Employers and employees alike need to understand the new overtime rules from the One Big Beautiful Bill Act.
Beginning with the current tax year (2025) and continuing through the 2028 tax year, the Act introduces a new federal income tax deduction specifically for qualifying overtime pay. The new deduction sunsets after the 2028 tax year unless extended by Congress in a new bill.
The new provision allows eligible employees to deduct up to $12,500 from their federal taxable income, or $25,000 for those filing jointly, based on the premium portion of their overtime earnings.
First, employers and employees need to understand what the premium portion of overtime earnings are.
Under the Fair Labor Standards Act (FLSA), overtime pay is typically calculated as time-and-a-half. The premium portion refers only to the extra “half” paid above the employee’s regular hourly rate. Moreover, only overtime mandated by the FLSA qualifies for this deduction. In other words, overtime earned under state-specific laws does not qualify.
Second, the deduction begins to phase out for individuals earning more than $150,000 annually, or $300,000 for joint filers.
Employees above these thresholds may see reduced or no benefit from the deduction. The deduction is reduced by $100 for every $1,000 over the $150,000 threshold. As such, an individual’s deduction would completely phase out at $275,000 in earnings.
Thirdly, employers are required to track and report qualified overtime compensation through their payroll systems.
This information will be included on employees’ W-2 forms (final IRS guidance on where this will be reported is still pending).
Finally, the new overtime tax rule is a deduction, not an exemption from withholding.
Overtime wages, including the premium portion, remain subject to withholding. In other words, the deduction is applied when employees file their Form 1040. Employees will receive their overtime pay as usual through their paycheck, with taxes taken out. The tax benefit to the employee will come when filing their annual tax return when they are allowed to deduct the premium portion of qualified overtime from their taxable income using the data reported on their W-2.
