2026 overtime tax deduction: what Houston employers must track

The qualified overtime deduction is an individual income tax deduction, not a direction for employers to stop taxing overtime wages. It generally concerns the qualifying premium required by the Fair Labor Standards Act, or FLSA, rather than the employee's entire overtime paycheck.

For 2026, employers should review payroll setup before year-end. The IRS's August 6, 2026 overtime FAQs address separate reporting, withholding and how qualifying compensation is determined.

Identify the qualifying premium

Consider a simplified example involving an FLSA-covered, nonexempt employee whose regular rate is $24 per hour, with no bonus or other regular-rate adjustment. The employee works five hours over 40 in a workweek and is paid $36 per overtime hour.

The total pay for those five overtime hours is $180. The additional half-time premium is $12 per hour, or $60. Under the stated assumptions, $60 is the qualifying premium to analyze, not the full $180.

Real payroll can be more complicated. Bonuses, multiple rates, special work-period rules and exemption status can change the calculation. Merely labeling an earning code “overtime” does not establish eligibility.

Keep reporting separate from the employee's deduction limit

The IRS directs employers to report 2026 qualified overtime compensation in Form W-2 box 12 using code TT. Report the qualifying compensation required by the instructions, rather than capping the reported amount at the employee's personal deduction limit.

The deduction itself is generally limited to $12,500 per return or $25,000 on a joint return, with an income-based reduction beginning above modified adjusted gross income of $150,000 or $300,000 for joint filers. Other eligibility requirements apply, including a qualifying Social Security number and joint filing when married. See the IRS's worker deduction overview.

Do not simply remove overtime from taxable wages

Overtime remains subject to the applicable payroll tax and withholding rules. An employer should not reduce federal income tax withholding for an expected deduction unless the employee provides an updated, valid Form W-4 accounting for it under the instructions.

Avoid promising workers that every dollar they call overtime will be tax-free. A weekend premium or voluntary extra pay is not necessarily qualified FLSA overtime.

Review the payroll trail now

Check employee coverage and exemption decisions, workweek hours, regular-rate calculations, earning-code mapping and year-to-date qualifying premiums. Compare a sample calculation with the payroll system before relying on its annual totals.

Preserve the calculation history and arrange a correction process for any reporting errors. This is particularly important where payroll providers changed during the year.

Tax N Tips offers payroll support and tax preparation. Book a consultation to review the records your business will need for 2026 reporting.

Sources checked September 5, 2026.