Overtime Deductions, Client Confusion & Smarter Tax Prep

Lee Reams II

Welcome to another episode of the Growth Minded Accountant Podcast. My name is Lee Reams II. I'm the founder and CEO of CountingWorks. Today we're going to talk about another tax season challenge that we have been getting feedback from our client base about, and that is the overtime rules. Like we talked about last week on the Trump accounts, each of these issues might add 10 to 15 minutes of more questions and explanations. Today, we're going to go over the overtime rules, the best way to communicate with your client, and ways to have a smarter prep task list.

Lee Reams II

Overtime has been one of the most misunderstood tax topics coming out of the One Big Beautiful Bill Act. A lot of workers heard “overtime deduction” and assumed all overtime counted, which is not true. Today we're going to break down what actually qualifies, why the 2025 tax season is going to be more work for tax professionals than they expect, and most importantly, how firms can use better client communication and technology to avoid chaos during appointments. Who better to walk us through this than Lee Reams Sr., our resident tax expert. Senior, how are you?

Lee Reams Sr.

I'm doing good, thank you.

Lee Reams II

All right, so let's start here. If we can clear up some misconceptions, during the election cycle, overtime was talked about like it was one simple bucket. But the first thing tax pros and their clients need to learn is that not all overtime qualifies. I don't totally understand the FLSA-defined overtime rules and how political messaging may have oversimplified the rule, but that is where the confusion starts. Why don't you start there and let's go from that point.

Lee Reams Sr.

What happened here is they tied this overtime deduction to the original Federal Fair Labor Standards Act, which was passed way back in the 1930s. I forget the exact year. What that does is require overtime at time and a half. Overtime is defined as hours in excess of 40 hours per week.

Lee Reams Sr.

Most states make overtime apply on a daily basis. For instance, if somebody works overtime for one day, they may get paid overtime in that state. But if they do not work 40 hours in a week, then they will not get any overtime deduction on the federal tax return.

Lee Reams II

All right. That sounds fun. Was this retroactive to last year, or did employers need to report all that? Or is that what is coming up in 2026 and beyond, when employers are required to report this?

Lee Reams Sr.

It is retroactive to 2025. However, employers are not required to correctly report it for 2025. It is up to the individual to analyze this themselves. That throws a lot of burden on the tax preparer. The preparer has to go back and analyze the overtime on a weekly basis because it is based on a 40-hour week.

Lee Reams Sr.

If someone is working less than 40 hours, say a 30-hour week, but they receive some overtime with it and do not reach 40 hours, then that overtime does not count for the deduction.

Lee Reams II

I think this is obviously the basis of how you could create a bottleneck if each tax pro has to go in and clean this up. It gets even worse because not all states are complying with the federal rules. If you could clarify that a little bit, I think that is another curveball here.

Lee Reams Sr.

For instance, California requires overtime after eight hours in a day. But if the employee does not work 40 hours that week, it does not meet the federal standard for overtime. Therefore, the deduction is based on the federal standard, and that overtime would not count for the deduction.

Lee Reams II

So if someone is working overtime several days during the year, you have to go back and look at this on a weekly basis to see if the overtime counts or not. And if they get more than time and a half, they can only deduct time and a half.

Lee Reams Sr.

Correct.

Lee Reams II

Because that comes from the FLSA, which is decades old and only requires time and a half. Some people might get double time, for example.

Lee Reams Sr.

You're correct.

Lee Reams II

But the federal requirement only goes up to time and a half.

Lee Reams Sr.

Yes. If John Doe is making $20 an hour and gets paid double time, meaning $40 an hour, that extra $10 is not deductible overtime. Only $5 is deductible because the deduction only goes up to the premium for time and a half. Does that make sense?

Lee Reams II

Yes, I totally get it. I just want you to clarify it because I want to get the complexity out there to tax professionals. Now I'm wondering how we educate clients and prepare them before the appointment. You're saying next year employers are going to be reporting this, so it should be much easier. This is definitely just a 2025 tax-year catastrophe in some ways. What is the thought going forward after this year?

Lee Reams Sr.

After this year, employers are required to report the overtime on the W-2, so it will not be an issue for 2026 tax returns. But because this is retroactive and employers were not ready for it because the law did not pass until July 4, they are not required to report it on the W-2 for 2025. It is up to the tax preparer and the taxpayer to come up with the amount.

Lee Reams Sr.

Hopefully, taxpayers have pay stubs that they can bring in. Those pay stubs should show how they were paid for the week or for whatever pay period applies. Then the tax preparer has to go back and figure out what amount of that overtime actually qualifies for the deduction. It is not complicated, but it is laborious.

Lee Reams II

What would you suggest as a game plan? I would say outbound newsletters, social media posts, and talking to clients before their appointments. If a client received overtime, they need to know the rules and how to prepare. Do you include this in intake forms? I know you worked on a worksheet that can help. Would you send this to clients ahead of time? How would you educate them so this does not become another 15- or 20-minute delay in the tax appointment?

Lee Reams Sr.

It is going to be longer than a 15- or 20-minute delay if the individual worked a lot of overtime. You probably need your staff to sit down with the payroll records and go through them ahead of time or after the fact. You are not going to do this during the tax appointment.

Lee Reams II

All right, so I'm going back to how you would work with your client. First of all, the tax savings can be huge, so it more than offsets any fee you are going to charge your clients to calculate this. But what is your best practice for doing this? How would you organize your clients and your staff? Even if your staff is doing it, it needs to be efficient as well. How would you use technology to help this process along?

