Qualified Overtime Compensation Deduction: What You Need to Know
The One, Big, Beautiful Bill (OBBB) introduced a new tax deduction for qualified overtime compensation, effective for tax years 2025 through 2028. The Treasury Department and IRS recently issued Fact Sheet 2026-01, providing guidance on eligibility, calculation, and reporting. This deduction allows eligible taxpayers to reduce their taxable income by the portion of overtime pay that exceeds their regular rate of pay.
At Velin & Associates, Inc., we advise clients across industries—including healthcare, online commerce, creative fields, and high-net-worth individuals—on how to leverage this deduction effectively and stay compliant with IRS rules.
What Is Qualified Overtime Compensation?
Qualified overtime compensation refers to the portion of overtime pay that exceeds an employee’s regular hourly rate. For example, under a typical “time-and-a-half” arrangement, only the additional 50% above the regular pay rate qualifies for the deduction.
- Applies to both W-2 employees and independent contractors receiving 1099 income.
⠀ - Reported on Form W-2 or 1099 by employers or payers.
⠀ - Deduction is only available for tax years 2025–2028.
This deduction effectively lowers taxable income, helping employees and contractors save on federal income taxes.
How It Works
- Determine the regular rate – the standard hourly wage without overtime.
⠀ - Calculate the overtime portion above the regular rate – this is generally 50% of “time-and-a-half” pay.
⠀ - Confirm it is reported – only overtime documented on W-2 or 1099 qualifies.
⠀ - Claim the deduction – report it on your federal income tax return in the applicable tax year.
Example of Eligible Overtime (brief): A healthcare professional working extended shifts may have overtime reported on a W-2. Only the additional pay above their normal hourly rate is deductible.
Who Can Benefit
This deduction is particularly relevant for:
- Employees and contractors in healthcare who regularly work overtime shifts.
- Creators, influencers, and online business owners who take on additional projects beyond normal working hours.
- E-commerce and retail workers with seasonal spikes in workload.
- High-net-worth individuals and business owners who receive overtime or bonus pay as part of consulting arrangements.
By reducing taxable income, this deduction may also indirectly reduce other income-related taxes, such as IRMAA surcharges for Medicare.
📝 Reporting and Compliance
The IRS FAQs clarify several important points:
- Reporting Requirements
- W-2 employees: overtime reported by employers.
- 1099 independent contractors: overtime or additional compensation reported by payers.
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- Difference Between 2025 and 2026–2028
- For 2025, employers received penalty relief for new reporting requirements.
- Starting 2026, taxpayers must track qualified overtime compensation accurately to claim the deduction.
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- Documentation
- Keep detailed records of hours worked and compensation received.
- Ensure the portion exceeding regular pay is clearly identified.
- This protects against IRS questions or audits.
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- Interaction with Other Deductions
- The qualified overtime deduction reduces taxable income but does not affect Social Security, Medicare, or other payroll taxes.
- Careful planning can help integrate this deduction into overall tax strategy.
Key Takeaways
- Qualified overtime deduction applies to the half portion of time-and-a-half pay.
⠀ - Available for tax years 2025–2028.
⠀ - Applies to both employees (W-2) and independent contractors (1099).
⠀ - Proper tracking and documentation are essential.
⠀ - Particularly beneficial for healthcare workers, creators, e-commerce operators, and high-net-worth individuals.
How Velin & Associates, Inc. Can Help
Even though this deduction is straightforward in theory, calculating it correctly and integrating it with other income and deductions can be complex. Velin & Associates, Inc. provides:
- Tax planning and guidance for claiming qualified overtime compensation
⠀ - Record-keeping and reporting advice for W-2 and 1099 income
⠀ - Integration with broader tax strategies for creators, medical professionals, and online commerce
⠀ - Compliance reviews to avoid IRS penalties and maximize savings
For more information about our tax planning services, contact us today: visit our website.
Velin & Associates, Inc
8159 Santa Monica Blvd STE 198/200 West Hollywood, CA 90046
323-902-1000
dmitriy@losangelescpa.org
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