OBBBA Overtime Deduction: Employer Reporting and Schedule 1-A
Almost every client conversation I had about the OBBBA overtime deduction this past filing season collapsed into an argument over one number. The client sees $15,000 of overtime on a pay summary and expects a $15,000 deduction. The statute gives them $5,000.
What Is the OBBBA Overtime Deduction?
The OBBBA overtime deduction is a temporary federal income tax deduction under IRC Section 225 for qualified overtime compensation, capped at $12,500 per return and $25,000 on a joint return. Section 70202 of the One Big Beautiful Bill Act (Public Law 119-21, enacted July 4, 2025) created it, redesignating the prior Section 225 as Section 226.
It is temporary on both ends. Section 70202(g) applies the amendments to taxable years beginning after December 31, 2024, and Section 225(g) terminates the deduction for any taxable year beginning after December 31, 2028. Four filing seasons total.
It does not require itemizing. Section 70202(b) amended Section 63(b) to add "the deduction provided in Section 225" as a new paragraph (6), which places it among the deductions a taxpayer can claim while still taking the standard deduction.
The eligibility gates are mechanical. Section 225(d) denies the deduction unless the return carries the Social Security number of the individual who received the overtime, and the 2025 Form 1040 instructions add that the SSN must be valid for employment and issued by the SSA before the due date of the return including extensions. Section 225(e) requires a married taxpayer to file jointly. Omitting the number is not a soft error: OBBBA added subparagraph (Z) to Section 6213(g)(2), classifying an omitted Section 225(d) SSN as a mathematical or clerical error.
Which Overtime Pay Actually Qualifies?
Only the premium half of time-and-a-half qualifies, so a client paid $15,000 for overtime hours in 2025 has a $5,000 deduction. Example 1 in the 2025 Form 1040 instructions walks that exact fact pattern: $15,000 divided by three is the half portion.
Section 225(c)(1) defines qualified overtime compensation as overtime "required under Section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate" at which the individual is employed.
Two words do most of the work: required and excess. Pay the FLSA does not require is out, and the part of the payment that merely replaces the regular rate is out. That knocks out four categories of pay clients routinely call overtime:
- Premium above time-and-a-half. The 2025 Form 1040 instructions are blunt: "The amount of overtime paid that is over time-and-a-half is not qualified overtime compensation." A contract or state statute that buys a richer premium does not enlarge the federal deduction.
- Weekend and holiday premium under 40 hours. Extra pay for a Saturday or a holiday is generally not qualified overtime compensation if the employee did not work more than 40 hours that workweek.
- Overtime paid to FLSA-ineligible employees. Per the instructions, "Overtime pay that is paid to these FLSA-ineligible employees is not qualified overtime compensation."
- Qualified tips. Section 225(c)(2) carves out anything already treated as a qualified tip under Section 224(d), so the two OBBBA deductions cannot double count the same dollar.
The threshold question is not how many hours the client worked. It is whether the client is covered by the FLSA and not exempt from its overtime requirement. FS-2026-01 concedes this is a fact-specific determination turning on occupation, work activities, and earnings, which hands a labor law question to tax preparers.
How Does the Deduction Reach the Return?
The deduction reaches the return through Schedule 1-A, Part III, No Tax on Overtime, whose line 38 total carries to Form 1040 line 13b, or line 13c on Form 1040-NR.
Part III has two input lines, and the instructions are emphatic about not confusing them with gross figures. Line 14a takes only the qualified overtime compensation included in Form W-2 wages, not total wages. Line 14b takes only the qualified overtime included in Form 1099-NEC box 1 or Form 1099-MISC box 3: "Do not enter the total amount from Form 1099-NEC, box 1, or Form 1099-MISC, box 3."
One sequencing point changes planning conversations. MAGI is computed in Part I of the schedule, and the deduction lands on line 13b, so the income figure driving the phaseout is fixed before this deduction is ever applied. The deduction cannot loosen its own limitation, and it does not shift any other AGI-driven threshold on the return.
Where no separate accounting appeared on the 2025 wage statement, the instructions supply five calculation methods, the workhorse being to divide total overtime-hour pay by three. For the underlying rules they point to Notice 2025-69, and if reading IRS guidance quickly is not yet a reflex, here is how I work through a notice.
What the Employer Has to Do
For tax year 2025 the separate reporting carried no penalty, and most of the payroll clients I asked had done nothing about it.
