What Businesses Should Know About the New Overtime Deduction

The Department of the Treasury and the Internal Revenue Service issued new guidance on a deduction tied to overtime pay under the One Big Beautiful Bill Act. The newly released IRS FAQs clarify how the deduction works, confirm transitional relief for 2025, and identify where employees should look for authoritative information. Understanding those boundaries may help employers respond consistently to questions that may surface as employees seek clarity on eligibility, calculations, and documentation.

A Brief Overview of the Deduction

The One Big Beautiful Bill Act introduced a new deduction for qualified overtime compensation for tax years 2025 through 2028. Under the law, individuals may deduct the portion of overtime pay that exceeds their regular rate, generally the half portion of time-and-a-half pay required under federal law.

In January, The Department of the Treasury and the IRS released a fact sheet with frequently asked questions addressing eight common areas of uncertainty including eligibility, calculation methods, and reporting. These FAQs are intended to provide timely guidance and may be updated as additional review occurs.

What Employers Need to Know for 2025

For the 2025 tax year, employers are not required to change payroll reporting practices. Qualified overtime compensation does not need to be separately reported on Forms W-2, 1099-NEC, or 1099-MISC. The U.S. Treasury and the IRS also provided penalty relief related to the new reporting rules under Notice 2025-62.

This relief reflects a practical limitation. Payroll forms for 2025 were not updated to accommodate separate reporting of qualified overtime compensation. As a result, mandatory reporting has been deferred until 2026. While some employers may choose to provide supplemental information, there is no requirement to do so for 2025.

AAFCPAs advises that clients view 2025 as a transition year focused on awareness.

Questions Employees May Ask and How to Address Them

Even without new reporting requirements, employees may have questions, including:

• Am I eligible for overtime under federal law?
• Does my overtime qualify for the deduction?
• How do I determine the deductible amount?
• What is the maximum deduction, and are there income limits?

A central consideration is Fair Labor Standards Act (FLSA) status. Only overtime required under the FLSA qualifies for the deduction. Employees eligible under the FLSA generally must receive overtime pay for hours worked in excess of 40 in a workweek at a rate not less than one and one-half times their regular rate. Whether an employee is covered and not exempt is a fact-specific determination based on job duties, compensation structure, and other factors.

AAFCPAs advises that clients direct employees to Notice 2025-69 and the instructions to Schedule 1-A of Form 1040 for detailed guidance on calculating the deduction. For clients uncertain about how FLSA classifications apply across different roles or evolving positions, AAFCPAs can help to ensure clarity and compliance.

Looking Ahead to 2026

Beginning in 2026, employers will be required to separately report qualified overtime compensation using updated payroll forms. Although those requirements are not yet in effect, the guidance signals the direction of future reporting and reinforces the value of early awareness.

Being familiar with IRS guidance, knowing where to direct employees, and reviewing internal processes related to overtime eligibility may help organizations navigate this change smoothly. AAFCPAs encourages clients to reach out with questions to ensure consistent application and informed responses.

How We Help

AAFCPAs supports businesses and entrepreneurs in navigating complex tax developments including the new qualified overtime deduction and other OBBBA provisions by offering integrated guidance across business tax and entrepreneurial tax and advisory. We help employers address questions about FLSA status, eligibility, and reporting while guiding you in pointing employees to authoritative IRS resources and ensuring consistent and compliant communication. Our approach combines proactive planning, compliance, and coordination across payroll, benefits, and operational processes to align with broader tax strategies. Whether managing international, federal, state, or local tax obligations, optimizing deductions, or planning for long-term financial health, AAFCPAs provides practical guidance that helps organizations and their owners make informed decisions while reducing administrative burden.

These insights were contributed by Greta Whelan, CPA, MST, Tax Director.

Questions? Reach out to our author directly or your AAFCPAs partner.

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