ttention: This is a machine-generated transcript. As such, there may be spelling, grammar, and accuracy errors throughout. Thank you for your understanding!
Jeremy Wells: They say politicians campaign in poetry, but they govern in prose. And nowhere is that more evident than in tax policy. Consider the new quote no tax on overtime deduction added by public law 11921. Otherwise [00:00:30] known as the One Big Beautiful Bill act of 2025. The language used to describe that provision, both during the legislative negotiations and since the law's enactment, presents an interpretation that just flat out does not match the actual effect, and that can leave both taxpayers and tax professionals confused. So in this episode, I'm going to break down exactly how the overtime deduction [00:01:00] works, including what overtime compensation qualifies. How to calculate the deduction and how to handle erroneous overtime reporting by employers, which is going to be especially important starting in 2026. And we'll talk about that. We'll also throughout the course of this episode, think about how to discuss this deduction with taxpayers and clients who are going to be responding to everything they've heard in the coverage of [00:01:30] the law and the deduction. And again, a lot of that is not going to match up with the way the deduction actually works. So we'll talk about separating fact from fiction in this episode on the qualified overtime deduction. So upon completion of this course or after you finish listening to this episode, you should be able to classify qualifying overtime compensation. There's a lot of different kinds of compensation that may or may not be called overtime. We'll talk about [00:02:00] what for purposes of the deduction actually is qualifying overtime compensation.
Jeremy Wells: We'll also look at how to calculate the qualified overtime deduction on the new schedule one A that was introduced for tax season 2025. We'll also evaluate employer overtime reporting with respect to potential errors and what workers are going to have to do if those errors occur. The rules were very [00:02:30] relaxed in 2025 because the deduction was new, and all of those provisions that allowed a lot of on the fly calculations are not going to be available starting with tax year 2026. So taxpayers and their tax professionals are going to have to be on the watch to make sure that employers are correctly reporting these amounts on their w-2s and potentially very rarely [00:03:00] some other forms as well, which we'll talk about. So let's get into the no tax on overtime deduction. The one big beautiful bill act section 70202 added the new IRC section 225. Now this is important because the Oba actually renumbered some of these sections. What [00:03:30] ended up being section 224 for the no tax on Tips deduction. And then 225 for the no tax on overtime deduction. Uh, I might talk about the no tax on tips in a future episode. Uh, I haven't scheduled that one yet, but I am working on the notes for that one. But right now we've recently, as of the time of recording, had some updates on the no tax on overtime.
Jeremy Wells: So I wanted to get this course put together so that you've got it in time [00:04:00] for the next filing season. Now, this new IRC section 225 provides for a deduction based on qualified overtime compensation. And that is a phrase you will hear me use over and over and over again in this episode, because that's the phrase that shows up in the code section qualified overtime compensation. It's going to be important to understand that not all overtime [00:04:30] will qualify for this deduction. There is only certain overtime compensation that will actually qualify. And especially starting in 2026, that compensation is going to have to be reported in a very specific way in order for the earner to be able to take advantage of the deduction That compensation is going to have to be reported on a form W-2 or in [00:05:00] some rare instances, on a 1099 neck or 1099. Miscellaneous. We'll talk about where that might occur and later on in the episode. The deduction is effective for taxable years beginning after December 31st, 2024. So tax year 2025 for calendar five for a calendar year, filer is going to be the first year where they're able to get this deduction. And then there's no deduction [00:05:30] allowed currently under the law for any taxable year beginning after December 31st 2028. So again, for a calendar year, filer tax year 2028 is going to be the last year of that deduction. So we're really only talking about four years here 2025 through 2028 barring any extension, whether temporary or permanent, of this provision by Congress, and it would take an [00:06:00] act of Congress to extend this deduction any further beyond the year 2028.
