IRS Provides Overtime Tax Exemption Guidance

Beginning with tax year 2025, non-exempt employees may deduct the “half” portion of their time-and-a-half overtime pay on the federal tax returns. 

In November, the IRS released guidance regarding tax exemption for qualified overtime for tax year 2025.

This follow-up includes guidance for handling compensatory time (comp time) when employees receive comp time instead of overtime pay. Employers must maintain accurate records of comp time earned and used.  However, separate reporting of the “half” portion for tax exemption purposes is only necessary when an employee receives a payout for unused comp time.

Following are scenarios you may encounter:

• A non-exempt employee who received comp time for hours worked over 40 leaves the district and is paid out their accrued time. The employer must report the qualified overtime hours (the “half” portion of the paid hours) separately from regular wages.
• The district pays out any accrued comp time to employees at the end of the fiscal year. Payments must record the qualified overtime separately from payments at the regular rate of pay. However, any comp time hours that are allowed to be rolled over into the next fiscal year are not paid out and thus not included in the payout calculation.

As a reminder, Forms W-2 and 1099 won’t have dedicated boxes for indicating qualified overtime in 2025, so employers have the option to report qualified overtime in Box 14 of Form W-2 or on a separate statement.

Separate reporting of qualified overtime becomes mandatory in 2026.

Additional information can be found in our July article Overtime Tax Exemption.