Is Overtime Pay Taxed Under the One Big Beautiful Bill?  

Key Takeaways: 

• The Overtime Deduction has a retroactive start date of January 1, 2025, and it will expire on December 31, 2028.

• Under the One Big Beautiful Bill, eligible employees can deduct up to $12,500 in overtime pay from their federal taxable income ($25,000 for joint filers). 

• The deduction applies only to FLSA-qualified overtime and phases out for high earners with MAGIs above $150,000 (single) or $300,000 (joint). 

• Overtime earnings are subject to Social Security and Medicare taxes withheld from your gross pay, which contribute to your retirement and healthcare benefits, as well as applicable state income taxes unless your state enacts similar deductions.

• Employers must still withhold full taxes from overtime pay; the deduction is applied when you file your tax return, potentially increasing your refund. 

• Contractors do not qualify for the deduction, and income reclassification is not permitted. 

• Employees can maximize benefits by adjusting W-4s, increasing pre-tax contributions, and tracking overtime hours accurately. 

Overtime pay is an integral part of many workers’ compensation packages. While employees may appreciate the boost to their paychecks, questions often arise about how overtime earnings are taxed. This is especially true after the passage of the One Big Beautiful Bill in July 2025. Understanding the tax treatment of overtime pay is essential for managing your finances and avoiding unexpected tax bills.  

What is Overtime Pay? 

Overtime pay refers to the additional compensation employees receive when they work more than the standard number of hours defined by their employer or labor laws. In the United States, the Fair Labor Standards Act (FLSA) generally mandates that non-exempt employees be paid at least 1.5 times their regular rate for hours worked beyond 40 in a workweek. 

Let’s look at an example.

If an employee earns $20 per hour and works 45 hours in a week, they’ll receive $20 per hour for the first 40 hours and $30 per hour for the additional 5 hours. This results in $150 in overtime pay. Overtime is particularly common in industries like healthcare, retail, manufacturing, and transportation, where demand for services often requires employees to work extended hours.  

How is Overtime Pay Taxed After the One Big Beautiful Bill?  

From a payroll perspective, overtime pay is taxed like regular income. It is subject to the same federal income tax, state and local taxes (where applicable), and payroll taxes (Social Security and Medicare).

However, under the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduces a major change to how overtime pay is treated at tax time. 

The “No Tax on Overtime” Rule 

Quick example: Suppose you earn $10,000 in overtime at time-and-a-half, and $4,000 of that represents the half-time premium. You may deduct up to $4,000 when you file — not the full $10,000 — subject to the $12,500 cap for single filers or $25,000 for married filing jointly.

Overtime pay remains fully subject to payroll taxes and withholding, so your paychecks won’t increase under the OBBBA. However, eligible employees can take advantage of a new overtime tax deduction. The deduction is available for FLSA-qualified overtime pay up to $12,500 for individuals and $25,000 for joint filers, phasing out for MAGIs above $150,000 (single) or $300,000 (joint).

This above-the-line deduction is retroactive to January 1, 2025, continues through 2028.

The deduction begins to phase out for modified adjusted gross income (MAGI) exceeding $150,000 for single filers and $300,000 for joint filers. Individuals must also have a valid Social Security number to qualify. Importantly, this deduction applies only to federal income tax and does not affect payroll taxes or state/local taxes unless a state adopts a similar provision. Some additional considerations include:

• Overtime earnings remain subject to state income taxes (if applicable), Social Security, and Medicare taxes. 
• The deduction is not available for those using the Married Filing Separately status. 
• This deduction is an below-the-line deduction, reducing your taxable income before AGI and can be claimed whether or not you itemize.
• This deduction is temporary and will be in effect from 2025 through 2028. 

Phaseout Mechanics

The overtime deduction does not disappear all at once once your income crosses the MAGI threshold.

Instead, it gradually decreases as income rises.

Formula: Reduce the maximum deduction by $100 for every $1,000 of MAGI above the applicable threshold.

