By David B. Falwell, CPA – Tax Manager, and Andrea C. Johnson – Tax Senior

The One Big Beautiful Bill Act (OBBBA), signed into law in July 2025, introduced a highly publicized “No Tax on Overtime” provision. Despite the catchy name, it doesn’t make all overtime completely tax-free. However, it does create a new federal income-tax deduction for eligible workers.

For tax years 2025 through 2028, qualifying employees can deduct the premium portion of their overtime pay (the extra half-time rate above regular hourly wages) as an “above-the-line” deduction, meaning it reduces taxable income even if you take the standard deduction.

In plain terms, if your regular hourly rate is $20 and your overtime rate is $30, only the extra $10 per hour qualifies for the deduction. The goal is to provide employees who work long hours with a modest reward in the form of a tax break on these additional earnings.

Qualifications

The deduction is intended to benefit eligible hourly workers who meet all of the following criteria:

• Non-exempt status: You must be a non-exempt employee under the Fair Labor Standards Act (FLSA), meaning you are entitled to overtime pay. This deduction does not apply to independent contractors or consultants. Note that in some professional settings, certain hourly employees may still be treated as exempt under the FLSA. If an employee’s classification is unclear, employers should consult an employment attorney.
• Qualified overtime pay: You must have received qualified overtime compensation, defined as the federally required premium paid for hours worked in excess of 40 in a workweek.
• Separate reporting: You must file a federal income tax return that separately reports qualifying overtime compensation. Employers are expected to report this information on 2025 Forms W-2.

Caps and Phase-Outs

As with many tax incentives, the deduction has specific limits and phase-out thresholds based on income and filing status:

• Up to $12,500 in deductions for single filers and $25,000 for married joint filers per year.
• Phases out starting at $150,000 MAGI (Modified Adjusted Gross Income) for single taxpayers and $300,000 MAGI for joint taxpayers.
• Available only for tax years 2025–2028, unless extended by Congress.

Limitations

While “No Tax on Overtime” makes a great headline, there are key restrictions to understand:

• Overtime still counts toward gross pay and still has Social Security, Medicare, and state taxes withheld. The deduction only reduces your federal taxable income.
• Only the FLSA-mandated portion qualifies. Overtime rules specific to states or union contracts that pay double-time aren’t automatically included.
• High-income employees may see little benefit. Once you exceed the MAGI threshold, the deduction gradually disappears.

For Employees

Keep track of your overtime hours and verify that your employer separates the “premium” portion on your pay stubs. When filing, ensure your tax software or preparer accounts for the new deduction on your 2025 return. The IRS has indicated that the Form W-2 will be updated for tax year 2026; however, for tax year 2025, it is currently unclear how this information will be reported to employees. The AICPA has requested that the IRS provide more guidance on how qualified employees are to claim this deduction.

For Employers

Update payroll systems to correctly tag qualified overtime. The IRS has clarified that employer reporting requirements will begin with the 2026 tax year. For tax year 2025, the IRS has indicated it does not intend to modify payroll tax forms, and penalties will be waived for employers that do not separately report qualified overtime during this transition period.  However, employers are expected to use available methods to report 2025 qualified overtime amounts, such as including the information in Box 14 of Form W-2 or providing a separate year-end statement.

For Tax Professionals

Expect new W-2 boxes or IRS worksheets to identify qualified overtime. Payroll and other reporting forms will not change for tax year 2025, but expect them to change for tax year 2026. The deduction will appear on the new Schedule 1-A (Form 1040) as an above-the-line adjustment to income.

Bottom Line

The OBBBA’s “No Tax on Overtime” provision is a meaningful win for America’s hourly workers. While it won’t make overtime entirely tax-free, it does provide a reward for those putting in extra hours and a bit more take-home pay at the end of the day.

If you regularly work overtime or manage payroll for hourly employees, now’s the time to understand the new rules, verify eligibility, and ensure proper reporting before the 2025 filing season.