The One Big Beautiful Bill Act (OBBBA) added a new deduction for qualified overtime compensation. Following passage of this legislation, the Internal Revenue Service has issued several rounds of guidance on the applicability of the deduction to specific workplaces and occupations. Last month, the agency released updated responses to FAQs on the tax deduction. One question posed by the IRS involves the ability of employees considered exempt under the Fair Labor Standards Act to claim the deduction.

If an employee meets the FLSA duties and salary tests for a specific exemption, employers are not prohibited from paying overtime on top of the regular salary. The IRS FAQ makes clear that such overtime amounts are not deductible under the OBBBA. If the employee is classified as FLSA exempt, they cannot deduct any overtime pay provided by the employer. However, the FLSA does not require employers to claim an FLSA exemption for a particular employee. For example, if a worker meets the duties test for the administrative exemption, the employer could decide that it does not want to guarantee that employee’s salary and continue to pay them on a non-exempt or hourly basis.

Could an employer and employee agree to classify an otherwise exempt employee as non-exempt for purposes of allowing them to deduct overtime pay? The IRS FAQ does not directly address this question. It does state that business owners are themselves ineligible for the deduction even if they are also employed by the company. The guidance does not explain whether an employee who meets an applicable duties test cannot deduct overtime even if they are not paid on a salaried basis.

This may be more of a hypothetical than real-world issue. Given the cost of overtime to employers, few would agree to manipulate FLSA exempt status just to save the worker taxes on a portion of their wages. However, we sometimes see situations where, for legitimate business reasons, employers decline to use a potentially available FLSA exemption. In those cases, affected employees may want to consult with a tax professional before claiming the federal income tax deduction for such overtime wages.

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