Jeremy Wells: This deduction is available for Non-itemizers. However, it does not reduce adjusted gross income, so it is not an adjustment to income. It is. So it is not going to appear on schedule one. But it's also not an itemized deduction. It's available to taxpayers [00:06:30] who take the standard deduction as well as the ones who itemize. So it's not going to appear on schedule A either. It's neither an above the line deduction, meaning it doesn't reduce AGI and it's not a below the line deduction, meaning you don't have to itemize to take it. There are actually four new deductions created by the ob A. This is one of them. The qualified overtime deduction. There's also the qualified Tips deduction which I just mentioned [00:07:00] the qualified vehicle passenger loan interest deduction and then the deduction for seniors. Those are all together reported on the new schedule one A which was introduced for tax year 2025. We'll talk later on in the episode about how the calculation of the no tax on overtime deduction works on schedule one a and because I've used that phrase [00:07:30] as it appears in the ob A and as it appears on schedule 1AA few times now, I want to make sure that I'm clear.
Jeremy Wells: No tax on overtime, just like no tax on tips or no tax on Social Security is not what actually happens. Those phrases might give the impression that those types of income are exempt or excluded from tax. Rather, [00:08:00] these four provisions in the ob A actually create deductions that have limitations and phaseouts. They are not exemptions of income. They are not exclusions from income. Qualified overtime compensation remains included in gross income, and because it is part of a worker's compensation, it is subject to federal income tax [00:08:30] withholding, Social Security and Medicare taxes and federal unemployment tax. And depending on the state, it's likely also subject to state income tax withholding as well as other state taxes such as unemployment tax. So the critical thing to keep in mind here as we're discussing no tax on overtime as well as the other ob A, uh, deductions or the, uh, tax [00:09:00] cuts for working class families, as they're also described by the administration and some in Congress. Those are deductions, and they are not exclusions or exemptions from income. Like I mentioned, the deduction is subject to limitations and income phaseouts. So the qualified overtime deduction cannot exceed [00:09:30] $12,500 or $25,000 on a joint return. That is the maximum possible qualified overtime deduction, $25,000 for married filing jointly. $12,500 for all other filing statuses, no matter how much qualified overtime compensation, no matter from how many different sources the taxpayer has. Those are the hard limits [00:10:00] for this particular deduction.
Jeremy Wells: Moreover, the deduction is reduced by $100 for every full $1,000 of modified adjusted gross income, over $150,000, or $300,000 on a joint return. And it's important to keep in mind that that reduction applies [00:10:30] to the deduction after the cap, after that limitation. And we will look at examples of how that works later on. So when we talk about the calculation of the deduction. The first thing we're going to look at is the amount of qualified overtime compensation. Then we're going to look at that hard limit at $12,500 or $25,000 for a joint return. And then we're going [00:11:00] to look at the reduction that income phaseout based on modified AGI. For purposes of this deduction, modified AGI means adjusted gross income without the income exclusions under IRC sections nine, 11, nine, 31, and 933. 911 is the foreign earned income exclusion, and nine, 31 [00:11:30] and 33 are for overseas territories, possessions and Puerto Rico. Now, it's important to keep in mind that none of the amounts that I've just gone over the hard limits of $12,500, or $25,000 on a joint return, and the modified AGI thresholds of $150,000, or $300,000 on a joint return. And those reductions of $100 [00:12:00] for every thousand dollars of modified AGI. None of those amounts are indexed for inflation. There is no provision in section 225 that allows for indexing those amounts. So for the four years that this deduction is allowed, there is no accounting for inflation.
Jeremy Wells: Those are the amounts for all four years. So once you know those amounts you don't have to worry [00:12:30] about them changing each year due to inflation. Those will be those amounts for the next four years. As long as Congress does not change or alter this law. This particular code section in any way. By the way, that all comes from IRC section 225 B essentially, for the first part of this episode, we're walking through IRC section 225. There is some other guidance from IRS. We'll go over later. [00:13:00] However, uh, pretty much all of what we have for the deduction comes from the code section itself. When we start talking about what qualified overtime compensation means, this is where we as tax professionals, uh, or if you're listening to this as a business owner or an employer, you're going to have to get a little bit familiar with federal employment law, [00:13:30] at least in terms of the Fair Labor Standards Act. So for the purposes of qualified overtime deduction, Qualified overtime compensation means compensation required under the Fair Labor Standards Act, or FLSA, section seven, in excess of the employee's regular rate. And we're going to break down what a lot of that means. It's [00:14:00] important to keep in mind that tips deductible under the new IRC section 224 do not qualify. So any qualified tips that are deducted under that ob A provision, which is the new IRC section 224.
