The One Big Beautiful Bill Act (OBBBA), signed on July 4, 2025, created a new federal deduction for overtime pay for tax years 2025 through 2028. It is often called “No Tax on Overtime,” which makes it sound as if all overtime pay is now tax-free. It is not. Only the premium portion of overtime that federal law requires your employer to pay can be deducted.
This article is for people working in the U.S.—local hires and expatriate staff at Japanese companies, hourly workers in restaurants, factories, and offices, and their families. It answers three questions: Do I qualify? How much can I deduct? And what should I look for on my Form W-2?
Timing matters. Starting with tax year 2026, you cannot deduct more than the amount your employer reports in box 12 of your W-2 using code TT. Before the year ends is a good time to confirm whether you are exempt or non-exempt and to check your pay stubs.
Key points
- Only overtime required under section 7 of the Fair Labor Standards Act (FLSA) counts, and only the part that exceeds your regular rate. If you are paid time-and-a-half, the deductible part is the extra “half.”
- The deduction is capped at $12,500 per year ($25,000 on a joint return). It is reduced by $100 for each $1,000 of modified adjusted gross income (MAGI) above $150,000 ($300,000 on a joint return).
- Employees who are exempt from the FLSA overtime rules cannot claim it, even if the company voluntarily pays them overtime. Overtime required only by state law or a union contract does not count either.
- You need a valid Social Security number (SSN) that allows work, and married taxpayers must file jointly.
- For 2025 you could calculate the amount from your pay records. From 2026 on, the amount in W-2 box 12, code TT is the most you can deduct.
What counts as “qualified overtime compensation”
The IRS defines qualified overtime compensation as overtime pay required under section 7 of the FLSA that exceeds the regular rate at which you are employed. The FLSA generally requires employers to pay at least one and one-half times the regular rate for hours worked over 40 in a workweek. The “one times” part is ordinary pay; only the extra “half” is deductible.
The Form 1040 instructions note that employers may label this “half” portion on pay statements as “overtime premium” or “FLSA Overtime Premium.” IRS Fact Sheet FS-2026-13 gives this weekly formula:
FLSA hours worked over 40 in a workweek × one-half × your FLSA regular rate = qualified overtime compensation for that week
| How overtime is paid | Deductible part |
|---|---|
| Time-and-a-half for hours over 40 in a week | The extra one-half (one-third of total overtime pay) |
| Double time for hours over 40 in a week | Only the one-half the FLSA requires (one-quarter of total overtime pay) |
| Overtime required only by state law or a union contract | Not deductible (except any part the FLSA also requires) |
| Overtime the company voluntarily pays to exempt employees | Not deductible |
| Extra weekend or holiday pay in a week with 40 or fewer hours | Generally not deductible |
This is a federal income tax deduction. According to FS-2026-13, overtime pay (including qualified overtime) is still subject to federal income tax withholding and employment taxes such as Social Security tax. You can take the deduction whether you itemize or take the standard deduction, and you figure it on the new Schedule 1-A (Form 1040).
Who qualifies—and who does not
You must be covered by the FLSA and not exempt from its overtime requirement. If you are FLSA-exempt, you cannot claim the deduction even if you receive overtime under state law or a union agreement.
Common exemptions listed in FS-2026-13 include:
- Executive, administrative, and professional employees (including elementary and secondary school teachers)
- Employees in certain computer-related occupations
- Outside sales employees
- Certain commissioned retail employees and other specific groups
Being paid a salary does not by itself make you exempt. The U.S. Department of Labor explains that job titles do not determine exempt status; your duties and your pay must both meet the regulatory tests. A salaried employee who is classified as non-exempt and receives FLSA overtime can deduct the premium portion.
