IRS Updates 2026 Overtime Pay Tax Exemption Rules, Employers Required to Report on W-2 Forms

The IRS has clarified how employees can claim the federal tax deduction for qualifying overtime pay, including new reporting requirements for employers.

The IRS updated its frequently asked questions on the "overtime pay exemption" deduction earlier in August, following confusion during the 2025 tax filing season. Employers will be required to include qualifying amounts on employees' 2026 W-2 forms, meaning taxpayers will no longer need to determine qualifying amounts themselves.

IRS Clarifies What Counts as Overtime Pay

The overtime tax benefit was included in President Donald Trump's "One Big Beautiful Bill," which was signed into law in July 2025. The temporary deduction applies to tax years 2025 through 2028, allowing eligible employees to deduct up to $12,500 for single filers and up to $25,000 for married couples filing jointly.

The deduction applies only to the overtime premium—the extra half of the standard hourly rate at 1.5 times. For example, an employee earning $40 per hour who earns $60 per hour during overtime can only count the $20 premium toward the deduction. The benefit begins to phase out at $150,000 for single taxpayers and $300,000 for married couples filing jointly.

Economist Justin Wolfers also highlighted this distinction, arguing that the legislation does not fully eliminate taxes on overtime pay. Wolfers stated that the benefit applies only to the extra half of the 1.5 times hourly rate, subject to limits and eligibility requirements.

Employers Will Report Qualifying Amounts

The updated IRS FAQ requires employers to report amounts eligible for the deduction using code "TT" in Box 12 of employees' 2026 W-2 forms.

The IRS also clarified that if overtime pay required by state law or union agreements differs from the Fair Labor Standards Act, only the portion required by federal law qualifies for the deduction.

This change addresses issues that arose during the first filing season. For the 2025 tax year, the IRS and Treasury Department waived employer reporting requirements because payroll systems and tax forms were not yet ready. As a result, many taxpayers had to estimate their qualifying overtime pay using pay stubs or final wage statements.

Tom O'Saben, director of tax content and government relations at the National Association of Tax Professionals, told CNBC that tax professionals had to use employees' pay stubs and make "best estimates" of qualifying overtime amounts.

Andrew Lautz, senior director of federal policy at the Tax Foundation, said employer reporting should make the process easier for employees.

"This filing season was complicated, and I expect employer reporting will make the process less complicated for employees," Lautz said.

Overtime Deduction Tied to Bigger Refund Expectations

More than 29 million taxpayers claimed the overtime deduction for the 2025 tax year ahead of the April 15 filing deadline. The average deduction exceeded $3,100, with 75% of claimants earning less than $100,000 and 96% earning less than $200,000.

The deduction also featured prominently in government expectations for refunds. Treasury Secretary Scott Bessent previously projected household refunds could increase by $1,000 to $2,000, citing provisions including the tip and overtime deductions.

President Trump later predicted the "biggest tax refund season ever," pointing to the legislation's tax changes, including the overtime provision. He described the "One Big Beautiful Bill" as combining 17 initiatives into a broader tax package.

However, the scope of the overtime benefit remains narrower than the phrase "overtime tax-free" might suggest. Wolfers previously stated that employees earning 1.5 times their hourly rate only receive the benefit on the extra half, and only within applicable limits.

Employees Should Check Their 2026 W-2 Forms

Even with employer reporting, tax professionals advise employees to check overtime amounts on their W-2 forms against their payroll records.

O'Saben said he plans to have clients bring in pay stubs to verify the accuracy of reported amounts.

If amounts are incorrect, employees cannot simply adjust the deduction themselves. Lautz said taxpayers who believe their employer reported too much or too little qualifying overtime must request a corrected W-2 form.

The reporting change means the 2026 filing process should no longer require employees to reconstruct their qualifying overtime from payroll records, but checking W-2 forms against those records may still be important.