Jeremy Wells: Those do not qualify. So tips normally would be included in compensation and could potentially be included in overtime compensation. However, that [00:14:30] could allow for a double deduction that is specifically prohibited in IRC section 225 C, so any amount of tips deducted under section 224 do not qualify as qualified overtime compensation under IRC section 225. This is where we have to start getting familiar with federal labor law. 29 U.S.C. section 207, which [00:15:00] is the codification of FLSA. Section seven that I mentioned earlier, generally prohibits an employer from employing a worker for more than 40 hours during a workweek, unless the worker receives compensation for those excess hours at a rate not less than one and one half times the regular rate. Put that another way if the employee [00:15:30] is covered under FLSA and is Nonexempt, and we'll talk about what that means here in a bit. If the employer is covered under FLSA and works more than 40 hours in any given workweek, then that employee is has to be paid at least one and a half times their normal rate for the hours in excess of 40 hours. [00:16:00] We'll look at some examples later on of how this works in practice. But in general, if an employee works more than 40 hours in any workweek, the employer has to pay the employee at least one and a half times her regular rate for each hour, over 40 hours. Each workweek stands alone, meaning that hours do not carry over into future weeks, and any hours worked [00:16:30] in excess are not absorbed by prior weeks with fewer than 40 hours.
Jeremy Wells: So the unit of work here that we're concerned with when it comes to qualified overtime compensation is the workweek. That is the unit that we're looking at. The regulations under 29 U.S.C., section 207 define a workweek as a period of 168 continuous [00:17:00] hours, or seven continuous 24 hour periods. And like I said, each workweek stands alone and a workweek begins when it is established. And the regulations don't really say who establishes it. But we would assume that the employer would establish the workweek based on determining when that employee is going to work and the pay periods for [00:17:30] that employee. Now, the regulations do require that the workweek must remain consistent. It can be changed. An employer can change an employee's workweek, but not if the intention is to avoid paying overtime. So in other words, once that employee is hired to a certain workweek, the only time the employer can change that workweek is is if there [00:18:00] is some pressing business need to do so. Other than that, changing that employees work week could potentially, uh, appear like avoidance of having to pay overtime. And if that is the intention, then that employer is required to maintain the same consistent workweek for that employee. Now, I mentioned before that each workweek stands alone. Consider, for example, [00:18:30] that an employee works 30 hours in one work week and then 50 hours the next work week, then 35 hours in the third workweek.
Jeremy Wells: So altogether, that employee might have overtime in 1 or 2 of those weeks, but not overall. However, the unit of analysis here is the individual workweek without regard to any prior [00:19:00] or following workweek. So in this case, even though there was a deficit of hours, there were hours under 40 in the first week and the third week in that middle week, that employee worked in excess of 40 hours. In fact, that employee worked 50 hours. So that is ten hours for that workweek that the employer must pay that employee if covered under FLSA must pay that employee [00:19:30] at least one and a half times that employee's regular rate for that ten hours in excess of 40 hours. During that workweek, the employer cannot add together the first two weeks and say, well, on average, that's 40 hours a week. So there's no overtime to be paid. That's not how it works. The employee works more than 40 hours in any given workweek, regardless of how much that employee worked any weeks prior or after. [00:20:00] Then that employee is due overtime pay for that workweek. An employer can establish a single workweek for a location or department as a whole, or different work weeks for different employees or groups of employees. Now, I would not recommend this for payroll purposes and just for administrative purposes, but it's entirely possible that an employer can create unique work [00:20:30] weeks for different locations, departments, groups of employees, or even individual employees.