For example, a single filer with $175,000 in MAGI is $25,000 over the phaseout threshold. That reduces the maximum overtime deduction by $2,500 (25 increments of $100), leaving up to $10,000 available before applying the qualified overtime limits. This is another reason high earners should review their full-year income before assuming they qualify for the full deduction.

Half-Time Premium Deduction

It’s crucial that taxpayers understand that this deduction applies only to the “half-time premium” portion of overtime pay as defined by the Fair Labor Standards Act (FLSA). In other words, you can deduct only the extra half of your “time-and-a-half” overtime pay above your regular hourly wage.

For example, if your regular wage is $20 per hour and your overtime pay is $30 per hour, the deduction applies to the additional $10 earned per overtime hour—not the full $30. If you work 100 overtime hours, you may deduct $1,000 (100 hours × $10) from your federal taxable income. You may do so as an above-the-line deduction at tax time, not during payroll withholding.

Special Cases That Can Affect Qualified Overtime

In most cases, the deductible amount is the “half” portion of time-and-a-half overtime pay. However, some workers have overtime arrangements that are more complicated.

The key rule is that qualified overtime compensation includes only the amount required under the FLSA that exceeds your regular rate of pay. Per IRS Notice 2025-69, if an employer pays more than the FLSA requires, the deductible amount is limited to the FLSA-required premium portion.

If you are paid double time, only the FLSA premium portion counts.

Per IRS Notice 2025-69, if your employer pays twice your regular rate for overtime, the qualified overtime amount is limited to the extra half-time required by the FLSA — not the full double-time premium. To calculate: if your paystub shows the overtime premium separately, divide that premium by 2. If your paystub shows only the total double-time pay, divide by 4.

For example, $20,000 in total double-time pay ÷ 4 = $5,000 of qualified overtime compensation.

Some firefighters, police officers, and similar public safety workers may use a work-period rule instead of the normal 40-hour workweek.

Under FLSA Section 7(k), certain fire protection and law enforcement employees can have a work period of 7 to 28 consecutive days. For a 28-day period, overtime generally begins after 212 hours for fire protection employees or 171 hours for law enforcement employees, rather than after 40 hours in a single week. According to IRS Notice 2025-69, the same fractional calculation methods (divide by 3 for time-and-a-half, divide by 4 for double-time, etc.) still apply — adjusted for the alternative work period. A firefighter covered by this rule may not have qualified overtime simply because one week exceeds 40 hours; the calculation depends on when FLSA overtime is actually triggered under that employee’s applicable work period.

Some hospital and residential care employees may use a 14-day “8 and 80” overtime system.

Under FLSA Section 7(j), hospitals and residential care establishments may use a fixed 14-day work period instead of the standard 40-hour workweek if there is a prior agreement with affected employees.

Under this system, overtime may be based on hours worked over 8 hours in a day or 80 hours in the 14-day period. IRS Notice 2025-69 confirms that employees under an 8-and-80 arrangement determine qualified overtime based on the daily and 14-day thresholds — not just weekly hours.

Comp time can be treated differently from cash overtime.

Certain state and local government employees may receive compensatory time off instead of cash overtime, at a rate of at least 1.5 hours of paid time off for each overtime hour worked. Per IRS Notice 2025-69, if a government employee later receives cash wages for compensatory time based on a 1.5x rate, those wages may be treated as qualified overtime compensation, calculated using the divide-by-3 method. There is generally no deductible qualified overtime compensation until the employee is actually paid taxable wages for the comp time.

These edge cases are a good reminder that the deduction is not based solely on whether your employer calls something “overtime.” It depends on whether the pay is FLSA-required overtime and how much of that pay exceeds your regular rate.

How to Document and Find Your Qualified Overtime

To claim the overtime deduction, you need to know how much of your overtime pay counts as qualified overtime compensation.

This is not always the full overtime amount shown on your paycheck. In most time-and-a-half situations, only the extra “half” portion is deductible. Per IRS Notice 2025-69 and the IRS FAQ on qualified overtime, here’s how to find and document it:

Check your 2025 Form W-2.

