The IRS just released critical new guidance that could benefit your employees and simplify your payroll operations. The IRS recently issued Fact Sheet 2026-01 addressing frequently asked questions about a valuable tax benefit under the One Big Beautiful Bill Act (H.R. 1). If your business has employees working overtime, this guidance directly impacts your payroll reporting and your employees’ tax returns.
What Is the Qualified Overtime Pay Deduction?
The IRS just released new guidance on a valuable tax benefit under the One Big Beautiful Bill Act (H.R. 1). Your employees may now qualify for a deduction on the extra pay they earn from overtime work.
This deduction applies specifically to overtime compensation that exceeds the regular hourly rate.
Does Overtime Pay Deduction Apply to Your Business?
The qualified overtime deduction affects employees covered under the Fair Labor Standards Act (FLSA). This includes most private-sector employees who work in hourly positions.
If your business has employees working more than 40 hours per week, this guidance directly impacts your payroll and tax filing requirements.
Certain professional, administrative, and executive roles may be exempt from overtime requirements entirely. Your specific situation depends on job duties, work activities, and compensation levels.
How Overtime Compensation Qualifies
When you pay employees at the federally required 1.5 times rate, only that specific premium portion qualifies.
However, situations often arise where businesses pay more than the required amount. Some employers offer 2x pay or “time and a half plus a bonus” to attract workers or recognize loyalty.
In these cases, only the portion required by federal law qualifies for the deduction—not the extra amount.
Federal Employees Need Special Attention
Are any of your employees federal workers? The IRS specifically addressed how this deduction applies to government employees. Federal employees covered by the FLSA can claim this deduction, but verification is more complex.
Most federal employees can verify their FLSA eligibility on their Standard Form 50, Notification of Personnel Action.
This document clearly indicates whether an employee is covered under FLSA overtime requirements or falls under an exemption.
Important Deadlines: 2025 vs. 2026
For Tax Year 2025: Different reporting rules apply as businesses adjust to the new requirement. The IRS provided penalty relief for 2025 information reporting.
For Tax Years 2026-2028: Standard reporting requirements apply. Your payroll system will need to track and report qualified overtime compensation separately.
Reporting Requirements Your Business Must Follow
Your payroll team needs to accurately identify and track qualified overtime on employee records. Incorrect reporting triggers compliance issues and may result in corrections with the IRS.
The IRS expects payers to report this information on employee tax documents starting with the 2025 tax year. Your payroll processor must capture data about which employees are covered under the FLSA, how many overtime hours they worked, and the amount of overtime compensation paid.
How the IRS Protects Businesses from Penalties
The IRS explicitly stated that businesses acting in good faith while following these FAQs won’t face penalties if the guidance later changes.
This protection covers negligence penalties and accuracy-related penalties as long as you reasonably relied on the official FAQs and made good-faith efforts to comply.
Common Questions Business Owners Ask
1. Do I have to offer overtime or use this deduction?
The FLSA requires overtime pay for covered employees. This deduction is automatic for qualifying compensation—you don’t “opt in.”
2. Will this save us money on payroll taxes?
This deduction reduces employees’ taxable income, which affects their personal income tax—not your business payroll tax obligations. However, lower employee withholding may improve cash flow.
3. What if our state has different overtime rules?
This federal deduction applies regardless of state rules. Consult with a tax professional about state-specific implications.
4. Does this apply to salaried employees?
Generally, the FLSA overtime rule applies to hourly employees. Most salaried positions are exempt. Your specific situation depends on job duties and salary levels.
Which Employees Are Actually Covered?
The FLSA covers most private-sector employees, but significant exceptions exist. Certain professional, administrative, and executive roles may be exempt.
Each situation is unique based on job duties, work activities, and compensation levels.
How Virtue CPAs Can Help
This new deduction involves complex payroll and tax reporting rules. Getting it wrong creates compliance risk and potential missed deductions for your employees.
Our team can review your payroll structure, confirm employee classifications, and ensure your business reports are qualified overtime correctly for 2025 and beyond.
Ready to protect your business and maximize this new benefit for your employees? Schedule a consultation with Virtue CPAs today. We serve small and midsized businesses across Georgia and help you stay ahead of tax law changes.
Contact Virtue CPAs today at (678) 952-9001 or info@virtuecpas.com.
Disclaimer: This article provides general information about IRS Fact Sheet 2026-01. For specific tax advice regarding your business situation, consult with a qualified tax professional or CPA.