Jeremy Wells: That might make sense for various reasons. However, the more different work weeks you introduce into your payroll system, the more likelihood you have for confusion and then eventually mistakes. But like I said, once that work week is established for an employee, it remains fixed regardless of [00:21:00] the schedule of hours worked by the employee. So once an employee is on a certain workweek, even if that employee is schedule weekly work rotation, for example, changes that employee stays on that same workweek unless the employer needs to make a change to the beginning of a work week, which is intended to be permanent [00:21:30] and is not designed to evade the overtime rules in the FLSA. The simplest approach here would be to establish a workweek, and it does not have to follow the calendar week, but it can. So the simplest approach here would be to establish a workweek that is the calendar week and tell managers and those with scheduling authority over employees. If your company is trying to minimize [00:22:00] the amount of overtime that it's assigning to monitor its employees schedules and attempt to either spread the work out more evenly across different employees, or to monitor individual employees who tend to rack up more overtime and limit them from doing so. Um, that is just the nature, especially of hourly employees.
Jeremy Wells: And I've had clients where the payroll costs seemed [00:22:30] excessive. And when we looked back through the payroll records, it was because a handful of employees were racking up significant overtime. Sometimes that is necessary. Sometimes those employees have relatively unique skills or attributes or even work schedules within the company. And so the company becomes more reliant on those particular individuals and is in a position where overtime is just a necessity for those particular employees. [00:23:00] But from a business perspective, paying one and a half times minimum a employees rate when other employees could be working those hours and may not have gotten to 40 hours within a work week, that is an important business consideration that you should be working with either an accountant or a payroll professional to be looking for those kinds of situations in your own businesses. The [00:23:30] regulations for the FLSA are in 29 Code of Federal Regulations, part 778. That part includes all of the Department of Labor's regulations with respect to FLSA. There's a lot of detail in that part of the regulations that deal with what qualifies as overtime and how overtime should be calculated. So if you have questions from a client [00:24:00] or within your own business as to the specifics of federal overtime law, then looking at the FLSA and that particular part of the regulations is where you should be able to find answers. Again, this is this is a bit awkward for.
Jeremy Wells: Tax professionals because we are by nature not necessarily experts in federal labor law. However, when [00:24:30] Congress creates a deduction for workers that is based on federal labor law, that puts us in a position where we are going to have to become more familiar with this part of federal federal law. At the same time, it's important to understand that we are not necessarily labor law experts. So when it comes to questions [00:25:00] of the treatment, specific treatment of employees and what employers can and cannot do with regard to their employees, the smart move for a tax professional would be to refer that client to an employment attorney, or a human resources or HR professional, someone who is a professional in the space of labor law and labor relations, to make sure that the employer [00:25:30] is doing the right thing in those situations. The only legal analysis we as tax professionals, should really be doing here is whether the overtime compensation is considered qualified overtime compensation for purposes of this deduction. And to some extent, making sure that payroll is correctly and properly reporting that [00:26:00] qualified overtime compensation. It's not necessarily that we need to become experts in labor law, and then therefore take on the HR and payroll clerk responsibilities of clients or the small businesses that we work with, but we do need to be familiar enough with it just to be able to make sure that what is being reported and handled as far as overtime compensation and the reporting of that for tax purposes, is correct.
Jeremy Wells: Now, [00:26:30] I mentioned earlier that this only applies to the qualified overtime compensation, and therefore the deduction only applies to FLSA covered and Nonexempt employees. In other words, an employee must be covered by FLSA and not exempt from it in order to qualify for the deduction. Only overtime pay that is required under FLSA [00:27:00] section 7 or 29 U.S.C. 207 qualifies for the deduction. Whether an individual is covered by and not exempt under the FLSA is a fact specific determination that depends on the individual's occupation, work activities and earnings. Again, we are not necessarily experts in labor law, [00:27:30] but we are going to have to work with our small business clients to make sure that they understand the importance of correctly categorizing their employees as FLSA covered and Nonexempt for the purposes of correctly reporting their overtime through payroll. And that is going to be a facts and circumstances determination for each individual [00:28:00] employee. It's also important to keep in mind that voluntary or state mandated overtime compensation that is in excess of the FLSA requirements does not qualify for the deduction. Remember the FLSA requirement is that for covered nonexempt employees, the employer must pay at least one and a half times the employee's normal [00:28:30] rate. So that is the requirement under FLSA. One and a half times the employee's normal rate for any hours during the work week in excess of 40.