For tax year 2025, employers are not required to separately report qualified overtime compensation. However, some employers may choose to report it voluntarily in Box 14 of your W-2 or provide the amount through an online payroll portal or a separate written statement.

Check with your employer or HR department to see if this information was provided.

Review your final paystub or year-end payroll summary.

If your employer did not separately identify the overtime premium, your final paystub or annual payroll history may show your total overtime pay for the year, which you can then use to calculate the qualified portion.

Use the IRS-approved calculation methods from Notice 2025-69.

• Time-and-a-half pay: Divide total overtime pay by 3. Example: $15,000 in total overtime ÷ 3 = $5,000 of qualified overtime compensation.
• Double-time pay (total shown on paystub): Divide total overtime pay by 4. Example: $20,000 in total double-time pay ÷ 4 = $5,000 of qualified overtime compensation.
• Double-time pay (premium shown separately on paystub): Divide the shown premium by 2. Example: $10,000 premium ÷ 2 = $5,000 of qualified overtime compensation.
• Mixed rates: Calculate each pay rate separately using the applicable method, then add the results together.

Do not assume all overtime qualifies.

The deduction applies only to FLSA-required overtime.

Overtime required only by state law — but not federal law — does not qualify for the federal deduction.

For 2026 through 2028, check Box 12 of your W-2.

Starting with tax year 2026, employers are required to separately report qualified overtime compensation on updated Forms W-2 (Box 12, Code TT), 1099-NEC, and 1099-MISC. Only separately reported amounts will qualify for the deduction in those years.

Quick example: Your final 2025 paystub shows $9,000 in total overtime pay at time-and-a-half. Divide $9,000 by 3 to get $3,000 of qualified overtime compensation — before applying the $12,500 annual cap and phaseout rules.

Keep your W-2, year-end payroll statement, final paystub, and any employer-provided overtime documentation with your tax records. This can help support the amount you claim if the IRS later asks how you calculated your deduction.

No Special Overtime Rate

It’s important to note that overtime pay does not have its own unique tax rate.

Instead, overtime is taxed like your regular income, using the same federal, state, and local rates that apply to your other wages. If your total income, including overtime, pushes you into a higher tax bracket, only the portion of income within that bracket is taxed at the higher rate, instead of all of your earnings. In other words, overtime itself doesn’t trigger extra taxation; it simply contributes to your overall taxable income.

Does This Mean Overtime Isn’t Taxed at All? 

Overtime is not tax-free. It remains fully subject to payroll taxes (Social Security and Medicare) and state income taxes.

The OBBBA allows eligible workers to claim a federal income tax deduction on the FLSA-required premium portion of overtime — it does not eliminate taxes on overtime. Your employer will still withhold taxes on overtime wages throughout the year just as before; the deduction is claimed when you file your federal return. Here’s how taxes still apply.  

Federal Income Tax 

Previously, all overtime pay was fully taxable as regular income. Now, under the OBBBA, qualified employees can reduce their taxable income by claiming the overtime deduction.

For example, if an employee earns $60,000 in base wages and $10,000 in overtime, and $5,000 of that overtime represents the half-time premium, they may deduct up to $5,000 (subject to the $12,500 individual cap) from their federal taxable income. Federal payroll taxes and withholding remain unchanged, and the deduction does not affect state or local taxes unless those jurisdictions adopt a similar rule.

How to Claim It

You claim the overtime deduction on the new Schedule 1-A, Additional Deductions — not directly on your W-2 or paycheck. Qualified overtime is calculated in Part III of Schedule 1-A, with the deduction shown on line 21. The total additional deductions from Schedule 1-A then flow to Form 1040 or 1040-SR, line 13b.

This is a below-the-line deduction, meaning it reduces taxable income after AGI is calculated.

It is available whether you take the standard deduction or itemize, but it does not reduce your AGI. Because it does not lower AGI, it will not improve your eligibility for income-based credits or other thresholds that are calculated using AGI.

