IRS Overtime Deduction | Year-End Payroll Checklist for Manufacturers
Published on by Bryan Gayhart in Manufacturing, Wholesale / Distribution
- Updated IRS guidance clarifies the qualified overtime deduction and reporting requirements for the 2026 tax year.
- Mandatory W-2 reporting requires employers to separately report qualified overtime compensation in box 12 using code TT beginning with 2026 wages.
- Overtime eligibility is limited to the premium required under the Fair Labor Standards Act (FLSA), with specific considerations for exempt employees and owner-employees.
- Incorrect reporting can result in penalties and require employers to issue corrected W-2 forms.
- Year-end preparation should include reviewing payroll systems, employee classifications, and reporting processes to help ensure compliance.
The IRS recently issued Fact Sheet FS-2026-13, updating its guidance on the “No Tax on Overtime” deduction and clarifying reporting requirements for 2026. For manufacturers and distributors with multiple shifts and employees regularly working overtime, these updates have important implications for payroll and HR teams.
The overtime deduction, introduced under the One Big Beautiful Bill Act (OBBBA), isn’t new. However, the IRS has clarified what employers must do to track and report qualified overtime compensation on Form W-2 beginning with the 2026 tax year.
What’s changed for overtime deduction reporting?
FS-2026-13 updates the original January 2026 FAQs and provides additional guidance on reporting requirements. The deduction remains available for up to $12,500 in qualified overtime compensation ($25,000 for joint filers), with phaseouts beginning at modified adjusted gross income above $150,000 ($300,000 for joint filers).
Key changes employers should be aware of include:
- Mandatory W-2 reporting: Beginning with tax year 2026, employers must separately report qualified overtime compensation in box 12 of Form W-2 using code TT. The temporary reporting relief available for 2025 no longer applies.
- Corrected forms for employees: If a W-2 incorrectly reports qualified overtime compensation, employees generally need a corrected Form W-2c from their employer rather than calculating a replacement amount themselves.
- Employer error correction: Employers who discover errors in box 12, code TT must issue a Form W-2c. Incorrect reporting may also result in penalties under Internal Revenue Code sections 6721 and 6722.
- Withholding requirements: Employers aren’t required to automatically adjust federal income tax withholding for the deduction. Employees who want to account for it in their withholding can submit an updated Form W-4 using the worksheet for step 4(b).
Who’s affected under the new overtime deduction rules?
These requirements are particularly relevant for manufacturers and distributors with employees who qualify for overtime under the Fair Labor Standards Act (FLSA), including many production, warehouse, and distribution center workers.
A few employee classification considerations are worth reviewing:
- Owner-employees: Individuals with a 20% or greater ownership interest who actively participate in management may qualify for the FLSA’s executive exemption, depending on their responsibilities and compensation. Overtime payments to exempt employees don’t qualify for the deduction.
- Exempt employees: Salaried supervisors, administrative staff, and other employees who meet the FLSA’s executive, administrative, or professional exemptions generally aren’t eligible for FLSA-required overtime. Additional compensation paid to these employees doesn’t qualify for the deduction.
- Overtime premiums: Only the portion of overtime compensation required under the FLSA qualifies. For example, when an employee earns time and a half, generally only the additional half of their regular rate is eligible, rather than the full overtime payment. Additional premiums, such as double time or overtime paid solely because an employee works more than eight hours in a day, generally don’t qualify unless required under the FLSA.
Incorrect classifications or overtime calculations can lead to inaccurate W-2 reporting and potential compliance concerns.
What do overtime deduction updates mean for my manufacturing or distribution business?
For many manufacturers and distributors, the biggest challenge is ensuring payroll systems can accurately identify and report qualified overtime compensation.
Before preparing 2026 W-2s, employers should confirm that their payroll provider or internal system can track the FLSA-required overtime premium separately from total overtime pay. They should also verify that box 12, code TT is configured correctly and review employee classifications, particularly for supervisors, team leads, and owner-employees.
Communication with employees is another important consideration. Workers may have questions about the new reporting code and how the deduction affects their tax returns. Providing a brief explanation ahead of tax season can help employees understand what to expect and reduce confusion.
Reviewing these processes before year-end can help identify potential issues and reduce the need for corrections during W-2 filing season.
Next steps
If you’re unsure whether your payroll system can accurately track qualified overtime or whether employee classifications meet FLSA requirements, our Fractional HR Support & Advisory Services team can help evaluate your existing processes and identify areas that may need attention.
Working alongside our tax pros, our HR team can guide payroll reporting, employee classifications, and related compliance considerations. Contact us today for a free consultation to discuss how we can help your organization prepare for year-end reporting.
Related resources
For additional guidance on the tax law changes affecting businesses and employees, check out our OBBBA Toolkit, which brings together resources on key provisions of the legislation. Manufacturers and distributors may also find valuable industry insights in our Manufacturing & Wholesale Distribution Benchmarking Report, including information to help evaluate performance and identify opportunities for improvement. For organizations looking to strengthen their workforce practices, our Fractional HR Toolkit offers additional resources on HR compliance, workforce planning, and improving HR processes.