Jeremy Wells: Anything above and beyond that, that is either voluntary by the employer or mandated by a state or local government, not the federal government, not under FLSA. Anything [00:29:00] in excess of that minimum FLSA requirement does not qualify for the deduction. And we'll look at some examples later on of how we calculate the deduction when we have these extra forms of compensation included. Now, what are some of these exemptions to FLSA? Common exemptions include those working in executive administrative, professional, outside sales and certain computer [00:29:30] analyst and programmer roles. There is a list that the Department of Labor provides, along with other information on coverage and exemption under the FLSA. In fact, sheet number 14 coverage under the Fair Labor Standards Act. There's also the handy reference guide to the Fair Labor Standards Act. Those are both Department of Labor publications. So if you search for those terms online along with the phrase Department of Labor, you should be able to [00:30:00] pull up those reports and be able to find out what exactly is meant by executive, administrative, professional, outside sales and certain computer analyst and programmer roles and determine whether a certain employee is covered or exempt from FLSA. Now all of this is discussed in notice 2020 569 from the IRS. We're going to talk more about that notice here in just a minute. Back to IRC section 225DA [00:30:30] taxpayer must include her Social security number on the return.
Jeremy Wells: To qualify for the deduction, IRS will treat a missing or incorrect Social Security number as a mathematical or clerical error. Note that a mathematical or clerical error is an exception to normal deficiency assessment procedures in IRC section 6213, which allows the IRS to assess additional tax without first [00:31:00] issuing a notice of deficiency. If a taxpayer claiming the overtime deduction fails to provide a Social Security number, it's going to be very important to make sure that a taxpayer claiming this deduction has a proper Social Security number. Now, that means that a work authorized Social Security number issued before the returns due date, including extensions, satisfies the requirement. However, [00:31:30] I tens do not, so I-10 holders cannot qualify for this deduction. It must be a Social security number, but it can include a work authorized social security number that is issued by the returns due date, including extensions. Now what's interesting is and we'll mention joint returns here in a minute. But neither the statute nor subsequent IRS guidance clarifies [00:32:00] what happens on a return on a joint return, when only one spouse has a Social Security number. What it. What the text of the code section says is that the taxpayer essentially claiming the deduction, earning and reporting the qualified overtime compensation must have a Social Security number. The code section does not say anything about the. Another [00:32:30] spouse that is on that return having a Social Security number. So speaking of married taxpayers, as I mentioned before, the threshold and the limitation on the deduction are doubled for married taxpayers filing a joint return.
Jeremy Wells: On the other hand, married taxpayers, as defined under IRC section 7703, must file a joint return to [00:33:00] qualify for the deduction. There is no deduction available for a married filing. Separate return. So the only filing statuses that allow the deduction are single head of household and married filing jointly married filing separately does not get the deduction. Now section 7703 B treats certain spouses living apart as not married. So, for example, an abandoned spouse [00:33:30] claiming head of household can claim the deduction without a joint return. This depends on filing status, not necessarily legal married status. So it's important to understand exactly what filing status your client really is. Or if you're a taxpayer, what your actual filing status is not necessarily just your legal marital status, but rather your filing status based on whether you are married or not. [00:34:00] Now for 2025, because the Oba was past mid year and a lot of this was new. Irs granted reporting and calculation relief for tax year 2025. First, IRS provided transition penalty relief to employers in notice 2020 562 that effectively dropped the requirement to report qualified overtime compensation [00:34:30] separately on forms W-2, 1099, NAC, and 1099 miscellaneous. That is a bit of a of a strong way to phrase that. However, what ended up happening is that most employers opted to either provide some sort of separate accounting for qualified overtime on a pay stub, or on some other report given to employees and omit any reporting from the W-2.
