No Tax on Overtime Pay 2025: Full Guide to Eligibility and Benefits

The no tax on overtime law, part of the One Big Beautiful Bill Act (OBBBA), is now federal law in the United States. Retroactive to January 1, 2025, this provision allows eligible employees to deduct a portion of their overtime earnings from federal taxable income. While the headline suggests a simple tax break, the details reveal several limits, requirements, and considerations that workers and employers must understand. This guide provides a complete overview of the law, its implications, and how to maximize benefits while staying compliant.

What Is Overtime and How Is It Taxed?

Overtime pay refers to the additional compensation employees earn for working more than 40 hours in a workweek. Under federal law, this pay is calculated at time-and-a-half, meaning employees receive 1.5 times their standard hourly wage for overtime hours.

For example:

• Hourly wage: $20 per hour
• Overtime rate: $30 per hour
• Deductible portion under the no tax on overtime law: $10 per hour (the “extra half” of time-and-a-half pay)

Taxation Before the Law:
Previously, all overtime wages were fully subject to federal income tax, Social Security, Medicare, and applicable state taxes. Employees received the same deductions as regular wages, without any special consideration for the extra hours worked.

Taxation After the Law:
With the no tax on overtime law:

• Only the premium portion of overtime pay (the “half” of time-and-a-half) qualifies for a federal tax deduction.
• Social Security, Medicare, and state/local taxes are not affected.
• The deduction is available when filing federal income tax returns and does not alter payroll withholdings during the year.

This distinction is crucial for employees who work overtime and plan their finances based on take-home pay throughout the year.

How the No Tax On Overtime Law Works

The law is a federal income tax deduction, not a payroll exemption. Key components include:

1. Eligibility
   • Nonexempt employees under the Fair Labor Standards Act (FLSA) who earn overtime pay.
   • Hourly employees who work time-and-a-half hours over 40 per week.
   • Workers earning up to $150,000 individually or $300,000 for joint filers.
2. Deductible Overtime
   • Only the “extra half” of overtime pay qualifies.
   • Example: $22 per hour regular pay, $33 per hour overtime → $11 per hour deductible.
3. Annual Deduction Limits
   • $12,500 for individuals
   • $25,000 for married couples filing jointly
4. Law Duration
   • Retroactive to January 1, 2025
   • Effective through December 31, 2028
5. Federal Taxes Only
   • Social Security, Medicare, and state/local taxes continue to apply.
   • Certain states may introduce similar overtime deductions, but this is separate legislation.

The deduction is designed to reward eligible hourly employees, allowing them to retain more of their earnings without altering payroll processes.

Who Benefits From the No Tax On Overtime Deduction

The primary beneficiaries are middle-income hourly workers who regularly log overtime hours. Specific insights include:

• Hourly vs. Salaried Employees: Salaried workers who do not receive extra pay for extra hours generally do not qualify.
• Low-Income Workers: Many low-income workers already benefit from the standard deduction and child tax credits, so the overtime deduction may offer minimal additional savings.
• High-Income Workers: Workers above $150,000 individually or $300,000 jointly are excluded.

Example Scenario:
A factory worker earning $22 per hour works 50 hours per week. Ten hours of overtime at $33 per hour results in a qualified deduction of $11 per hour. Over 50 weeks, the total deduction equals $5,500, potentially reducing federal tax liability by approximately $900.

The law is therefore targeted, offering meaningful benefits only to specific employees who meet the criteria.

Payroll and Employer Considerations

Employers must maintain standard payroll operations despite the new law. Key points:

1. Payroll Withholding Remains Unchanged
   • Federal income tax, Social Security, Medicare, and state/local taxes continue to be withheld on overtime pay.
   • Employees do not see immediate changes in their paychecks.
2. Recordkeeping Requirements
   • Track FLSA-qualified overtime hours and premium pay separately.
   • Maintain accurate, digital payroll records to facilitate year-end tax reporting.
3. W-2 Reporting for 2025
   • The IRS has not updated Form W-2 for 2025.
   • Employees may calculate deductions using pay stubs and employer records.
4. Form W-2 Updates for 2026
   • Proposed code TT in Box 12 will report qualified overtime premiums for federal deduction purposes.
5. Employee Guidance
   • Employees may adjust Form W-4 withholding to align taxes with anticipated deductions.
   • Clear communication ensures workers understand the deduction without errors in tax filing.

Employers who maintain accurate records reduce compliance risks and help employees claim deductions efficiently.

Equity and Economic Implications

While the law rewards overtime, it introduces several structural and economic considerations:

1. Horizontal Equity Concerns
   • Two workers with identical annual salaries may face different tax burdens depending on whether they receive hourly overtime or salaried overtime.
   • The law incentivizes taxing based on effort, not income, which could be viewed as inconsistent with traditional tax principles.
2. Labor Market Effects
   • Employers may extend hours for existing staff rather than hiring additional workers, reducing potential job creation.
   • A 50-hour week for one employee could replace the same total hours spread across multiple employees.
3. Health and Productivity
   • Encouraging extended overtime may negatively affect worker well-being and productivity.
   • The Economic Policy Institute warns that long overtime hours can lead to physical and mental health issues.
4. Policy Tradeoffs
   • The $89 billion cost over ten years is modest compared to the $3 trillion OBBBA budget.
   • Funds could have been allocated to child care, wage increases, or other forms of income support.

Employees who qualify for the deduction can implement strategies to enhance financial gains:

1. Accurate Recordkeeping
   • Maintain detailed time and attendance records.
   • Confirm FLSA overtime hours and premium pay are documented.
2. Tax Filing
   • Deduct qualified overtime when filing federal income tax returns.
   • Ensure deductions do not exceed annual caps ($12,500 for individuals, $25,000 for joint filers).
3. Investment Strategies
   • Consider allocating overtime earnings to automated investment platforms, such as Acorns or employer-sponsored plans, to grow tax-advantaged savings.
4. Payroll Adjustments
   • Update withholding if necessary based on expected deduction to optimize cash flow.

By following these steps, eligible workers can maximize the financial impact of the no tax on overtime law.

The no tax on overtime law is a targeted, federally mandated deduction for FLSA-qualified overtime hours. While not a blanket exemption, it provides middle-income hourly workers a modest tax break, allowing them to retain more of their earnings. Employers must maintain standard payroll operations while ensuring accurate overtime tracking to support employee claims.

This law highlights the intersection of labor policy, tax planning, and economic incentives. Workers who understand eligibility, limits, and reporting requirements can leverage the deduction effectively while planning for tax returns in 2025 and beyond.

Frequently Asked Questions (FAQ)

Source of information

• Bipartisan Policy Center – 2025 Tax Bill: No Taxes on Overtime, Simplified
• Internal Revenue Service – One, Big, Beautiful Bill Act: Tax deductions for working Americans and seniors
• Internal Revenue Service – One, Big, Beautiful Bill Act of 2025 provisions
• Illinois State – No Tax on Overtime Provision in the One Big Beautiful Bill Act (OBBBA)
• Patriot Software – No Tax on Overtime 2025: What Employers Need to Know