The new tax legislation, part of the "One Big Beautiful Bill", includes a temporary tax break for overtime pay, allowing eligible workers to deduct a portion of their overtime earnings from their federal income taxes. Section 70202 of the Act creates an above-the-line deduction for “qualified overtime compensation,” defined as “overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate ... at which such individual is employed.”
As such, the Act only applies to federal overtime pay. However, a handful of states have overtime laws beyond what is required by the federal FLSA (i.e., 1.5 times the regular rate of pay for hours worked in excess of 40 per workweek). For example, in California, employers must also pay an overtime premium on hours worked in excess of 8 hours per day. Among others, Alaska, Colorado, and Nevada are a few of the states that also have unique overtime provisions. The difference between state and federal overtime standards could create an administrative headache for employers.
The new provision, applicable to tax years 2025[1] through 2028, aims to reduce the tax burden on overtime work, specifically for those making less than $150,000 individually or $300,000 jointly. The deduction is capped at $12,500 for individual filers and $25,000 for joint filers. It's important to note that the deduction is above-the-line, meaning it's available to all taxpayers, even those who do not itemize deductions. The deduction is reduced by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).
Overtime pay remains subject to payroll taxes for Social Security and Medicare. The legislation does instruct Treasury and the Internal Revenue Service to adjust the income tax withholding tables to account for this provision.
The primary impact to employers and payors will be the need to track overtime pay and report it separately on Forms W-2 and Forms 1099-NEC[2], respectively. Only the premium paid for overtime above the worker’s “regular rate” is subject to the new deduction. Employers will be required to separately report the overtime amount on the applicable information return. Until additional guidance is provided by Treasury and the Internal Revenue Service, employers/payors are instructed to apply a reasonable method in determining and reporting overtime pay.
One outstanding question will be what impact, if any, the new provision will have on salaried workers. There may be an incentive for employers to push salaried non-exempt workers on to hourly pay arrangements to take advantage of this new provision.
[1] The tax provision is applies retroactively to January 1, 2025.
[2] Employers are instructed to report the amount of overtime compensation for nonemployees on Forms 1099-NEC, despite the fact that under the Act qualified overtime compensation is “overtime compensation paid to an individual required under section 7 of the FLSA that is in excess of the regular rate at which such individual is employed.” Presumably, Treasury and the IRS will provide additional information with respect to this issue.