Jeremy Wells: We'll talk about how that's going to be different in 2026 [00:35:00] here in a minute. The IRS encouraged, but did not require employers to provide workers with the necessary information to calculate and report their qualified overtime deductions, such as including the amount of qualified overtime compensation on pay stubs or in box 14 of form W-2. We'll see. Starting with 2026, that requirement is going to move to box 12 and become a more formalized requirement on the W-2. Irs also [00:35:30] provided reasonable methods for taxpayers to calculate the deduction when employers didn't report qualified overtime compensation in notice 2025. 69 in fact, that notice 2020 569 provided seven different reasonable methods for employees to use to calculate the deduction that notice, and those reasonable methods for calculating the deduction are specific [00:36:00] to tax year 2025, and they will not apply to any other tax year, including 2026. That particular notice allowed employees to reasonably estimate their deduction using the information that they could get from their employers. That's not going to be true for 2026. That reporting relief ends after tax year 2025, so [00:36:30] IRS issued updated FAQs regarding the qualified overtime deduction on August 6th of 2026. These FAQs supersede the earlier FAQs that were issued in January of 2026, and they make it a little more difficult for both employers and their employees to correctly report the qualified overtime compensation deduction.
Jeremy Wells: Employers [00:37:00] must now report the full amount of qualified overtime premium paid on form W-2. Box 12 code TT. So it's no longer okay to just provide that information on a pay stub or other statement. And it's no longer okay to include that amount in box 14. That amount must be reported in box 12 code TT. Now it's also possible for [00:37:30] a worker to be paid as an independent contractor, but earn over time under federal labor law. Irs says in the FAQs that this is going to be exceedingly rare. However, both the statute and IRS allow for the remote possibility that an individual could be an independent contractor for income tax purposes, but an employee for [00:38:00] labor law purposes. So form 1099 NEC now includes box one. D starting with 2026 and form 1099. Miscellaneous includes box 14. That's where you're going to see overtime paid to someone whose payments are reported on those forms. Now, if a worker disagrees with the amount of qualified overtime compensation reported [00:38:30] on a form, she must request a corrected form from her employer. However, a taxpayer cannot claim a deduction for more qualified overtime compensation than was actually paid. So the practical rule here is effectively, the taxpayer is allowed a deduction based on the lesser of the amount of qualified overtime compensation actually paid or [00:39:00] the amount properly reported by the employer.
Jeremy Wells: If the employer makes an error in the reporting, that would be in the taxpayer's favor. The employee still has to limit the deduction based on what was actually paid, not what was reported. However, if the employer reports less than what the employee earned in terms of qualified overtime compensation, the only recourse available [00:39:30] for the employee is to request a corrected form, such as a corrected W-2 or corrected 1099 neck or miscellaneous. An understated W-2 caps the deduction, but an overstated W-2 doesn't expand it beyond what was actually paid and received. So note that form 4852 does not satisfy the requirement under section 225 A because it is not furnished pursuant [00:40:00] to section 6051 A 19. And that is the language directly from that IRS fact sheet that provides those updated FAQs. So in other words, a worker can't use the substitute form for an erroneous W-2 to claim the deduction. Only a corrected W-2 from the employer will work in such a case. I want to make here a brief point about IRS guidance in the form of these FAQs and fact sheets. [00:40:30] These are non-authoritative, meaning they cannot be relied on or used by the IRS to resolve a case. And if an FAQ incorrectly interprets the law, then the law obviously prevails. However, good faith reliance on the. This IRS non-authoritative guidance provides reasonable cause penalty protection, So even if you disagree with the FAQs relative to your [00:41:00] reading of the law.
