Who Qualifies for the Qualified Overtime Compensation Deduction and What the IRS Rules Say
New Federal Deduction for Qualified Overtime Pay
Congress recently created a new above the line federal deduction for qualified overtime compensation. The Internal Revenue Service released a detailed fact sheet explaining who qualifies, what counts as eligible overtime pay, and how the deduction is claimed on an individual tax return. This provision is designed to reduce taxable income for workers who earn overtime wages, but the rules are narrow and require careful documentation.
This deduction applies only to qualifying overtime compensation as defined under federal labor law. It does not apply to all extra pay, bonuses, or incentive compensation that may appear on a paycheck.
What Counts as Qualified Overtime Compensation
Qualified overtime compensation generally includes amounts paid to an employee for hours worked in excess of the standard forty hour workweek, where those overtime payments are required under the Fair Labor Standards Act. The deduction is limited strictly to the overtime premium portion of wages, not the entire hourly wage paid for overtime hours.
- Overtime pay must be legally required under federal labor rules
- Only the overtime premium portion qualifies
- Voluntary bonuses or employer discretionary pay do not qualify
- Independent contractor compensation does not qualify
Taxpayers should not assume that all higher hourly pay or shift differentials qualify. The IRS makes clear that only mandatory overtime premiums qualify for the deduction.
Income Limits and Filing Requirements
The overtime deduction is subject to income based limitations. Higher income taxpayers may see the deduction reduced or eliminated entirely. The deduction is claimed on the individual return and reduces adjusted gross income, which can also impact other tax calculations and phaseouts.
Accurate payroll records are critical. Taxpayers must be able to substantiate the portion of wages that represent qualified overtime compensation if questioned.
How This Interacts With State Overtime Rules
Many states, including California, have overtime rules that are more generous than federal law. State law overtime does not automatically qualify for the federal deduction. Only overtime that meets the federal definition counts for purposes of this deduction.
For a deeper discussion of how overtime pay is treated differently under California law, see my related article California Nonconformity With Federal Overtime and Tip Deductions .
You may also want to review how overtime wages interact with other wage based exclusions and limitations discussed in Who Qualifies for the New Tip Income Exclusion and Why SSTB Employees Are Excluded .
Practical Takeaway for Taxpayers
The new overtime deduction can provide meaningful tax savings for eligible workers, but it is far from automatic. Misclassification of pay, incorrect assumptions about what qualifies, and incomplete payroll reporting are common issues. Proper review of wage statements and employer payroll records is essential before claiming the deduction.
See current federal rates on the Economic Dashboard .
Source: IRS Questions and Answers About the New Deduction for Qualified Overtime Compensation
