No Tax on Overtime for 2026: How the Overtime Deduction Works

Under the federal tax law enacted on July 4, 2025 (Public Law 119-21, often called the One Big Beautiful Bill Act), workers who earn overtime pay may be able to deduct part of it on their federal income tax return for 2025 through 2028. The idea is simple, but the details matter, especially in California, where overtime rules are more generous than federal law. The IRS updated its questions and answers on the deduction on August 6, 2026 (Fact Sheet FS-2026-13), and starting this year employers must report qualified overtime on Form W-2. Here is what that means for you.

How much can be deducted

Up to $12,500 per return, or $25,000 on a joint return, for each tax year from 2025 through 2028.
Income limit. The maximum is reduced by $100 for each $1,000 of modified adjusted gross income (MAGI) over $150,000, or $300,000 for joint filers.
No need to itemize. The deduction is available whether you itemize or take the standard deduction. It is figured on Schedule 1-A of Form 1040.
Requirements. You need a valid Social Security number, and married couples must file jointly.

Only the “half” in time-and-a-half counts

The deduction does not cover your entire overtime check. It covers only “qualified overtime compensation”: the premium portion of overtime that the federal Fair Labor Standards Act (FLSA) requires, above your regular rate of pay. In most cases that is the “half” in time-and-a-half.

Example: You earn $30 an hour and work 50 hours in a week. The FLSA requires time-and-a-half for the 10 hours over 40, so you are paid $45 for each of those hours. Your qualified overtime for that week is the $15-per-hour premium times 10 hours, or $150, not the full $450 of overtime pay.

If you are not eligible for overtime under the FLSA (for example, many salaried employees who are exempt from the FLSA’s overtime rules), you have no qualified overtime, even if your employer chooses to pay you extra for long hours.

Why this matters in California

California requires overtime in situations federal law does not, such as hours over eight in a workday, and it requires double time in some cases. The IRS has made clear that overtime paid only because of a state law, a union contract, or an employer’s own policy is not qualified overtime. If your employer pays more than the FLSA requires, such as double time, only the amount minimally necessary to satisfy the FLSA counts. For many California workers, this means the deductible amount is noticeably smaller than total overtime pay.

California also does not follow the deduction itself. According to the Franchise Tax Board’s summary of the federal law (last updated October 2026), California does not conform to the overtime deduction, so all of your overtime remains taxable on your California return.

New for 2026: box 12, code TT on your W-2

For 2025, employers were not required to report qualified overtime separately, and workers could use reasonable methods to figure the amount. Beginning with tax year 2026, employers must report the total qualified overtime compensation on Form W-2 in box 12 using code TT.

This makes the W-2 the key document. According to the IRS, for years after 2025 an employee generally may not rely on personal records if the employer leaves qualified overtime off the W-2 or understates it. Instead, the employee needs a corrected Form W-2c from the employer. If your 2026 W-2 does not look right, raise it with your payroll department early.

What the deduction does not change

Payroll taxes. Overtime is not excluded from wages. It is still subject to Social Security and Medicare taxes and to federal income tax withholding.
Your paycheck, unless you act. Employers may not reduce withholding for the overtime deduction on their own. If you want less withheld during the year, you can give your employer a new Form W-4. The 2026 Form W-4 lets you account for the expected deduction in Step 4(b), and the IRS Tax Withholding Estimator has been updated as well. Be careful not to under-withhold, especially since California still taxes the overtime.

For employers

Track FLSA-required overtime premiums separately from overtime paid under California law, union contracts or company policy.
Report the qualified amount on 2026 Forms W-2 in box 12, code TT. If you discover an error, the IRS says you must file and furnish a Form W-2c as soon as possible.
Talk with your payroll provider now, before year-end, so the numbers are right when W-2s are prepared in January.

Steps to take now

Review your pay stubs to see how your overtime is calculated and labeled.
If your income is near the $150,000 or $300,000 threshold, consider how year-end bonuses or pre-tax (traditional) retirement contributions affect the phase-out.
If you reduce federal withholding, make sure your California withholding still covers your state tax.

Sources

Overtime rules can get complicated quickly, especially for California employers. Don’t hesitate to contact the office or call us at (858) 549-1295 if you have questions.

This article provides general information as of October 2026 and is not tax advice for your specific situation. Tax rules change, and the right answer depends on your facts.