The FLSA allows employees of a political subdivision of a State or an interstate governmental agency to receive compensatory time off (“comp time”) in certain circumstances in lieu of cash overtime compensation. According to Notice 2025-69 from the IRS, an employee who banks overtime as comp time and uses it for time off does not generate a wage payment at that time. Consequently, nothing is reported as taxable wages in that period; and there is no deduction under the OBBBA as qualified overtime compensation for that year. If the employee eventually is paid out accrued comp time (e.g., upon separation of employment), the employee may take the overtime amount into account for purposes of the OBBBA in the year the comp time is paid.
EXAMPLE: Diane works for a County that gives compensatory time at a rate of one and one-half hours for each overtime hour worked. If Diane works 50 hours of overtime in 2025 that is banked as compensatory time off. Nothing is reported as taxable wages for 2025, and no deduction is available to Diane under the OBBBA for 2025.
However, in 2026, Diane is paid wages of $4,500 for compensatory time off accruals for overtime worked. To determine the amount of qualified overtime compensation received in tax year 2026, Diane may include $1,500, one-third of these wages, for purposes of determining the qualified overtime compensation deduction.
