Employees can now deduct up to $12,500 a year of qualified overtime pay on their federal return, or $25,000 on a joint return, and starting with 2026 W-2s, employers have to report that overtime in a new spot on the form. For contractors whose field crews work long weeks, that makes January's W-2s more involved than usual. From running payroll and job costing for contractors, we've found that most payroll setups were never built to separate the piece of overtime this deduction cares about, so it's worth checking yours before year-end.
This post covers what counts as qualified overtime, what you have to report as the employer, and where construction and home service payroll tends to trip over the details.
What the deduction covers
The deduction comes from the One Big Beautiful Bill Act, and it belongs to your employees, not to the business. Employees claim it on their own tax return, and it begins to phase out once modified adjusted gross income passes $150,000 for single filers or $300,000 for joint filers. Your withholding doesn't change because of it.
The part that matters for your payroll is the definition of qualified overtime. It only covers overtime the Fair Labor Standards Act requires, which generally means hours over 40 in a workweek for non-exempt employees, and it only covers the premium portion of that pay. On a time-and-a-half hour, the "half" qualifies and the regular rate doesn't.
A worked example
Picture an HVAC technician earning $30 an hour who works an average of six overtime hours a week for 50 weeks. That's 300 overtime hours at $45 an hour, or $13,500 of total overtime pay for the year.
Only the premium qualifies, which is the extra $15 an hour above the regular rate. That puts the technician's qualified overtime at $4,500, and that's the figure that belongs in the new W-2 reporting, not the full $13,500. A payroll system that only tracks total overtime dollars can't produce the right number without someone doing the math by hand for every employee.
What employers have to report
Starting with tax year 2026, employers report qualified overtime compensation on Form W-2 in box 12 using code TT. You report the full qualified amount you paid, even if the employee earns too much to deduct all of it, because the income limits are the employee's problem to work out on their return. If the amount is wrong after W-2s go out, the fix is a corrected Form W-2c.
The relief the IRS allowed for 2025 doesn't carry over, so this year's W-2s are the first where the box 12 figure has to come straight from your payroll records. If you use a payroll provider, ask now whether they're already tracking the FLSA premium separately and whether they'll populate box 12 automatically. If the answer is anything other than a clear yes, you want to know in November, not in late January.
What doesn't count
Overtime premiums that come from somewhere other than the FLSA don't qualify. That includes overtime paid under a union contract or company policy beyond what federal law requires, daily overtime, double time, and shift differentials. If you pay double time on Sundays as a perk, only the federally required piece of those hours can be reported, and only if the hours pushed the employee past 40 for the week.
Employees who are exempt from overtime under the FLSA don't qualify either, which typically includes salaried managers and estimators who meet the exemption tests. Employee-owners with at least a 20 percent ownership stake who actively manage the business are also generally excluded.
Where contractor payroll gets complicated
Construction and home service payroll has a few wrinkles that make this harder than it looks. Many contractors pay different rates for different kinds of work, like a higher rate for installs than for service calls, and the FLSA regular rate in a week with mixed rates is usually a weighted average rather than either rate. Bonuses and spiffs tied to production can also change the regular rate, which changes the premium. If your techs earn sold-job spiffs, our post on HVAC payroll and crew cost tracking covers how to keep that pay organized in the books.
Prevailing wage work adds another layer, since overtime on public projects can be required under more than one law and fringe benefits don't always count toward the regular rate the same way. If you run certified payroll, have your payroll provider confirm how prevailing wage overtime hours are coded before W-2s are produced, because those are the hours most likely to be split incorrectly.
In Florida, where there's no state income tax, this federal deduction is the whole benefit for your crew, and storm season can push overtime well above normal for months at a time. That makes accurate reporting worth getting right, because a technician who worked heavy hurricane-recovery hours may have a meaningful deduction riding on your box 12 figure.
What to do before year-end
Start by confirming every field employee is classified correctly as exempt or non-exempt, since only non-exempt employees can have qualified overtime. Then check that overtime is set up in payroll as its own pay type, separate from regular hours, double time, and any premium pay you offer by policy. Finally, pull a year-to-date overtime report and spot-check a few employees by hand using the premium math above, so you catch problems while there's still time to fix the payroll settings.
It's also worth telling your crew. Most field employees have heard about "no tax on overtime" and assume it covers every overtime dollar, so a short note explaining that only the premium portion counts will save you questions in February.
Clean overtime tracking pays off beyond the W-2, too. When overtime sits in its own pay type and flows into your job costing at the burdened rate, you can see which jobs are eating overtime and what it's really costing you. Our free Labor Burden Calculator shows what an hour of field labor costs once taxes and workers' comp are added in.
This post is educational and based on IRS guidance as of this writing. The rules for individual employees and unusual pay arrangements can get specific, so confirm the details with your tax pro or payroll provider.
When it's time for help
For a contractor with two or three employees and simple hourly pay, a payroll provider and a quick review may be enough. Once a home service or construction business passes about $500,000 in revenue, crews usually involve mixed rates, spiffs, and overtime that shifts with the season, and that's when payroll and the books need to be set up to track it correctly from the first paycheck of the year.
At Prophet Accounting, we work with contractors and other home service trades across Port St. Lucie, the Treasure Coast, and nationwide. We set up payroll pay types and job costing so overtime, burdened labor, and crew costs are tracked correctly all year, and so year-end reporting comes straight from the records. Schedule a consultation at prophetaccounting.com/contractors or give us a call at (772) 380-2871. For a quick read on monthly bookkeeping costs, our pricing calculator gives you a ballpark in about two minutes.