Jeremy Wells: Following the guidance provides protection against a reasonable cause penalty. So it's it's. Against a penalty based on a reasonable cause position. So it's important to keep these FAQs in mind. Even if you disagree with IRS's interpretation on these points, let's work through some examples to illustrate what's happening with this deduction. So first of all, let's consider Eves 2025. [00:41:30] W-2 doesn't report her qualified overtime compensation. However, her final pay stub for the final payroll run of the year shows year to date over time premium of $5,000. Now, for the purposes of determining the amount of the qualified overtime compensation received in tax year 2025, she can include $5,000 or that FLSA overtime premium in the [00:42:00] calculation of a qualified overtime deduction. Now, I want to make a note here that for 2026, Eve would not be able to use any of her qualified overtime compensation, even if it was provided to her on a pay stub or other statement from her employer, because it was not correctly reported on her W-2, she would need to ask her employer for a corrected W-2 before she could claim that deduction. So for 2025, [00:42:30] she can use that pay stub from her employer for 2026. That's not allowed unless that amount is reported correctly on her W-2 in box 12 using code T. So for all of these examples. Note that different employers and payroll providers are going to use terms differently and or interchangeably.
Jeremy Wells: I'm using overtime premium here [00:43:00] to mean the FL s a half time premium. Always confirm what an amount actually is before you start applying the rules that I'm about to go through here. Now consider Eves 2025. W2 still doesn't report the qualified overtime compensation, but the pay stub for the final payroll run shows year to date over time of $15,000. Not overtime premium, but overtime. [00:43:30] Eve confirms with her employer that this is the amount of her total overtime pay at one and a half times her regular rate for her hours over 40 hours in a workweek. So this is her total overtime compensation. So for purposes of determining the amount of qualified overtime Compensation received. Remember, she can only deduct the FLSA premium, the half of the one and a half [00:44:00] portion of that overtime pay. So she needs to take that $15,000 and divide it by three. Because the first $10,000 was at her normal rate. The last $5,000 was at her one and a half times rate. That is the FLSA overtime premium. Now consider a situation where she is paid an overtime premium [00:44:30] of $10,000. She confirms with her employer that this amount is the portion of her double time pay in excess of her regular rate, or 1.0 times the regular rate. So effectively she's paid the regular rate. And then that amount doubled for her hours, over 40 hours in a workweek. She receives double time for overtime hours. [00:45:00]
Jeremy Wells: So for purposes of determining the qualified overtime compensation, she can include $5,000, right. Half of that overtime premium. That is not her FLSA overtime premium. The full $10,000. Only $5,000. Only the one and a half times her normal rate is her FLSA overtime premium. And so that's the only qualifying amount [00:45:30] she can use for the deduction. She was paid $10,000 overtime premium. But that's based on double time not one and a half time. Now consider a similar situation where her total overtime on the pay stub is $20,000. Right? So for purposes of determining her qualified overtime compensation, she would need to divide by four because that $20,000 represents the full amount of [00:46:00] double time overtime paid to her. So only one quarter of that is her actual FLSA overtime premium. Now let's look at how the deduction is actually calculated. And remember all of those examples from 2025 are out the door. Because for 2026 those amounts will have to be properly reported on form W-2. Box 12 code TT. If there is a question [00:46:30] about the amount in box 12 code TT, then the employee is going to have to take that up directly with the employer. And if it's found to be that it is an error, there's going to have to be a request for a corrected w two before that taxpayer can claim the deduction. Let's look at how the actual deduction is calculated though. So in 2026 Amos a single taxpayer received [00:47:00] $15,000 in qualified overtime compensation.
Jeremy Wells: So that $15,000 is the actual FLSA premium amount. That is the correct amount of qualified overtime compensation that's going to be reported on his W-2. Box 12 code TT. Now his modified AGI is $75,000 for the year. So he is below the $150,000 Magi limitation. [00:47:30] So he can deduct up to $12,500 of his overtime pay on his federal income tax return. Now, why only $12,500? Because that is the top limit for a single filer. A joint filer would be up to $25,000, but a single or head of household filer is half that $12,500. The remaining $2,500 of [00:48:00] qualified overtime compensation is not deductible. And in section 225, there is no provision for any kind of carryover. So that extra $2,500 of qualified overtime compensation is never going to be deductible. Now consider the same taxpayer. But his modified AGI for the year is $175,000. So that is $175,000 [00:48:30] is $25,000 in excess of the AGI, the modified AGI limit for a single filer. So his modified AGI reduces his maximum deduction after the cap by $2,500, or $25,000 divided by $1,000. That's 25 times $100 for each thousand dollars of Magi over the limit, [00:49:00] so that $2,500 reduces the maximum deduction after the cap. So the maximum deduction would have been $15,000, but it's limited to $12,500 by the filing status limit. Then that $2,500 Magi reduction, or phaseout takes the deduction down to just $10,000.