State Income Tax 

States have their own tax rules, and the federal deduction does not automatically apply at the state level. For example, a worker in California earning $90,000 in base pay and $10,000 in overtime can deduct up to $10,000 for federal taxes, but their full $100,000 remains subject to California’s progressive income tax. Meanwhile, workers in states like Texas or Florida won’t owe state income tax regardless. 

Is Overtime Still Withheld from My Paycheck? 

Even with the federal deduction in place, employers must still withhold taxes on overtime wages as if they are fully taxable.

This includes: 

• Social Security (6.2% on wages up to $176,100 in 2025) 

• Medicare (1.45% on all wages, plus an extra 0.9% for high earners) 

• State and local income taxes, where applicable 

The deduction is claimed at tax time, meaning it does not reduce your tax withholding throughout the year. As a result, some employees may choose to update their W-4 forms to better reflect their lower expected taxable income. 

Other Taxes Applied to Overtime Pay  

In addition to federal and state income taxes, overtime pay is also subject to Social Security and Medicare taxes, collectively known as FICA taxes.  

Social Security Tax  

The Social Security tax rate is 6.2% on earnings up to a wage base limit, which is $176,100 in 2025. Overtime pay contributes to your total wages. If your annual income exceeds the wage base limit, earnings above this threshold are not subject to Social Security tax.

For example, if your base wages are $150,000 and you earn $30,000 in overtime, only $26,100 of the overtime would be taxed for Social Security. 

$176,100 – $150,000 = $26,100 

Medicare Tax  

The Medicare tax rate is 1.45% on all earnings with no wage cap. An additional 0.9% Medicare tax applies to income above $200,000 for single filers or $250,000 for joint filers. The overtime deduction does not apply to these payroll taxes. 

Does Overtime Pay Affect Tax Refunds or Owed Taxes?  

Yes, potentially. Employers withhold taxes on the full amount of overtime wages, which can result in higher overall tax withholding if your increased earnings place you in a higher tax bracket.

However, this withholding is just an estimate, and eligible employees can claim deductions on their federal tax return to reduce their taxable income from overtime pay, which may result in a larger refund or lower final tax bill. If withholding was underestimated or you don’t qualify for the full deduction due to high income, you could still owe additional taxes.

Strategies to Maximize the New Overtime Tax Break  

This deduction provides a unique opportunity to rethink your tax strategy:  

Adjust Your W-4  

Update your W-4 form to account for lower taxable income. The IRS Withholding Estimator can help determine if you’re over-withholding based on your new overtime treatment. 

Automate a Tax Savings Account  

Direct 20–25% of each overtime check into a dedicated savings account. Automate the transfer so you never have to think about it.  

Boost Pre-Tax Contributions  

Increase contributions to a 401(k), HSA, or FSA.

Pre-tax deposits reduce your taxable income and counteract “bracket creep” from overtime.  

Track Overtime Closely 

Maintain accurate records of FLSA-qualified overtime. 

Consult a Professional  

A CPA or enrolled agent can project your full-year tax picture, including overtime, and recommend precise withholding or estimated payment tweaks.  

Special Considerations 

Overtime pay, while financially beneficial, may influence various aspects of your tax situation beyond just the amount owed to the IRS. Understanding these nuances can help you make informed decisions.  

Tax Credits and Eligibility

Overtime earnings can affect eligibility for tax credits like the Earned Income Tax Credit (EITC). Because the overtime deduction is a below-the-line deduction, it does not reduce AGI or the gross income used to calculate some credits, so be sure to check qualification thresholds carefully. Note: per the tax law, deducted overtime income is still considered earned income for purposes of the EITC and the Child Tax Credit.

Household Tax Brackets 

Married filers must consider how overtime income affects the combined AGI and whether it triggers a phase-out of the deduction or changes tax credit eligibility. 

Labor Market and Policy Considerations 

The One Big Beautiful Bill’s overtime provision has sparked debate. 

Supporters claim it incentivizes hard work and puts money back into workers’ pockets.

Opponents warn it may: 

• Discourage base wage increases in favor of tax-free overtime. 

