax Statement, showing a higher amount. The rationale for this is based on IRC section 225(a), which requires that qualified overtime be separately reported on the employee’s Form W-2 for qualified overtime compensation to be deductible by the employee. As such, any amount not reported on the Form W-2 is not eligible for the deduction, and the employee is not able to use Form 4852 (substitute for Form W-2) to increase the deduction where the employer will not provide a Form W-2c.
This places increased pressure on employers to properly identify, calculate, and report qualified overtime compensation. It also places a burden on employees to ensure their records match what the employer reports on Form W-2 so that they claim a deduction only for what is actually paid, but only to the extent of what is reported in Box 12, Code TT.
New Correction Requirements Increase Employer Exposure
FS-2026-13 adds a new FAQ addressing correction obligations. If an employer discovers an error in the amount reported in Box 12, Code TT, according to FAQ 11, the employer must issue a Form W-2c and provide the corrected form to the affected employee as soon as possible. Failure to do so may trigger information return penalties under IRC sections 6721 and 6722, though reduced penalties may apply for timely corrections.
This guidance, in combination with the guidance that employees are limited to what’s correctly reported on Form W-2, may create new employee relations and litigation risks. Employees whose deductions are limited by inaccurate reporting may pressure employers to issue corrected Forms W-2. Employers that decline such requests or fail to investigate potential reporting errors could face disputes over lost tax benefits.
IRS Provides a Detailed Formula for Calculating Qualified Overtime Compensation
The revised FAQs offer considerably more guidance on calculation methodology than the January version.
The IRS confirms that qualified overtime compensation generally equals:
(Hours worked in excess of 40 during an FLSA workweek) × (½) × (the employee’s FLSA regular rate of pay).
The guidance stresses that only the overtime premium portion qualifies for the deduction. Thus, while an employee generally will receive time-and-one-half pay for overtime hours worked, only the additional one-half premium constitutes qualified overtime compensation.
The IRS guidance also confirms alignment between the deduction and existing FLSA rules for:
- FLSA workweek determinations.
- Hours worked calculations.
- Computation of the FLSA regular rate of pay.
- Alternative overtime calculation methods under the FLSA.
For many employers, these rules may require payroll systems to track data differently than they currently do for state law overtime, collective bargaining agreements, or employer-specific premium pay arrangements.
Expanded Guidance on FLSA Exemptions
Another notable change is the IRS’s expanded discussion of who is and is not eligible for the deduction.
The fact sheet emphasizes that only overtime required under the FLSA can qualify. Employees exempt from the FLSA’s overtime requirements are ineligible for the deduction, regardless of whether they are eligible for or receive overtime-like payments under employer policy, state law, or collective bargaining agreements.
The IRS specifically highlights several common exempt categories, including:
- Executive employees
- Administrative employees
- Professional employees
- Outside sales personnel
- Certain computer employees
- Certain commissioned retail employees
The guidance also adds a new FAQ confirming that employee-owners holding at least a 20% bona fide ownership interest and actively engaged in management generally are treated as exempt executives and therefore are not eligible for the deduction. See FAQ 5.
Non-FLSA Overtime Generally Does Not Qualify
The IRS further clarifies that employers must distinguish between overtime required under the FLSA and supplemental overtime payments provided voluntarily or under other legal requirements.
For example, premiums for:
- Hours worked beyond eight in a day
- Weekend work
- Holiday work
- Double-time arrangements
may exceed what the FLSA requires. In those situations, only the amount necessary to satisfy the federal overtime requirement constitutes qualified overtime compensation. Any excess payment does not generate an additional deduction.
This distinction could prove challenging for employers with complex premium pay structures, multiple state law overtime requirements, or collectively bargained compensation programs.
In particular, the distinction between FLSA-required overtime and state law is likely to create employee confusion and implementation challenges. Some employees will be subject to FLSA overtime exemptions that do not have parallels in state law, such as the seasonal amusement and recreational establishment exemption, specific federal exemptions for auto dealerships/sales mechanics, the highly-compensated employee exemption, and exemptions for certain agricultural and motor carrier workers. For purposes of the deduction, employers therefore will need to independently evaluate whether workers are exempt from overtime under the FLSA regardless of whether the workers qualify for state overtime, creating a new compliance challenge.
New Withholding Guidance
FS-2026-13 also addresses a question many employers have raised: whether withholding should be reduced automatically to reflect the deduction.
The IRS answer is no. Qualified overtime compensation remains fully subject to federal income tax withholding. Employers generally may not reduce withholding unless an employee submits an updated Form W-4 reflecting the anticipated deduction. The IRS also updated the 2026 Form W-4 to allow employees to account for the deduction.
Clarified Eligibility Requirements
The guidance confirms two important employee eligibility requirements. First, under FAQ 25, married employees (within the meaning of IRC section 7703) must file a joint return with their spouse to claim the deduction.
Second, under FAQ 24, the employee must have a social security number that is valid for employment and issued by the Social Security Administration (SSA) before the due date of the employee’s individual income tax return (including extensions). Employees who do not satisfy either requirement are ineligible for the deduction regardless of the amount of qualified overtime compensation reported on their Form W-2.
As a reminder, the deduction is capped at $12,500 per individual return ($25,000 for joint filers) and is reduced for taxpayers whose modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 for joint filers).
What Employers Should Do Now
The revised FAQs signal that the IRS expects robust compliance beginning in 2026. Employers should:
- Review payroll systems to ensure qualified overtime compensation can be separately identified and reported.
- Evaluate whether existing overtime calculations properly track FLSA-required overtime versus non-FLSA premium pay.
- Develop procedures for reviewing employee requests for corrections and issuing Forms W-2c where appropriate.
- Train payroll, HR, and employee relations personnel on the new reporting requirements.
- Review worker classifications and FLSA exemption determinations, as eligibility for the deduction depends on FLSA status.
While beyond the scope of this article, state and local government employers should pay particular attention to the compensatory time rules, and federal agencies should review OPM’s FLSA regulations to ensure their payroll systems properly identify and report the qualified overtime compensation component.
Employers can point their employees to the updated FAQs or Notice 2025-69 if they have questions on claiming the qualified overtime compensation deduction.
Takeaways
The IRS’s focus on separate reporting, correction obligations, and detailed FLSA analysis means that payroll reporting accuracy will directly affect employees’ ability to claim the deduction. Employers that have not yet implemented processes for calculating and reporting qualified overtime compensation should do so promptly, as reporting errors may now carry both tax reporting penalties and employee relations consequences.
