No Tax on Overtime Passed: Premium Only, Cap, and Phase-Out

A federal “no tax on overtime” provision is now law. The One, Big, Beautiful Bill Act, signed on July 4, 2025, created an above-the-line federal income tax deduction for overtime pay that runs from tax year 2025 through 2028. The deduction is narrower than the slogan: it covers only the overtime premium (the “half” in time-and-a-half), it caps at $12,500 for single filers and $25,000 for joint filers, and it phases out at higher incomes.¹

Only the Premium Portion Is Deductible

The new deduction, codified at 26 U.S.C. § 225, applies to “qualified overtime compensation.” That term means only the extra pay above your regular hourly rate that your employer is required to pay under the Fair Labor Standards Act. In practice, that is the “half” in time-and-a-half.¹

An example puts numbers on it. Say you earn $30 an hour and work 50 hours in a week. Your employer pays $30 for each of the first 40 hours and $45 for each of the 10 overtime hours. The deductible portion is only the extra $15 per overtime hour, not the full $45. Over those 10 hours, you could deduct $150, not $450. The base rate on overtime hours stays fully taxable.²

If your employer pays double time, only the FLSA-required premium still counts. Using the same $30 rate, an employer paying $60 an hour for overtime gives you $30 above your regular rate, but the deductible amount is still $15 per hour, because that is the portion the FLSA actually requires.²

Who Qualifies

The deduction is available only to workers who are FLSA non-exempt. If you are classified as exempt (typically salaried workers in executive, administrative, or professional roles), no amount of extra hours generates qualified overtime compensation, even if your employer voluntarily pays you overtime.²

The Department of Labor’s salary threshold for exemption currently sits at $684 per week ($35,568 per year). If you earn less than that on salary, you are generally non-exempt and entitled to overtime regardless of job duties. Most blue-collar workers, first responders, and non-management employees are automatically non-exempt regardless of pay.³

The law also imposes filing-side requirements:

Your modified adjusted gross income must be under $150,000 ($300,000 for joint filers) to receive the full deduction.
You must include a valid Social Security number on your return.
Married taxpayers must file jointly. Married-filing-separately returns cannot claim the deduction.

The deduction is available whether you take the standard deduction or itemize.⁴

The Cap and the Phase-Out

The maximum annual deduction is $12,500 for single filers and $25,000 for joint filers. Overtime premium above the cap is not deductible.¹

For every $1,000 your modified adjusted gross income exceeds $150,000 ($300,000 joint), the deduction drops by $100. The deduction disappears entirely at $275,000 for a single filer claiming the full $12,500, or $550,000 for joint filers claiming the full $25,000.¹

To translate the cap into dollars saved: a worker earning $25 an hour who works 10 overtime hours a week for 50 weeks generates $6,250 in deductible overtime premium ($12.50 extra per hour times 10 hours times 50 weeks). In the 22% federal bracket, that deduction saves roughly $1,375 in federal income tax for the year. Real money, but a long way from “no tax on overtime.”

How to Claim It

The IRS created a new Schedule 1-A for reporting the overtime deduction. The schedule walks through the calculation and feeds into your Form 1040.⁵

Starting with 2026 W-2 forms, employers are expected to report qualified overtime compensation in Box 12 using code “TT.” For the 2025 tax year, many employers will not have updated their payroll systems in time. The IRS allows you to calculate qualified overtime compensation yourself using pay stubs, earnings statements, or other documentation, as long as you use a reasonable method.⁶

If you are filing your 2025 return (due April 2026) and your employer did not separately track premium pay, gather your weekly pay stubs. Multiply your overtime hours by half your regular hourly rate for each pay period, then total the year.

Payroll Taxes and Withholding Do Not Change

The deduction reduces federal income tax only. Your overtime pay, premium included, remains fully subject to Social Security tax (6.2%) and Medicare tax (1.45%). Your employer continues to withhold those amounts from every overtime hour and pays a matching share.⁷

Federal income tax withholding also continues on the full overtime amount. The deduction is claimed on your annual return, not through reduced paycheck withholding, so your take-home pay each period will not change. You will see the benefit as a larger refund or smaller balance due at filing time.⁸

Overtime pay still counts as gross income under 26 U.S.C. § 61, still appears on your W-2 as wages, and still figures into your adjusted gross income before the new deduction is applied.⁹ That matters for AGI-based credits like the Earned Income Tax Credit, whose phase-out calculations may use income before the deduction is applied.

State Income Tax Is a Separate Question

Whether your state income tax follows the federal deduction depends on how your state handles federal tax changes. States with rolling conformity, which automatically adopt federal taxable income as their starting point, will generally allow the deduction without further legislation. States with static conformity may require you to add the deduction back to your state taxable income until state lawmakers vote to adopt it.

As of late 2025, many states had not committed to conforming with the overtime deduction and planned to address it in their 2026 legislative sessions. If you live in a state with an income tax, check your state’s position before assuming your overtime premium is tax-free at both levels.

The Deduction Expires After 2028

The overtime tax deduction applies to tax years 2025 through 2028. After December 31, 2028, no deduction is allowed unless Congress passes new legislation to extend it or make it permanent.¹ Temporary tax provisions often get extended, but there is no guarantee. Treat it as a four-year benefit window rather than a permanent change to how overtime is taxed.

1
Office of the Law Revision Counsel. 26 USC 225 – Qualified Overtime Compensation
2
Internal Revenue Service. Questions and Answers About the New Deduction for Qualified Overtime Compensation
3
U.S. Department of Labor. Earnings Thresholds for the Executive, Administrative, and Professional Exemption from Minimum Wage and Overtime Protections Under the FLSA
4
Internal Revenue Service. One, Big, Beautiful Bill Act – Tax Deductions for Working Americans and Seniors
5
Internal Revenue Service. IRS Published Schedule Taxpayers Will Use to Claim Deductions on No Tax on Tips, No Tax on Overtime, No Tax on Car Loans, No Tax on Seniors
6
Internal Revenue Service. IRS Notice 2025-69 – Guidance for Individual Taxpayers Who Received Qualified Tips or Overtime
7
Internal Revenue Service. Publication 15 – Employer’s Tax Guide – Section: Overtime Compensation
8
Internal Revenue Service. How to Take Advantage of No Tax on Tips and Overtime
9
Office of the Law Revision Counsel. 26 US Code 61 – Gross Income Defined