New regulations under the One Big Beautiful Bill Act (OBBBA) are reshaping how employers handle payroll reporting, specifically concerning overtime compensation. These changes introduce a new above-the-line tax deduction for employees receiving qualified overtime compensation, a significant benefit that depends on accurate employer reporting.
Understanding the OBBBA and Overtime Reporting
The OBBBA represents a significant shift in payroll compliance, designed to provide tax relief to workers who put in extra hours. At the core of this legislation is the introduction of a tax deduction for qualified overtime compensation. However, for an employee to claim this deduction, the IRS requires a clear paper trail.
The groundwork is being laid in tax year 2025 for mandatory reporting, which will require employers to separate the overtime premium portion of pay from regular wages on Form W-2. This will enable the IRS and the employee to easily identify the exact amount eligible for the new tax deduction.
Starting in tax year 2026, employers will be strictly required to separate the overtime premium portion of pay from regular wages on Form W-2. Specifically, this information will be listed in Box 12 using the new Code TT. This separation allows the IRS and the employee to identify the exact amount eligible for the new tax deduction.
Defining Qualified Overtime Compensation
Qualified overtime compensation refers exclusively to the overtime premium required by the Fair Labor Standards Act (FLSA). Typically, this is the “extra half-time” amount paid to non-exempt employees when they exceed 40 hours in a single workweek.
It is critical to note that the entire amount paid for an overtime hour is not considered qualified compensation — only the premium portion above the regular rate counts.
How to Calculate Qualified Overtime
There are a variety of ways to calculate qualified overtime compensation, including:
Standard Overtime Calculation
If an employee has a regular rate of $20/hour and works overtime, their overtime rate is $30/hour (1.5x the regular rate):
- Total pay for OT hour: $30
- Regular rate: $20
- Premium portion: $10
In this case, only the $10 premium is considered qualified overtime under the OBBBA.
Overtime With Shift Differential
Consider an employee working an evening shift with a base rate of $20/hour plus a $2/hour evening differential:
- Regular rate: $22/hour
- Overtime rate: $33/hour ($22 x 1.5)
- Premium portion: $11 ($33 – $22)
Here, the $11 premium per overtime hour is the reportable amount.
Overtime With Nondiscretionary Bonus
When a nondiscretionary bonus affects the regular rate of pay, the calculation adjusts accordingly. If an employee’s total earnings (including an $800 bonus) result in a regular rate of $44.05/hour:
- Overtime rate: $66.07/hour
- Premium portion: $22.02 ($66.07 – $44.05)
The $22.02 is the qualified amount per overtime hour.
What is Excluded?
Not all extra pay qualifies for this new reporting requirement. It is vital to filter out the following from your OBBBA tracking:
- Shift differentials on regular hours: Evening, weekend, or on-call pay for non-overtime hours does not count.
- Premiums exceeding FLSA requirements: If you pay double-time or triple-time (generous policies above the federal minimum), the excess above the standard 1.5x base rate requirement is excluded.
- Paid time off (PTO): Overtime policies that allow PTO to count toward the 40-hour threshold do not generate qualified premiums under this specific IRS rule.
- Exempt employees: Payments to employees not eligible for FLSA overtime are excluded.
IRS Transition Relief for 2025
Recognizing the complexity of updating payroll systems, the IRS has issued Notice 2025-62 providing transition relief for tax year 2025.
Under this relief, employers will not be penalized for failing to report qualified overtime amounts separately on 2025 W-2s, provided that all other required information on the form is accurate. This grace period allows vendors and internal payroll teams time to reconfigure their calculation engines and reporting outputs.
However, despite this relief, accuracy remains crucial. While the specific separation of the line item is not penalized, reporting incorrect total amounts remains subject to other standard penalties. Employers must ensure their aggregate data is precise.
Key Considerations for Employers
Although the IRS is not enforcing penalties for 2025, the tax deduction remains in effect for employees. Therefore, employers are strongly encouraged to provide employees with a breakdown of their overtime compensation through final pay statements that clearly delineate these figures or a manual calculation summary.
Preparing for Compliance
To prepare for full compliance in 2026 and support employees now, organizations should:
- Review payroll codes: Ensure your system can distinguish between the base rate and the premium portion of overtime pay.
- Audit pay rules: Verify that shift differentials and nondiscretionary bonuses are correctly factored into the regular rate of pay for overtime calculations.
- Communicate with employees: Inform your workforce about the OBBBA deduction and where to find the necessary information on their pay stubs or year-end summaries.
Your path to compliance will depend on how you currently manage time and attendance. If your current provider doesn’t offer automatic FLSA overtime tracking for the new reporting requirements, you’ll need to plan ahead.
For Businesses Using Timekeeping Software
Confirm with your provider that their system updates will support the required reporting, including isolating FLSA overtime premiums from other types of pay. Determine if they will provide guidance and any necessary updates as the 2026 tax year approaches to ensure a smooth transition.
For Businesses Relying on Manual Timekeeping
If your company doesn’t use timekeeping software and relies on manual methods like spreadsheets or timecards, it’s time to start planning. You’ll need a system to calculate and isolate FLSA overtime premiums from other earnings accurately.
This typically means setting up and consistently using separate earning codes for FLSA overtime. Establishing this process ahead of the 2026 deadline will be crucial. If you’re unsure how to proceed, consider reaching out to payroll or HR technology providers that offer specialized compliance solutions.
Turn Payroll Complexity Into Clarity
The OBBBA introduces complexity to payroll processing, but it also offers tangible financial benefits to your workforce. By auditing your pay codes and understanding the distinction between FLSA premiums and other forms of compensation, your organization can help facilitate a smooth transition.
Automate Overtime Tracking With Centrally HR
At CBIZ, we believe compliance should be simple. To address the new IRS rule, we are enhancing Centrally HR, our HRIS, with an intelligent feature designed to handle FLSA overtime calculations for you — quietly in the background.
See how Centrally HR can help you maintain compliance with shifting pay reporting regulations.
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