Key Takeaways
- The federal deduction for qualified overtime compensation is available through 2028, but “No Tax on Overtime” does not mean all overtime wages are tax-free.
- Generally, only the overtime premium required under the Fair Labor Standards Act (FLSA) qualifies for the deduction, not the employee’s full overtime wages.
- Employees must be covered by the FLSA and eligible for overtime under its rules for their overtime compensation to qualify.
- Beginning with 2026 Forms W-2, employers must separately report qualified overtime compensation in Box 12 using code TT.
- Dental practices should confirm now that their payroll systems or providers are properly tracking qualified overtime rather than waiting until W-2 season.
- Questions about whether employees are properly classified as exempt or nonexempt should be addressed separately with an appropriate employment-law advisor.
If you have hourly employees who occasionally work more than 40 hours a week, there is a new tax rule that could affect both them and your practice’s payroll reporting.
The new federal deduction for qualified overtime compensation, sometimes referred to as “No Tax on Overtime,” took effect for 2025 and is available through 2028. But 2026 brings an important change for employers: businesses must now separately report qualified overtime compensation on employees’ Forms W-2. The IRS recently updated its guidance to provide additional details about how the deduction works and what employers need to report.
For dental practice owners, this is a good time to understand which employees may be affected and make sure your payroll provider is prepared to capture the necessary information.
“No Tax on Overtime” Doesn’t Mean All Overtime Is Tax-Free
The name can be misleading. The law does not make all overtime pay tax-free. The deduction applies only to qualified overtime compensation required under the Fair Labor Standards Act (FLSA). In the common situation where an eligible employee earns time-and-a-half for working more than 40 hours in a workweek, only the additional “half” portion qualifies for the deduction, not the employee’s regular hourly pay for those overtime hours. Overtime that isn’t required by the FLSA does not qualify.
For example, suppose an FLSA overtime-eligible employee normally earns $30 an hour and works five overtime hours. At time-and-a-half, the employee earns $45 for each overtime hour. The qualified overtime portion generally would be the additional $15 per hour, or $75, not the full $225 of overtime wages.
Who May Qualify?
Not every employee who works additional hours is eligible. The employee must be covered by the FLSA and not exempt from its overtime requirements. The IRS specifically notes that employees who are exempt from FLSA overtime requirements don’t receive qualified overtime compensation for purposes of this deduction, even if they receive some form of overtime pay under another arrangement. Common FLSA exemptions can include certain executive, administrative, and professional employees, among others.
In a dental practice, that means you shouldn’t assume that every employee who works beyond their normal schedule qualifies, or that every additional dollar you pay them is qualified overtime. Employee classification and the reason overtime is being paid matter.
How Much Can Employees Deduct?
Eligible taxpayers can deduct up to $12,500 of qualified overtime compensation per individual tax return, or up to $25,000 for a joint return. The deduction begins to phase out when modified adjusted gross income exceeds $150,000 for an individual or $300,000 for joint filers.
The deduction is available whether the taxpayer itemizes or takes the standard deduction. Married taxpayers must file jointly to claim it, and Social Security number requirements also apply.
There is another important distinction: the deduction doesn’t eliminate payroll taxes or automatically change income tax withholding. Qualified overtime compensation remains subject to applicable withholding and employment taxes. If an employee wants their federal income tax withholding adjusted to account for an expected overtime deduction, they generally need to provide an updated Form W-4.
What’s Different for Employers in 2026?
This is where dental practice owners need to pay particular attention. For 2025, employers received transitional relief and generally weren’t required to separately report qualified overtime compensation on Forms W-2. Beginning with tax year 2026, employers are required to separately report qualified overtime compensation on Form W-2, Box 12, using code TT.
The amount reported is the total amount of qualified overtime compensation paid to the employee. Employers don’t reduce that number based on the employee’s $12,500 deduction limit or income level; determining the employee’s ultimate deduction happens on the employee’s individual income tax return.
That means practices with overtime-eligible employees need payroll systems capable of distinguishing qualified overtime compensation from the rest of an employee’s wages.
If an employer later discovers that the qualified overtime amount reported on an employee’s W-2 is incorrect, the IRS guidance says the employer must file a corrected Form W-2c and provide it to the employee. Incorrect information reporting can also potentially result in penalties, although reduced penalties may apply for timely corrections.
What Should Dental Practice Owners Do Now?
You don’t need to become an expert in the FLSA or calculate every employee’s deduction yourself. But if anyone on your team receives overtime pay, now is a good time to make sure the people who handle your payroll understand the new requirements.
Start by identifying which employees are classified as overtime-eligible under the FLSA and whether they receive overtime during the year. Then talk with your payroll provider about how qualified overtime compensation is being tracked and confirm that your system will separately report the appropriate amount on 2026 Forms W-2.
This is also a good reminder that employee classification matters. If you aren’t certain whether particular team members are properly classified as exempt or nonexempt for overtime purposes, that is a separate employment-law question worth addressing with the appropriate advisor rather than waiting until W-2 preparation begins.
Don’t Wait Until W-2 Season
The new deduction may ultimately benefit employees, but it creates a new reporting responsibility for employers. Waiting until year-end to figure out how much qualified overtime each employee received could create unnecessary headaches, particularly if your payroll system hasn’t been tracking it correctly throughout 2026.
If your dental practice has employees who receive overtime, talk with your payroll provider now. And if you have questions about how the qualified overtime deduction could affect your tax planning or reporting, the Edwards & Associates team can help you understand what the new rules mean for you and your practice.
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