1. What’s New?
- Starting January 1, 2025, the OBBBA (signed into law on July 4, 2025) introduces a new above-the-line federal deduction for qualified overtime compensation, valid through tax year 2028. This deduction is available regardless of taking the standard deduction or itemizing your qualifying expenses.
- Individuals can deduct up to $12,500/year, while joint filers can deduct up to $25,000 of overtime premium pay from federal taxable income. Married taxpayers must file a joint return to claim the deduction.
- Unless individual states (with an income tax statute) adopt this provision, overtime pay will still be taxable on state and local personal income tax returns.
- Since this is a deduction and not an exclusion, income taxes, as well as FICA and Medicare, will still be withheld on all income, including overtime. While I have not seen any discussion on this topic, there may be a future means or provision to enter an adjustment on Form W-4 to reduce overall withholding. We will have to monitor the Form W-4 to see if it is revised to provide a provision for such an adjustment.
2. What Counts as “Qualified Overtime”?
- Only the premium portion (e.g., the extra half-hour pay in “time‑and‑a‑half”) is deductible, not the entire overtime paycheck.
- The overtime must be paid under FLSA Section 7 and reported separately on a Form W‑2 (or Form 1099 for eligible contractors).
- Independent contractors generally do not qualify, since FLSA doesn’t require overtime coverage for them.
- If you are at least a 20% owner in a C or S Corporation, you are exempt from the FLSA overtime requirements. Thus, you cannot pay yourself overtime and then exclude it on your personal return.
3. Who Qualifies?
| Eligibility Condition | Details |
| Filing Status | Available to both itemizers and standard deduction filers. |
| Taxpayer ID | Must include a valid Social Security Number; married individuals must file jointly if claiming the joint limit. |
| Income Limits | Phases out starting at $150,000 MAGI (modified adjusted gross income) for singles, $300,000 for joint filers. |
| Employment Classification | Must be non-exempt under the FLSA and receive overtime pay under law (excludes exempt salaried employees). |
4. Benefits & Limitations
- This deduction reduces taxable income, potentially lowering tax liability or increasing refundable credit, but does not eliminate payroll tax obligations (Social Security, Medicare).
- The benefit is more valuable in higher marginal tax brackets, though the MAGI phase-out limits mean some taxpayers may get reduced or no benefit.
- It provides targeted relief that rewards workers who earn overtime without affecting payroll or FICA collections.
5. Practical Implications
- Employers should prepare to report qualified overtime separately and retain accurate records from 2025 onward.
- Employees should carefully track their premium overtime hours and confirm their income qualifies them under MAGI limits.
- Tax preparers need to understand AGI calculations, filing status requirements, and interactions with other temporary OBBBA deductions (such as tips and auto loan interest).
- Some labor organizations, like the IAFF, have endorsed the provision for its benefit to public employees and shift workers.
⚖️ Summary Table
| Feature | Details |
| Who qualifies | FLSA-covered employees paid time‑and‑a‑half overtime |
| What’s deductible | Only the overtime premium portion up to $12,500/$25,000 |
| Income limits | Begins phasing out at $150K/$300K MAGI |
| Payroll tax | Still applies to overtime pay |
| Reporting requirements | Employers must include summary info on W‑2s or 1099s |
| Effective period | Tax years 2025 to 2028 |
There is a caveat to this deduction.
The only overtime pay considered for deduction is federal FLSA (Fair Labor Standards Act)- mandated overtime. Generally, overtime must be paid under the FLSA if a worker exceeds 40 hours per week.
Some states, including California, have different rules. For example, California mandates time-and-a-half overtime pay for time worked in excess of 8 hours a day, regardless of whether the total time worked in a week exceeds 40 hours. In addition, California requires double-time pay for hours worked in excess of 12 hours a day. The FLSA does NOT require overtime pay in either circumstance.
Therefore, not all overtime paid to a California (or other state) worker may qualify for the deduction.
Key Characteristics of an FLSA Workweek:
- Fixed & Recurring: It’s a consistent 7-day cycle (e.g., Sunday to Saturday, or Wednesday to Tuesday).
- 168 Hours: Composed of seven 24-hour periods.
- Employer Defined: The employer establishes the start day and time, but must document it.
- Not Averaged: Overtime isn’t averaged across multiple workweeks; each week is calculated separately.
The phrase “No Tax on Overtime” is misleading. It does not actually mean that overtime pay is no longer taxable. To the contrary, all OT pay remains subject to federal income tax and withholding rules. However, employees may be eligible to claim a limited income tax deduction for qualified overtime compensation. Employees may opt to adjust their Forms W-4 to reflect any expected deductions for qualified overtime compensation.
In addition, all overtime compensation remains fully subject to other payroll taxes. Those include Social Security and Medicare taxes (both the employer’s and the employee’s share). The OBBBA’s new tax deduction applies only for federal income tax purposes.
Summary
- The OBBBA’s overtime provision is a federal income tax deduction, not a payroll exemption.
- It provides relief for employees who regularly earn premium overtime, but only up to defined limits based on income and filing status.
- Employers and payroll systems should prepare for new reporting responsibilities in 2025.
- The real savings depend on tax rate and overtime volume; focus on potential tax savings rather than immediate withholding changes.
- State tax treatment varies; overtime deductions only apply at the federal level unless states conform in future legislation.