Following the enactment of the One, Big, Beautiful Bill Act (OBBBA), P.L. 119-21, the Internal Revenue Service has issued Fact Sheet 2026-01 (FS-2026-01) to provide immediate guidance regarding the new deduction for qualified overtime compensation. This guidance arrives alongside Notice 2025-62 (providing penalty relief for information reporting) and Notice 2025-69 (providing calculation methods for individuals). While the Notices provide the substantive administrative framework for the 2025 transition year, the Fact Sheet serves a distinct purpose by translating these technical requirements into accessible FAQs while offering specific, reliance-based guidance not found in the accompanying Notices.

Reasons for Issuance and the 2025 Transition Period

The primary impetus for this release is the immediate effective date of the OBBBA provisions juxtaposed against the logistical delay in updating information reporting systems. The legislation added Section 225 to the Internal Revenue Code, allowing for the deduction of qualified overtime compensation. However, as the IRS acknowledges, "Forms W-2 and 1099 for taxable year 2025 will not be updated to account for the OBBBA-related changes".

Consequently, the Service issued this news release and Fact Sheet "to provide general information to taxpayers and tax professionals as expeditiously as possible". The issuance addresses the immediate gap for the 2025 tax year where "employers and other payers are not required to report qualified overtime compensation separately on Forms W-2, 1099-NEC, and 1099-MISC". The release confirms that mandatory separate reporting will only commence for "tax years 2026 and later years".

Core Guidance: Definitions and Limitations

The Fact Sheet reiterates the statutory definition of "qualified overtime compensation," grounding it strictly in the Fair Labor Standards Act (FLSA). It states that qualified compensation is "overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act (FLSA) (29 USC § 207) that exceeds the regular rate at which the individual is employed".

Practitioners must advise clients that the deduction is capped. The guidance specifies: "The deduction is up to $12,500 of qualified overtime compensation earned for the year per return ($25,000 in the case of a joint return)". Furthermore, the deduction is subject to a modified adjusted gross income (MAGI) phase-out, which applies if MAGI "exceeds $150,000 ($300,000 for joint filers)".

A crucial technical distinction clarified in the text regarding the calculation of the deduction involves the "half" portion of overtime pay. The Fact Sheet clarifies: "For example, if an individual is paid at ‘one and one-half times’ their regular rate for an hour of overtime work as required by the FLSA, the ‘half’ portion of the ‘one and one-half times’ paid for an hour of overtime work is qualified overtime compensation".

Guidance Unique to the Fact Sheet: Federal Employee Eligibility

A significant portion of the Fact Sheet offers guidance that is effectively absent from Notices 2025-62 and 2025-69: the specific determination of FLSA status for federal employees. While Notice 2025-69 advises individuals generally to "make a reasonable effort to determine whether they are considered FLSA-eligible employees", the Fact Sheet provides precise instructions for federal personnel.

The Fact Sheet instructs that "FLSA eligibility for federal employees is typically documented on the employee’s Standard Form 50, Notification of Personnel Action". It directs practitioners and taxpayers to examine "block 35, ‘FLSA Category’". The guidance explicitly decodes these values: "’E’ means exempt or FLSA-ineligible and ‘N’ means nonexempt or FLSA overtime-eligible".

Furthermore, the Fact Sheet identifies the regulatory bodies governing these determinations, noting that while the Office of Personnel Management (OPM) administers the FLSA for most federal employees, exceptions exist for "employees of the Library of Congress, United States Postal Service, the Postal Regulatory Commission, and Tennessee Valley Authority". This level of agency-specific detail is a unique feature of the Fact Sheet and is critical for CPAs representing civil servants.

Penalty Relief and Reliance on FAQs

Another critical element found in the Fact Sheet, which differs from the standard penalty relief language in Notice 2025-62, is the explicit statement regarding reliance on these FAQs. Notice 2025-62 focuses on penalty relief for filers (employers/payors) under sections 6721 and 6722. In contrast, the Fact Sheet addresses the taxpayer’s reliability on the FAQ document itself.

The Fact Sheet states: "Nonetheless, a taxpayer who reasonably and in good faith relies on these FAQs will not be subject to a penalty that provides a reasonable cause standard for relief, including a negligence penalty or other accuracy-related penalty, to the extent that reliance results in an underpayment of tax". This provides a specific reasonable cause defense for practitioners taking positions based on the Fact Sheet, even though FAQs generally "will not be relied on or used by the IRS to resolve a case".

Differentiation from Voluntary Overtime

The Fact Sheet provides necessary clarification on "voluntary" or "contractual" overtime versus FLSA-mandated overtime, a distinction that requires careful analysis of union contracts and employer policies. The text states unequivocally: "An individual who is ineligible for overtime under the FLSA does not receive qualified overtime compensation regardless of other laws or circumstances (such as a collective bargaining agreement) providing for overtime pay".

Moreover, if an employer pays a premium higher than the FLSA requirement, the deduction is limited. The Fact Sheet provides a specific example not found in the Notices: "For example, if an employer pays double the individual’s regular rate for hours worked over 40 in a workweek, only the one-half portion that is relied upon to comply with the FLSA requirement is qualified overtime compensation".

Conclusion

FS-2026-01 acts as a vital bridge between the statutory language of the OBBBA and the practical application required for the 2025 tax year. For tax professionals, the document is essential not only for its general definitions but specifically for its detailed instructions regarding federal employees and its affirmative statement regarding penalty protection for taxpayers relying on these FAQs in good faith.

Prepared with assistance from NotebookLM.