“No Tax on Overtime” Explained

The One Big Beautiful Bill Act (OBBBA) was signed into law on July 4, 2025, which includes a provision that exempts part of overtime pay from federal taxes.

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Here are the key points:

• The no-tax-on-overtime provision starts for the 2025 tax year and ends after the 2028 tax year.

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• While federal income tax on a portion of overtime is exempt, employees still must pay Social Security, Medicare, and applicable state and local taxes.

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• According to the text of the bill (Text - H.R.1 - 119th Congress (2025-2026): One Big Beautiful Bill Act | Congress.gov | Library of Congress), the deduction for overtime will be considered “above-the-line,” meaning that they will be subtracted from a taxpayer's gross income during the calculation of their adjusted gross income for the tax year.

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• Not all overtime is eligible for the deduction. Only the extra overtime compensation, not the full amount, is deductible. For example, if someone earns $20/hour and $30/hour overtime, only the $10/hr increase is considered for the deduction.

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• The maximum annual deduction is $12,500 ($25,000 for joint returns). This amount decreases for individuals earning over $150,000 (or $300,000, in the case of a joint return), reducing by $100 for every $1,000 earned above that threshold. For example, if the employee’s income is $200,000, then the deduction is reduced by essentially 10% of $50,000, or $5,000, leaving the employee with a $7,500 deduction from overtime earnings. A single individual earning $275,000 or more would not be eligible for any deduction.

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• Overtime pay must align with the Fair Labor Standards Act (Fact Sheet #23: Overtime Pay Requirements of the FLSA | U.S. Department of Labor), which means it applies to hours worked over 40 in a week. Overtime paid under contracts (including collective bargaining agreement) or certain state laws (e.g., California law requiring daily overtime for hours worked in excess of eight in one day) only qualifies if it also meets the FLSA criteria.

Employers must report qualified overtime wages on employees' Form W-2. Since the law is retroactive to January 1, 2025, previously processed payrolls may need adjustments. The law allows businesses to reasonably estimate qualified overtime amounts for tax year 2025 using a method defined by the Treasury Secretary.

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Employers should work with their payroll providers or other tax professionals to ensure correct tracking of eligible overtime wages and consult legal counsel before making significant pay changes as IRS regulations are clarified.

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