Jeremy Wells: So even though Amos [00:49:30] as a single individual, could deduct up to $12,500 and receive $15,000 in qualified overtime compensation because of the limit and the phase out. He can only deduct $10,000 of that overtime pay, and that remaining $5,000 is never going to be deductible. Now consider Amos in 2026 is a married taxpayer who files jointly with a spouse, receive $15,000 in qualified overtime compensation [00:50:00] during the year. Their Magi is $250,000. They can deduct the full $15,000 of his overtime pay, because the maximum deduction for a married couple filing jointly is $25,000. Even if only one of the spouses is earning the overtime compensation, the maximum deduction on a joint return is $25,000. [00:50:30] But now consider the same situation. Only the Magi is $450,000, so the Magi reduces the maximum deduction after the cap by $15,000, or $150,000, because the threshold is $300,000 and Magi is $450,000, so that $150,000 divided by 1000 and then times $100. So that's $15,000. [00:51:00] So the phaseout reduces their otherwise allowable $15,000 deduction to zero. They can't deduct any of the overtime pay on their joint income tax return. So it's going to be important when you're doing tax projections and planning for 2026 to not only take into account the filing status and the Magi limit, but [00:51:30] also make sure and ask for pay stubs to make sure the employer is correctly reporting that overtime compensation. Now all of this gets reported on schedule one, a part three, line 14 A of the 2025 version, which is the only version available.
Jeremy Wells: The 2026 version isn't available yet, so there may be slight differences with the 2026 version, but based on the 2025 version, line 14 A was for qualified overtime compensation reported on a W-2. [00:52:00] Line 14 B was qualified overtime compensation reported on forms 1099 N, e C or miscellaneous. Again, IRS has said that should be exceedingly rare, but it is possible. And then line 14 C is the sum of those two. Line 15 will apply the filing status cap, so either 12,500 or 25,000 if a joint return. Remember, there is no deduction for married filing separately and then line 16 through [00:52:30] 20. Calculate the Magi phaseout and line 21 is the actual deduction. A couple of key takeaways here from this episode. First of all, Congress did not exclude overtime income, even though that's what the no tax on overtime. And the discussion around that makes it sound like it is not an exclusion. It created an individual deduction based on a particular slice [00:53:00] of FLSA overtime compensation. It is also not the entire overtime compensation. It is only the excess over that earner's regular rate, but only up to the amount required by FLSA or the half in one and a half times the regular rate. The deduction doesn't reduce AGI. So it cannot help with AGI reduction strategies, [00:53:30] even though it is available for Non-itemizers because the deduction doesn't reduce AGI, it will not affect calculations such as the premium tax credit.
Jeremy Wells: Irma taxable social security, net investment, income tax thresholds, student loan interest phase out or any AGI driven phase out. So be sure to keep those effects in mind as well. Those calculations will all stay the same even if [00:54:00] the taxpayer can take this deduction. It also doesn't reduce FICA or self-employment tax or the qualified business income deduction, because again, it doesn't affect any of those calculations. And this will be an important planning consideration for states with income taxes for states that base their income tax calculations on federal AGI, there won't be an effect. But for those that start with federal taxable [00:54:30] income, there will be if the taxpayer qualifies for the deduction. And finally, I want to remind you that that employer and employee friendly relief that was available for tax year 2025 will no longer be available, starting with tax year 2026. Employers must accurately report qualified overtime compensation on forms W-2, and employees must verify the amounts on those w-2s against [00:55:00] their pay records to make sure that those are the correct amounts. If you found value in this episode, please let me know by liking and leaving a comment in your podcast, Application of choice or on YouTube. And for the next episode, we're going to look at how gambling winnings and losses are taxed, including why you should rethink how you're handling those W2 GS.