Japanese companies: expatriates, local staff, and owners
At a U.S. office of a Japanese company, people who qualify and people who do not often work side by side. What matters is FLSA status, not nationality or visa type.
| Situation | Deduction |
|---|---|
| Hourly local staff paid time-and-a-half for hours over 40 a week | Premium (one-half) portion qualifies |
| Salaried employee classified as non-exempt who receives overtime | Premium portion qualifies |
| Employee classified as exempt, e.g., as a manager (including expatriates in such roles) | Does not qualify |
| Overtime pay given to exempt employees under company policy | Does not qualify |
| Owner-employee with at least a 20% equity interest who actively manages the business | Treated as an exempt executive—does not qualify |
The last row matters for people who run restaurants or shops, for example on an E-2 visa. FS-2026-13 explains that an employee who owns at least a bona fide 20 percent equity interest in the enterprise and is actively engaged in its management is treated as an exempt executive under the FLSA.
If you are not sure of your status, ask your HR or payroll team whether you are FLSA “exempt” or “non-exempt.”
SSN and filing status
The person who received the qualified overtime must have a valid SSN and must include it on the return. For this purpose, a valid SSN is one that is valid for employment and issued by the Social Security Administration before the due date of the return (including extensions). If your card says “Valid for Work Only with DHS Authorization,” the SSN is valid only as long as the DHS authorization is valid. An ITIN is not an SSN, so it does not meet this requirement. If both spouses received qualified overtime, both need valid SSNs.
If you are married, you must file a joint return to claim the deduction. It is not available on a married-filing-separately return.
If your spouse lives in Japan and is a nonresident alien for U.S. tax purposes, you cannot file jointly as-is. If you are a U.S. citizen or resident, you may choose to treat your nonresident spouse as a U.S. resident and file jointly (see IRS Publication 519). That choice brings your spouse’s worldwide income, including Japanese income, into the U.S. return, so compare the total tax both ways rather than looking at this deduction alone.
Nonresident aliens filing Form 1040-NR
Form 1040-NR has a line for Schedule 1-A deductions (line 13c), so nonresident aliens—such as many F-1 or J-1 students and trainees—may qualify if they meet the requirements. However, a nonresident alien cannot use the married-filing-jointly status on Form 1040-NR, so a married nonresident alien generally cannot claim this deduction. Whether you are allowed to work at all is an immigration question outside the scope of this article.
Limits and income phase-out
| Filing status | Maximum deduction | Phase-out starts at MAGI of |
|---|---|---|
| Single, head of household, etc. | $12,500 | $150,000 |
| Married filing jointly | $25,000 | $300,000 |
| Married filing separately | Not allowed | — |
MAGI is your adjusted gross income plus amounts excluded under section 911 (the foreign earned income exclusion) and certain territory exclusions. If you worked in Japan for part of the year and used the foreign earned income exclusion, the excluded amount is added back.
Schedule 1-A applies the steps in this order: first limit your qualified overtime to $12,500 (or $25,000), then divide the amount by which MAGI exceeds the threshold by $1,000, drop any fraction, multiply by $100, and subtract the result.
The deduction is taken after adjusted gross income is figured (Form 1040, line 13b), so it does not lower your AGI.
How to check your W-2: 2025 vs. 2026
Tax year 2025
For 2025, transition relief meant employers did not have to report qualified overtime separately on Form W-2. Some employers did so voluntarily in box 14, through an online portal, or on a separate statement.
If you received nothing separate, you could use one of the methods in Notice 2025-69. For example, if you only know your total time-and-a-half overtime pay, the premium is one-third of that total; for overtime paid at double time, the FLSA premium is one-quarter of the total. Keep the pay stubs that support your figure. If you already filed for 2025 without claiming the deduction, you can consider an amended return on Form 1040-X.
Tax year 2026 and later
Beginning with 2026, employers must report qualified overtime on Form W-2 in box 12 using code TT. FS-2026-13 states that for tax years after 2025, employees may not count any amount above what is reported in box 12, code TT.
- If code TT is missing or too low, ask your employer for a corrected Form W-2c. Without a correction, you cannot deduct the unreported amount.
- Form 4852, the substitute for a missing W-2, does not satisfy this requirement.
- If code TT shows more than you actually received, you may deduct only the qualified overtime you actually received.
What you can do before year-end
- Ask HR or payroll whether you are FLSA non-exempt.
- Check your pay stubs for overtime hours over 40 a week and the rate paid (time-and-a-half, double time), and keep records.
- Consider using step 4(b) (deductions) on the 2026 Form W-4 to account for the deduction in your withholding. Your employer cannot reduce withholding without a new W-4 from you.
