Clarifying the definition of “qualified overtime"
The IRS has issued a new fact sheet outlining guidance on four major tax deductions introduced by the One Big Beautiful Bill Act (OBBBA). This tax resource helps tax preparers interpret and apply the latest OBBBA updates, including deductions for employee overtime, reported tips, the newly created senior tax deduction and deductible interest on car loans.
The intent of Congress behind IRC Section 225, as introduced in H.R. 1, is becoming clearer, but not without debate. The definitions and transitional rules and reporting implications have backing from the IRS, major payroll providers and the Bipartisan Policy Center. Still, some areas remain unsettled and require further clarification, specifically the definition of “qualified overtime”. In the absence of additional guidance, here’s our best interpretation based on what’s currently available.
1. Definition: “qualified overtime compensation”
- Only the premium portion of overtime pay counts, that is, the amount over the regular rate, as required under FLSA § 7 (e.g., 0.5 × the regular pay)
- Example: If regular pay is $20/hr. and overtime is $30/hr., then $10/hr. × overtime hours = qualified overtime.
2. Transitional rule for 2025
- The deduction applies retroactively to Jan. 1, 2025, and remains effective through 2028.
- For tax year 2025 only, employers may use “any reasonable method” (per Treasury guidance) to estimate qualified overtime and tips reported on W-2s.
- Treasury may later define acceptable methods; employers choosing not to include reasonable estimates will still comply, but employees may miss the deduction unless it is adjusted later.
3. Reporting and payroll implications
- Employers should:
- Track overtime hours and calculate the premium portion per employee
- For 2025, pick a reasonable estimation method (e.g., percentage of overtime hours × average premium) for payroll postings.
- Voluntarily report estimated qualified overtime on Form W-2, separate from total earnings
- Track overtime hours and calculate the premium portion per employee
- After Treasury issues guidance, employers might adjust W-2s or provide corrected Forms 1099 for affected employees.
- For 2026 and beyond, payroll systems should natively compute and separate qualified overtime every week, consistent with the FLSA.
4. Example: Jane the barista working during the 2025 transition period
- Jane’s weekly work details:
- 50 hours, including 10 hours of overtime
- Regular pay rate is $20
- Total pay = $1,200 (40 hours x $20 = $800) + (10 hours x $30 = $300)
- Qualified overtime = $100 (10 hours x $10 premium above $20 regular hourly rate)
- W-2, Box 14 (or separate code), shows $100 qualified overtime (estimate OK)
- For 2026 and beyond, accurately compute and report the actual $100 per week.
- Tax outcome: Jane deducts qualified overtime from AGI, subject to the annual cap ($12,500 for individuals, $25,000 for joint filers).
5. Why the transitional rule matters
- Provides administrative relief for employers adapting payroll systems mid-year
- Ensures employees aren’t deprived of the benefit simply because retroactive calculations weren’t built into payroll systems from Jan. 1
- Reliance on estimates means employees should review W-2s and may need to make amendments once final guidance is released
6. Next steps for employers
- Select a reasonable estimation method now (e.g., proportional allocation)
- Track and report qualified overtime on 2025 W-2s accordingly
- Monitor Treasury releases for official guidance
- Upgrade payroll systems for accurate 2026 reporting
We’ve updated our tax summary to reflect this new information.
NATP is closely following the released guidance and will communicate with our members as additional details are provided.
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