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No Tax on Overtime? Understanding the New Federal Overtime Pay Deduction

  • Mark Plassmeyer, EA
  • Jan 14
  • 4 min read

One of the most talked-about changes in recent tax law is a new provision often summarized as “no tax on overtime.” While that phrase makes for a catchy headline, the reality is a bit more nuanced. Beginning in 2025, the One Big Beautiful Bill Act creates a temporary federal income tax deduction for certain overtime pay, but it does not eliminate taxes on overtime altogether.


If you expect to earn overtime—or already do—here’s what you need to know about how this new rule works, what qualifies, and what does not.



What the New Overtime Deduction Is

Under Section 70202, individuals may deduct qualified overtime compensation for tax years 2025 through 2028. The deduction applies only to the portion of overtime pay that exceeds your regular rate of pay—in other words, the “half” portion of “time-and-a-half.”


Example at a high level:

  • Regular pay = 1.0

  • Overtime pay = 1.5

  • Only the extra 0.5 portion is deductible


This is a deduction, not an exclusion. That distinction matters.

  • Overtime wages are still taxable income

  • Taxes will still be withheld from your paycheck as usual

  • You receive the benefit only when you file your individual tax return and claim the deduction


Key Limits and Time Frame

Here are the major guardrails built into the law:

  • Effective years: 2025 through 2028 only

  • Maximum annual deduction:

    • $12,500 for single filers

    • $25,000 for married filing jointly

  • Income phase-out:

    • Begins over $150,000 of modified adjusted gross income (MAGI)

    • $300,000 for joint filers

  • Available whether you itemize or not

  • You must have a valid Social Security number (SSN)


This deduction is available to both W-2 employees and certain non-employees, as long as the overtime is properly reported.


What Counts as “Qualified” Overtime Pay

This is where confusion is most likely.


For overtime pay to be qualified, it must meet all of the following conditions:

  1. Required by the federal Fair Labor Standards Act (FLSA)

  2. Paid at a premium rate (such as time-and-a-half or more)

  3. Properly reported on a Form W-2, Form 1099, another required statement, or directly by the taxpayer


For most taxpayers, this means only the premium portion of overtime worked in excess of 40 hours in a week will qualify.


Important: State or Local Overtime Rules

Overtime pay that exists only because of state or local law—and not because of the FLSA—is considered nonqualified overtime for this deduction.

That means:

  • If your state requires overtime in situations not covered by federal law

  • Or if a local government contract provides overtime beyond FLSA requirements

👉 That portion does not qualify for the federal deduction, even though it is still taxable income.


Who Does Not Qualify for Overtime Under the FLSA

The FLSA itself includes exemptions. Certain employees—often called “exempt employees”—are not legally entitled to overtime under federal law. If you are exempt under the FLSA, any additional pay labeled as “overtime” may not qualify for this deduction.


The tax rule does not change overtime eligibility under labor law. It simply follows it.


How to Claim the Deduction

You do not claim this benefit through payroll.


Instead, you must:

  • File an individual income tax return

  • Include your SSN

  • File jointly if married and seeking the higher limit

  • Claim the deduction based on qualified overtime compensation received during the year


The IRS and Treasury have indicated that transition relief will apply for tax year 2025 as employers and payroll systems adjust to new reporting requirements.


How Qualified Overtime Is Calculated: Examples

Let’s look at how the deduction works in practice.


Example 1: Clearly Stated Overtime Premium

Andrew’s payroll statement shows $5,000 labeled as “overtime premium.”✔ Andrew may treat the full $5,000 as qualified overtime compensation.


Example 2: Overtime Shown as a Total Amount

Andrew’s payroll instead shows $15,000 of total overtime pay, which includes both regular wages and the overtime premium.

Since time-and-a-half pay consists of:

  • 1.0 regular pay

  • 0.5 premium pay

The premium is one-third of the total.

✔ Qualified overtime = $15,000 ÷ 3 = $5,000


Example 3: Double-Time Overtime

Brad’s employer pays overtime at 2× the regular rate, and Brad receives $20,000 labeled as overtime.

Double-time consists of:

  • 1.0 regular pay

  • 1.0 premium pay

Only the premium portion qualifies.

✔ Qualified overtime = $20,000 ÷ 4 = $5,000


Example 4: Law Enforcement Work Periods

Carol is a non-exempt law enforcement employee paid overtime under a 14-day work period that complies with the FLSA. She receives $15,000 in overtime pay.

✔ Qualified overtime = $15,000 ÷ 3 = $5,000


Example 5: Compensatory Time Paid Out

Diane works for a state or local agency that grants compensatory time at 1.5 hours per overtime hour worked. In 2025, she is paid $4,500 for that compensatory time.

✔ Qualified overtime = $4,500 ÷ 3 = $1,500


The Bottom Line

The new overtime deduction can provide meaningful tax relief—but only if you understand its limits.

  • It is not a tax-free paycheck

  • It applies only to FLSA-required overtime

  • Only the premium portion qualifies

  • The benefit is claimed on your tax return, not in real time


As payroll reporting evolves and IRS guidance expands, this is an area where careful review—and good records—will matter. If you earn overtime or expect to in the coming years, understanding how this deduction works now can help you avoid surprises later.

 
 
 

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