- When your 2026 W-2 arrives, compare box 12, code TT with your own records.
Worked examples
Example: All figures below are hypothetical.
Example 1: Single hourly employee
You earn $30 an hour, work 500 FLSA overtime hours in 2026 (all paid at time-and-a-half), and your MAGI is $80,000.
- Total overtime pay: 500 hours × $45 = $22,500
- Qualified overtime (premium portion): 500 hours × $15 = $7,500 (one-third of the total)
- MAGI is under $150,000, so there is no reduction. Deduction: $7,500
Assuming a 22% marginal rate, your federal income tax would be about $1,650 lower. Social Security and Medicare taxes still apply to the full $22,500 of overtime pay.
Example 2: Married couple filing jointly, cap and phase-out
The couple’s combined qualified overtime is $28,000 and their MAGI is $310,000.
- Apply the cap: $28,000 → $25,000
- Reduction: ($310,000 − $300,000) ÷ $1,000 = 10 → 10 × $100 = $1,000
- Deduction: $25,000 − $1,000 = $24,000
Example 3: Dropping the fraction
A single filer has $8,000 of qualified overtime and MAGI of $175,500. The excess of $25,500 ÷ $1,000 = 25.5, which drops to 25, so the reduction is 25 × $100 = $2,500. The deduction is $8,000 − $2,500 = $5,500.
FAQ
I am paid a salary. Does that mean I cannot claim it?
Not necessarily. Exempt status depends on your duties and pay under the FLSA rules, not on being salaried. If you are salaried but classified as non-exempt and receive FLSA overtime, the premium portion qualifies.
I am paid double time. Can I deduct all of it?
No. Only the minimum premium the FLSA requires (one-half of your regular rate) counts. For double-time pay, that is one-quarter of the total overtime pay.
My 2026 W-2 has no code TT in box 12. What should I do?
Ask your employer for a corrected Form W-2c. For 2026 and later, you cannot deduct more than the amount properly reported in box 12, code TT.
Does the deduction lower Social Security or state tax?
It is a federal income tax deduction. Social Security and Medicare taxes still apply to all of your overtime pay. State income tax treatment varies, so check your state’s rules.
Can I claim it if my spouse lives in Japan?
Married taxpayers must file jointly. If your spouse is a nonresident alien, you cannot claim the deduction unless you choose to treat your spouse as a U.S. resident and file jointly. That choice has broad effects, so run the numbers first.
At CLT NY INC., an IRS Enrolled Agent can review whether you qualify for the overtime deduction and the other new 2025–2028 deductions and prepare your return, in English or Japanese. Contact us.
Related articles
- The Definitive Guide to Calculating the “Regular Rate of Pay” for Overtime in the US: Navigating Complexity Beyond Basic Hourly Wages
- Mastering Exempt/Non-Exempt Status Change Management: Aligning Effective Dates with Pay Periods for Seamless Transitions
- Mastering Form W-4: A Comprehensive Guide for Japanese Nationals on Adjusting U.S. Tax Withholding
- Local Hires: Employee (W-2) or Independent Contractor (1099)? IRS Penalties and Litigation Risks from Misclassification
- Choosing Your Filing Status: Married Filing Jointly vs. Separately, and the 6013(g) Election for Spouses in Japan
- Filing US Taxes as an H-4 or L-2 Spouse: How Employment Status Changes Your Filing Options, and the Section 6013(g) Trap
Sources: IRS: Tax deductions for working Americans and seniors; IRS FS-2026-13: Updates to questions and answers about the new deduction for qualified overtime compensation; IRS FS-2026-01: Questions and answers about the new deduction for qualified overtime compensation; IRS IR-2025-114; IRS Notice 2025-69; IRS Schedule 1-A (Form 1040); IRS 2025 Instructions for Form 1040 (Schedule 1-A); IRS 2026 General Instructions for Forms W-2 and W-3; IRS Instructions for Form 1040-NR; IRS 2026 Form 1040-ES (NR); IRS Publication 519; U.S. Department of Labor Fact Sheet #17A. Information as of October 2026. This article provides general information and is not individual tax advice.
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