Lee Reams II

We created a worksheet. We have a Google Sheets version of it in CountingWorks PRO. You could also create an intake form specifically for this to at least collect the information. But it is still the client's information. If someone is on a 26-week pay cycle, are you saying they have to print out or save every single one of those pay stubs to determine whether they had overtime during those periods?

Lee Reams Sr.

You are going to have to have something to go back to in order to figure it out. Luckily, the IRS has also said there will not be penalties if you use your best efforts to determine what the overtime was.

Lee Reams II

That was going to be my next question. This seems ripe for miscalculations and errors. Is that going to come back to bite taxpayers or tax pros on the compliance side?

Lee Reams Sr.

With the budget the IRS has, I do not know how they are going to check all this compliance. They have no way to verify it themselves. It is not like they have a W-2 to look at to see whether you did it right. If they want to challenge it, they will have to challenge taxpayers down the line, and that is going to be a problem for them as well.

Lee Reams II

So on the bright side, there is no IRS matching because there is no reporting from employers.

Lee Reams Sr.

Yes.

Lee Reams II

Okay. Is there an issue if I also receive tips and work overtime? Does that create anything?

Lee Reams Sr.

You work in the worst scenario.

Lee Reams II

I had to ask, so I'm asking.

Lee Reams Sr.

You might have to go back and look at tips as well because that is another issue.

Lee Reams II

But how does that affect this situation? Explain to me, if you are the tax professional, how you handle both issues when you have overtime and the tip issue.

Lee Reams Sr.

They are two separate issues. Handle them separately. They do not interact at all. The overtime is paid by the employer. The tips are what your customers give you as a bonus.

Lee Reams II

If you are saying this is going to take an extra half hour of work, I go back to how technology can help. What is your worksheet designed to do?

Lee Reams Sr.

The worksheet breaks it down by week. If the taxpayer is on some other schedule, you have to break it back down to a weekly payroll period and assume it is time and a half. The way my worksheet works is that it asks for the regular pay rate, then takes half of that, which is the premium bonus for time and a half. That is the dollar value for the deduction. Then you look to see how many hours exceed 40 in a week.

Lee Reams Sr.

Basically, it is a laborious job of going week by week, seeing what overtime they had in those weeks, calculating each week separately, and then summarizing all of the weeks of the year when they had overtime.

Lee Reams II

What percentage of clients do you think will do this themselves versus tax pros taking on this work?

Lee Reams Sr.

Slim to none.

Lee Reams II

So you are saying tax pros are taking it on?

Lee Reams Sr.

Yes.

Lee Reams II

What are the thresholds on overtime? If I make more than $20,000 or $30,000 in overtime, especially for peace officers or people in California making hundreds of thousands of dollars in overtime, are they hitting thresholds? What happens with them?

Lee Reams Sr.

It is limited to $20,000. That is the maximum deduction.

Lee Reams II

Would that be the maximum calculation for that person? Would you just calculate month one or four months or however long it takes until they hit the $20,000, and then that would be your documentation?

Lee Reams Sr.

That would be work for sure.

Lee Reams II

Do you need to bring any of these worksheets in when you file the return, or are they kept at the tax professional's office?

Lee Reams Sr.

The tax professional has to keep that, or the client has to keep it in their records.

Lee Reams II

Okay. You do not submit those to the IRS. They just want the basic number.

Lee Reams Sr.

Correct.

Lee Reams II

I'll finish up with what I would consider best practices for education. I know that with CountingWorks, we have already created content about this. We have sent blog articles and included this in client newsletters. I think there are workflows that could organize clients a little better. If you have segmented your clients and you know who receives overtime, would you proactively send out an email ahead of time saying, “This is what I need. This is how you are affected if you receive overtime,” and give them a checklist of how to prepare?

Lee Reams Sr.

It is hard to determine who is going to receive overtime. A police officer, air traffic controller, firefighter, or someone like that is someone you probably want to get ahead of it with. Those people are always getting overtime. Historically, you may know your clients pretty well. But I think you are really at the point where you need to send this notice out to all of them. You want to know if they worked overtime, and if they did, they need to contact you in advance. If you have staff, they can contact your staff and let your staff explain it to them.

Lee Reams II

I think that is awesome. I think we have put this together in a well-planned format for our clients. We have already covered a lot of this for current CountingWorks PRO clients on the education side. You can use our intake form to create your own process, and you can also use our worksheets. We are going to include those at the bottom of the description for this podcast.

Lee Reams II

This is a quick-hit Growth Minded Accountant episode, but I wanted to cover it because it is another big issue. If your clients are shielding $20,000, that is a significant amount of money. They are going to invest in this and make sure they do it right. Hopefully, this is not too big of a compliance nightmare for the industry. I think we have covered it. Anything I missed that you wanted to mention?

Lee Reams Sr.

I think we covered it pretty well. Like I said before, it is not a complicated calculation. It is just a laborious calculation. You have to look at it on a weekly basis, 40 hours, and there are 52 weeks in a year. That is a lot of looking.

Lee Reams II

Again, until you get to $20,000 and then you are done, I guess. That is it. Thank you for listening to the Growth Minded Accountant Podcast. We are back to our regular schedule tomorrow. Thank you again for all the followers. We broke through 6,000 subscribers last weekend, so we are really excited for all the new listeners. We hope to continue putting out great content for you in the future. Thanks again for being a follower of the Growth Minded Accountant Podcast. Until next time.