Section 6051(a)(19), added by OBBBA Section 70202(c)(1), requires the Form W-2 furnished to an employee to show "the total amount of qualified overtime compensation." Payors outside the employment relationship picked up matching duties under Section 6041(a) for the information return and Section 6041(d)(4) for the statement furnished to the payee.
Notice 2025-62 treats taxable year 2025 as a transition period and states that the IRS "will not impose a penalty under sections 6721, or 6722" where an employer or payor omits the separate statement of qualified overtime from any of those returns or statements, or from the copy filed with the SSA.
Read the condition on that relief carefully, because it is where a sloppy year gets expensive. The notice limits relief "to the extent that the person required to make the return or statement otherwise files and furnishes a complete and correct return or statement," and a complete statement must still include the overtime inside the aggregate wage or payment total. Skipping the separate line was forgiven. Leaving the wages out was not.
The notice also encouraged, without requiring, employers to furnish the number anyway, in box 14 of the Form W-2, through an online portal, or by separate written statement. Where an employer did use box 14, the 2025 Form 1040 instructions let the taxpayer rely on that figure and skip the five calculation methods.
Tax year 2026 is a different posture. FS-2026-01 is unambiguous: "For tax years 2026 and later years, employers and other payers are required to separately report qualified overtime compensation. Forms W-2, 1099-NEC, and 1099-MISC will be updated to allow employers and other payers to provide separate reporting."
What that guidance does not yet give is the box or code where the number goes. I would not build a payroll configuration around a box number nobody has published. Build the data capture instead, because the box assignment is a mapping exercise once it lands. Four things belong in the payroll system now:
- An earnings code that isolates the FLSA-required premium half, separate from any contractual premium sitting above time-and-a-half.
- An FLSA status flag on every employee record, covered and nonexempt versus exempt, since the deduction turns on it.
- Suppression of weekend and holiday differentials from the qualified bucket when the employee stayed under 40 hours in the workweek.
- Strict separation of the tips bucket from the overtime bucket, because Section 225(c)(2) will not let one dollar sit in both.
Withholding shifts on the same timeline. OBBBA Section 70202(f) directs Treasury to modify the Section 3402(a) withholding procedures for taxable years beginning after December 31, 2025, which is the overlap firms running payroll alongside 1040 work hit first.
Where the Phaseout Bites
The phaseout takes $100 of deduction for every $1,000 of MAGI above the threshold. Section 225(b)(2)(A) reduces the deduction, but not below zero, by $100 for each $1,000 by which the taxpayer's modified adjusted gross income exceeds $150,000, or $300,000 on a joint return. That is a 10 percent clawback of the deduction itself. Each additional $1,000 of MAGI inside the band adds $1,100 of taxable income, so the effective marginal rate runs about 1.1 times the client's bracket rate.
Run the arithmetic and the runway is longer than it looks, but only for clients already sitting at the cap. The statute applies that reduction to the amount allowable after the cap, so the band scales with the deduction the client actually has. At the full $12,500, dividing by the $100 rate gives 125 thousand-dollar steps above $150,000. At the full $25,000, 250 steps above $300,000. A single client with $3,000 of qualified overtime gets 30 steps and is fully phased out at $180,000 of MAGI.
The MAGI definition has a trap. Section 225(b)(2)(B) defines modified adjusted gross income as AGI increased by any amount excluded under Section 911, 931, or 933. A client running a foreign earned income exclusion adds it back for this test, which can push a return into phaseout on income that never appeared in AGI.
Married filing separately never reaches the phaseout at all, because Section 225(e) requires a joint return. And where both spouses have qualified overtime, the 2025 Form 1040 instructions state that "the $25,000 maximum amount of deduction limit applies to your combined overtime compensation. It is not a per spouse limit."
Then there is the state layer. South Carolina Information Letter #26-4 (Revised) confirms the state conforms to the Internal Revenue Code only as amended through December 31, 2024, and instructs taxpayers to adjust their return if they claimed the overtime deduction federally. That is the same decoupling running through state treatment of OBBBA bonus depreciation.
Bottom Line
The number your client wants to deduct is not the number on their pay summary, and the distance is a factor of three in the ordinary case. Section 225 reaches the FLSA-required premium and nothing else.
For 2026 the Section 6051(a)(19) obligation is live, the forms are being updated, and the withholding procedures change with them. The firms with an easy 2026 are the ones fixing payroll earnings codes now, while it is a configuration task rather than a March emergency. I built Tax Orator because chains like this one, statute to notice to fact sheet to a line on a brand new schedule, used to cost me a Saturday morning per provision.