Comp Time and No Tax on Overtime: State and Local Government Guide
For eligible state and local employees, FLSA comp time can produce qualified overtime compensation when the leave is paid or cashed out. The timing is different from ordinary overtime pay.
For eligible state and local government employees, FLSA compensatory time can count toward the OBBBA overtime deduction when the accrued leave is paid as wages or cashed out—not when the comp time is earned. The IRS applies a special timing and calculation rule under FLSA section 207(o).
Key takeaways
- The special comp-time rule applies to eligible state or local government employees, not private or federal employees.
- Comp time earned under section 207(o) is normally provided at one-and-one-half hours for each overtime hour.
- The qualified amount is treated as paid when the leave is used and paid, or when accrued comp time is cashed out at termination.
- For 2026–2028, the employer’s Box 12 code TT reporting remains important to the deduction.
When does comp time count for the tax deduction?
The IRS says qualified overtime compensation is not paid when an eligible state or local employee earns compensatory time off. It is paid when the employee takes the accrued leave and receives wages for it, or when accrued comp time is paid out on termination. That timing rule can put the deduction in a different tax year from the overtime work itself.
For example, comp time accrued in one year and used as paid leave in the following year is analyzed when the wage payment occurs. This is not a choice to move income between years; it is the IRS timing rule for this type of FLSA comp time.
Who is covered by the comp-time rule?
The cited IRS rule addresses employees of a state, a political subdivision of a state, or an interstate governmental agency who receive compensatory time under 29 U.S.C. 207(o). Section 207(o) does not apply to private employees or federal employees, so do not assume any employer’s “comp time” policy receives the same tax treatment.
You also need to be FLSA overtime-eligible. The deduction is for overtime compensation required under the FLSA, not every paid leave program. A payroll label such as “banked hours,” “flex time,” or “comp leave” does not settle the federal tax treatment.
How is qualified comp-time pay calculated?
The IRS explains that the qualified amount is determined from the paid or cashed-out accrued comp-time hours, the applicable rate under section 207(o), and a division by three. Payroll must apply the rate that belongs to the particular paid leave or cash-out event; the formula is not simply the value of all paid leave.
This is a specialized calculation, especially if rates changed between earning and using the time. Request the agency’s qualified-overtime calculation rather than trying to infer code TT from leave-bank balances. The standard Schedule 1-A cap and modified adjusted gross income phaseout still apply after the amount is determined.
What to keep and what to ask payroll
- Confirm that the leave is compensatory time under FLSA section 207(o), not a private-employer or federal flex-time arrangement.
- Keep the leave statement showing hours used or cashed out, the pay date, and the rate applied by the employer.
- Ask payroll whether the paid comp time is included in qualified overtime reporting and, for 2026–2028, how it appears in Box 12 code TT.
- Use the employer-reported qualified amount and complete Schedule 1-A; do not claim the deduction when time is merely accrued.
For the broader rule, review our no-tax-on-overtime calculation guide and the Schedule 1-A filing guide.
Frequently asked questions
Do I claim the deduction when I earn comp time?
Generally no. For state and local employees receiving comp time under FLSA section 207(o), the IRS says qualified overtime compensation is not paid when the comp time is earned. It is treated as paid when the employee takes the accrued leave and receives wages, or when unused time is paid out after termination.
Can a private-sector employee use the comp-time rule?
No. The IRS notes that the section 207(o) comp-time rule does not apply to private employees. Private-sector overtime and other leave arrangements must be analyzed under the ordinary FLSA and qualified-overtime rules, rather than by using the state-and-local-government comp-time formula.
Do federal employees use the same comp-time rule?
No. The IRS says section 207(o) does not apply to federal employees. Federal workers can have separate FLSA rules administered through the Office of Personnel Management or another federal authority. Review the federal-employee guidance and your agency’s payroll information before preparing a return.
Does paid comp time bypass the OBBBA overtime cap?
No. Comp-time pay that is qualified overtime compensation is still subject to the deduction rules. Schedule 1-A applies the $12,500 individual or $25,000 joint-return cap and the modified adjusted gross income phaseout. The payroll amount is not automatically the final deductible amount.
Sources
IRS Fact Sheet FS-2026-13, compensatory-time FAQ; IRS Schedule 1-A overview.
This article is general information, not tax or legal advice. The OBBBA deductions are federal rules, and payroll facts can be specialized. Use current IRS materials and consult a qualified tax professional about your own return.