• Encourage employers to overuse overtime instead of hiring additional staff. 

• Open loopholes for high earners to reclassify income as “overtime” to avoid taxes. 

Whether this deduction will remain after 2028 is unclear. Its renewal will likely depend on fiscal outcomes and political support. 

Frequently Asked Questions 

How does no tax on overtime work in the Big Beautiful Bill? 

The One Big Beautiful Bill Act lets eligible workers deduct up to $12,500 in overtime pay from their federal taxable income ($25,000 for joint filers) for tax years 2025 through 2028. This deduction lowers the amount of income subject to federal income tax but does not affect payroll or state taxes. This article covers overtime only.

Tip income may be treated differently under other provisions of the OBBBA; check current IRS guidance for tip rules in effect for your filing year.

Can I reclassify regular wages as overtime to avoid tax? 

No. Attempts to game the system may result in audits or penalties. Employers are responsible for correctly categorizing pay, and the IRS requires that only FLSA-required overtime qualifies.

Is overtime taxed more for Social Security and Medicare?  

No. Overtime earnings are subject to the same FICA rates, which is 6.2% for Social Security (up to the wage base) and 1.45% for Medicare (with an additional 0.9% on high earners), as regular wages.  

Is overtime taxed at the state level?  

Overtime is taxed under your state’s regular income-tax rules.

If your state has progressive brackets, the additional income may push you into a higher bracket, but there’s no special “overtime rate.” The federal OBBBA deduction does not automatically apply at the state level.

Is overtime taxed more when I’m a contractor or freelancer?  

As a contractor, you don’t get FLSA overtime but do pay self-employment tax (15.3% total FICA) on all earnings. There’s no extra income-tax surcharge specifically for overtime.

How is the overtime deduction reduced as MAGI rises, and at what MAGI is it fully eliminated?

The deduction is reduced by $100 for every $1,000 of MAGI above the applicable threshold. For single filers, the phase-out begins at $150,000 MAGI and the deduction is fully eliminated at $275,000 MAGI. For married filing jointly, the phase-out begins at $300,000 and is fully eliminated at $550,000 MAGI.

Where do I find my qualified overtime amount for 2025 and for 2026–2028?

For 2025, employers are not required to separately report qualified overtime, but some may voluntarily include it in Box 14 of your W-2 or on a separate statement.

If your W-2 doesn’t include it, use your paystubs and the IRS-approved calculation methods from Notice 2025-69 (such as dividing total time-and-a-half overtime pay by 3). Starting in 2026, employers are required to report qualified overtime separately on updated W-2s (Box 12, Code TT) and 1099 forms, and only separately reported amounts will qualify for the deduction in those years.

How do I split out the overtime premium if my paystub shows only total overtime pay at time-and-a-half?

Per IRS Notice 2025-69, divide the total overtime compensation by 3 to estimate the deductible premium. For example, $24,000 in total time-and-a-half overtime pay ÷ 3 = $8,000 of qualified overtime compensation.

Does overtime paid at double time (or other enhanced rates) qualify in full?

No. Only the FLSA-required premium — the extra “half” over your regular rate — is deductible.

Per IRS Notice 2025-69, if your paystub shows total double-time pay, divide by 4 to estimate the deductible FLSA premium. If the premium is listed separately, divide that premium figure by 2.

Which form do I use to claim the deduction, and does it affect AGI or just taxable income?

Claim the deduction on Schedule 1-A; it flows to Form 1040 or 1040-SR, line 13b. It is a below-the-line deduction, meaning it reduces taxable income but does not lower your AGI.

Tax Help in 2025 

Under the One Big Beautiful Bill, overtime wages are still taxed at the time of payment, but eligible employees can now deduct up to $12,500 ($25,000 for joint filers) when they file their federal tax returns. This change provides a meaningful opportunity to reduce taxable income and boost tax refunds, but it doesn’t alter how employers calculate and withhold taxes throughout the year.

Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.   

If You Need Tax Help, Contact Us Today for a Free Consultation