Quick context if you’re just joining this series: Section 70202 of the One Big Beautiful Bill Act created a temporary federal income tax deduction (tax years 2025 through 2028) for the FLSA-required premium portion of overtime pay. It’s capped at $12,500 per return, phases out above $150,000 in modified AGI, and does not affect payroll taxes. For the full overview, start with No Tax on Overtime: What K-12 Leaders Need to Know. This post is about what “qualified overtime” actually means in practice, and where the misconceptions are.
Important: This is operational guidance, not legal or tax advice. Where IRS guidance is still evolving, we note it. Always consult your district’s legal counsel or tax advisor for specific compliance decisions.
There’s a lot of incomplete information circulating about this law. Here are the misconceptions we’re hearing most often from K-12 leaders, and what the law and IRS guidance actually say.
The misconception: “All overtime pay is now tax-free.”
This is the most widespread misunderstanding. The deduction applies only to the FLSA-required premium portion, and only up to the annual cap. The benefit is a deduction from taxable income, not a dollar-for-dollar tax credit. The actual savings depend on the employee’s marginal federal income tax rate. For a worker in the 12% bracket, a $1,250 deduction saves about $150. For someone in the 22% bracket, a $4,000 deduction saves about $880. It’s a real benefit, but it’s not what the headlines suggest.
The misconception: “We don’t need to track overtime through payroll anymore.”
This misconception is actively dangerous. The law does not change any employer obligation under the FLSA. You still must track hours, pay overtime at the required rate, and run it through payroll. What’s new is that you also need to be able to isolate and report the qualifying premium portion separately. If anything, this law increases the tracking burden, not reduces it.
The misconception: “Shift differentials, stipends, and holiday premiums qualify"
They generally don’t. The deduction is limited to overtime compensation required under FLSA §7 that exceeds the regular rate. Supplemental pay elements like shift differentials, union-negotiated bonuses, extra duty stipends, and holiday premiums are typically separate from the FLSA-mandated overtime premium. However, some of these elements may factor into the FLSA regular rate calculation, which affects how the premium is computed. That’s an important distinction for payroll teams.
The misconception: “Double-time pay is fully deductible.”
Not quite. If an employee earns double-time ($40/hour on a $20 regular rate), the FLSA only requires time-and-a-half ($30/hour). The qualifying premium is $10/hour (the required “half” above the regular rate). The additional $10/hour above the FLSA requirement generally does not qualify. Districts or unions that pay above FLSA minimums need to understand this distinction.
The misconception: “The 2025 grace period means we don’t have to do anything yet.”
Transition relief for 2025 means employers won’t face penalties for not separately reporting qualified overtime on W-2s. But employees are already eligible for the deduction and may need to calculate it using their own pay records and IRS-provided methods. If your district can’t help employees identify their qualifying overtime, you’re creating confusion and administrative burden during tax season even if you’re not technically penalized for it.
The misconception: “This only affects income taxes, so payroll doesn’t need to change anything.”
The deduction is a federal income tax provision, but the operational requirements land squarely on payroll. Starting with the 2026 tax year, employers must separately report qualified overtime compensation on W-2s. Treasury has also been directed to modify withholding procedures under IRC §3402(a) for tax years beginning after December 31, 2025. Payroll systems need to be able to identify FLSA-eligible overtime, compute the premium portion, and report it as a distinct data element.
And it’s worth noting: state income taxes may not follow the federal deduction. Because §225 is structured as a below-the-line deduction affecting taxable income rather than AGI, states that use federal AGI as their starting point won’t automatically incorporate it. Districts in states with income taxes should check their state’s position.
The practical challenge for K-12 districts isn’t understanding the law in the abstract. It’s applying it to the compensation structures that already exist in your district. Here’s where it gets complicated:
The FLSA regular rate isn’t always the employee’s base hourly wage. Nondiscretionary bonuses, shift differentials, and certain other forms of remuneration can factor into the regular rate calculation. That means the “premium” portion of overtime can change depending on what else is in the paycheck. For districts with layered compensation, this is a harder calculation than it appears.
Most payroll systems track total overtime pay. Fewer are set up to isolate just the FLSA-required premium from everything else. If your district pays overtime at rates above FLSA minimums (through union agreements, board policy, or local practice), you need to be able to show which portion is the FLSA-mandated premium and which portion is supplemental. That requires pay codes and earning types structured to support the distinction.
For the 2025 tax year, employees may need to calculate the deduction using their own pay records and IRS transition methods. For 2026 and beyond, the burden shifts to employers to report the amount on W-2s. Either way, the underlying data has to be there. If your district can’t produce a clear, defensible record of FLSA-eligible overtime by employee and by pay period, you’re exposed on both ends.
For any individual employee’s overtime pay, the question sequence looks like this:
Touchpoint doesn’t calculate your overtime premium or file your W-2s. That’s the job of your payroll system and your time and attendance software.
What Touchpoint does is make sure the data going into those systems is worth trusting. Our SmartClocks capture every punch with accurate job codes, physical locations, and visual validation built in. That data flows directly into your time and attendance platform, giving your payroll team the clean, auditable foundation they need to isolate FLSA-eligible overtime by employee and by pay period.
The calculation and reporting happen downstream. But if the time data at the source is incomplete, inconsistent, or unreliable, everything downstream is compromised. That’s the problem Touchpoint solves.
We’re tracking everything districts need to know about overtime readiness in one place. Visit our Overtime Ready for 2026 resource page for the latest guidance and tools as they roll out.
Not sure where your district stands? Fill out the form below to book a 20-minute Readiness Consultation.