The New 2025 Overtime Deduction  

The One Big Beautiful Bill Act (OBBBA), enacted in 2025, introduced a new federal income tax deduction for “qualified overtime compensation” for tax years 2025 through 2028. Here are the key basics regarding overtime under the OBBBA:

1. What Is the Overtime Deduction?

• Deduction Amount: Individuals can deduct up to $12,500 per year of qualified overtime compensation from their federal taxable income. For married couples filing jointly, the deduction is up to $25,000 per year.
• Phase-Out: The deduction is reduced by $100 for every $1,000 by which the taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 for joint filers). MAGI includes adjusted gross income plus any amounts excluded under IRC §§911, 931, or 933 [1].

2. What Counts as “Qualified Overtime Compensation”?

• Definition: Only overtime pay that is required under section 7 of the Fair Labor Standards Act (FLSA) qualifies. This means overtime must be paid at a rate of at least one and one-half times the employee’s regular rate for hours worked over 40 in a workweek (or as otherwise specified for certain public sector or healthcare employees) [1].
• Exclusions: Overtime pay that is not required by the FLSA (such as extra pay for weekends, holidays, or state-only overtime rules) does not qualify. Also, tips that are deductible under the separate “qualified tips” provision are not included in the overtime deduction [1].
• FLSA Coverage: Only employees who are non-exempt under the FLSA (i.e., eligible for overtime) can have qualifying overtime. Exempt employees (such as certain executives, professionals, and administrative staff) are not eligible for the deduction on their overtime pay [5].

3. How Is the Deduction Claimed?

• Reporting Requirement: The deduction is only available for overtime compensation that is reported on information returns, such as Form W-2 (for employees) or Form 1099-NEC/1099-MISC (for nonemployees). For 2025, employers are not required to separately report qualified overtime on these forms, but employees can use payroll records, pay stubs, or other documentation to substantiate the amount [3].
• Social Security Number: The taxpayer must include their Social Security number on the tax return to claim the deduction [1].
• Married Filing Status: Married individuals must file jointly to claim the deduction; it is not available to those married filing separately [1].

4. How to Calculate Qualified Overtime

• General Rule: The deduction is for the “overtime premium”—the extra half-time portion of “time-and-a-half” pay required by the FLSA.
• Calculation Methods: If the payroll system or pay stub shows the FLSA overtime premium separately, use that amount. If not, reasonable methods are allowed, such as:
  • If the pay stub shows the total overtime pay (including both regular and premium), divide by 3 to estimate the premium portion (for standard time-and-a-half overtime).
  • For double-time overtime, divide by 4.
  • For other rates or special FLSA rules (e.g., law enforcement, healthcare), use a reasonable method based on the applicable FLSA provision [3].

5. Employer Responsibilities

• Reporting: Starting in 2026, employers must separately report qualified overtime compensation on Form W-2 (likely in a new box or Box 14). For 2025, there is transition relief and no penalty for not separately reporting, but employers should be prepared to update payroll systems for 2026 [2].
• Payroll Withholding: Overtime pay remains subject to federal income tax withholding, Social Security, and Medicare taxes. The deduction only affects the employee’s federal income tax return [5].

6. Duration

• Effective Dates: The deduction applies for tax years 2025, 2026, 2027, and 2028. No deduction is allowed for years after December 31, 2028 [1].

7. Key Takeaways

• The deduction is only for the FLSA-required overtime premium, not for all extra pay or state-only overtime.
• The deduction is subject to income phase-outs and a cap.
• Employers and employees must ensure proper documentation and reporting, especially as new reporting requirements take effect in 2026.
• The deduction does not affect payroll taxes or state/local income taxes [5].

For more detailed guidance, see IRS Notice 2025-69 and IRS Publication 15-T (2026), which provide calculation examples and further instructions [3] [4].