No Tax on Overtime Update: Deduction, Limits, and 2028 Sunset

The “no tax on overtime” law signed on July 4, 2025 does not make overtime pay tax-free. It creates a federal income tax deduction, under a new 26 U.S.C. § 225, that lets qualifying workers subtract up to $12,500 of overtime pay from taxable income ($25,000 for married couples filing jointly) for tax years 2025 through 2028.¹ Only overtime that your employer is legally required to pay under the Fair Labor Standards Act counts, and the deduction phases out at higher incomes. Payroll taxes, state income taxes, and local taxes still apply to every overtime dollar.

Deduction, Not Exclusion

The distinction matters for how much you actually save. An exclusion would remove overtime from your income as if you never earned it. A deduction lets you subtract the amount later when calculating federal tax owed. Your overtime still appears as gross income, still gets reported on your W-2, and still counts toward your adjusted gross income.²

The effect is real but bounded. If you earned $8,000 in qualifying overtime and sit in the 22 percent federal bracket, the deduction saves roughly $1,760 in federal income tax. Nothing more.

Who Qualifies

Eligibility is tied directly to the FLSA. You qualify if you are covered by the FLSA and not exempt from its overtime requirements, meaning your employer is legally required to pay you time-and-a-half for hours worked beyond 40 in a workweek.³⁴ That reaches most non-exempt hourly workers in construction, manufacturing, retail, healthcare support, transportation, and skilled trades.⁵

Several groups are left out:

Salaried exempt employees. If you are classified as executive, administrative, professional, outside sales, or a qualifying computer employee, your employer is not required to pay overtime. Even voluntary overtime pay, or overtime provided by a union contract, does not count as “qualified overtime compensation” under the statute.³
Independent contractors. FLSA overtime protections apply to employees. If you receive a 1099 rather than a W-2, you generally do not have FLSA-required overtime to deduct, though Schedule 1-A does include a line for 1099 income where the overtime meets the FLSA requirement.²
Workers without a valid Social Security number. The statute requires one.²
Married couples filing separately. You must file jointly with your spouse to claim the deduction.²

How Much You Can Deduct

The annual cap is $12,500 for single filers and $25,000 for joint filers. If your qualifying overtime for the year was less than the cap, you deduct the actual amount. If it exceeded the cap, the deduction stops at the limit.²

The deduction phases out at higher incomes. Once modified adjusted gross income exceeds $150,000 for a single filer or $300,000 for joint filers, the maximum deduction drops by $100 for every $1,000 of MAGI above the threshold. That means the deduction reaches zero at $275,000 (single) and $550,000 (joint).⁶

A worked example. A single filer with $180,000 in MAGI is $30,000 over the threshold. That’s 30 increments of $1,000, so the deduction shrinks by $3,000. Their maximum deduction is $9,500 instead of the full $12,500.

What This Deduction Does Not Touch

The nickname oversells it. The deduction only reduces federal income tax. Several other taxes on your overtime are unchanged.

Payroll taxes apply in full. You and your employer keep paying 6.2 percent for Social Security and 1.45 percent for Medicare on every overtime dollar. If your total earnings exceed $200,000, the additional 0.9 percent Medicare surtax applies to overtime as well. The law made no changes to the Federal Insurance Contributions Act.⁷

State and local income taxes also still apply. The federal deduction has no automatic effect on your state return, and most states have not enacted a parallel deduction. Alabama ran its own overtime exemption under Alabama Act 2023-421, but it expired on June 30, 2025, and overtime wages earned after that date are once again subject to Alabama income tax.⁸ If you live in one of the nine states with no income tax, this was never a concern.

Because the deduction does not reduce your adjusted gross income, it will not help with AGI-dependent calculations like ACA premium subsidies, income-driven student loan repayment amounts, or eligibility for other tax credits. Your overtime still counts as income for those purposes.

How to Claim It on Your Return

You claim the deduction on Schedule 1-A (Form 1040), a new schedule created for the deductions introduced by the One, Big, Beautiful Bill Act. The overtime calculation lives in Part III.⁶

Report your total qualifying overtime from your W-2 (box 1) or, in rarer cases, from a 1099-NEC or 1099-MISC. Apply the annual cap and the phase-out formula. The resulting deduction flows to Form 1040, line 13b. Attach Schedule 1-A when you file.⁶

Your 2025 W-2 May Not Break Out Overtime

For the 2025 tax year, the IRS granted transition relief. Employers do not have to separately identify qualified overtime compensation on W-2s or 1099s for 2025, and they will not be penalized for not doing so, as long as they file complete and otherwise correct returns.⁹ Starting in 2026, the IRS expects employers to report overtime in dedicated boxes on updated W-2 forms. If your 2025 W-2 does not break out the overtime, you will need to identify the qualifying amount yourself using pay stubs or payroll records.

No Change to Your Paycheck Withholding for 2025

The IRS did not update federal withholding tables for 2025 to reflect this deduction. Your employer continues to withhold federal income tax on overtime the same way as before. You get the savings when you file your return, not in each paycheck. Updated procedures are expected for 2026.

The Deduction Ends After 2028

The statute allows no deduction for any tax year beginning after December 31, 2028.² That gives it a four-year lifespan covering tax years 2025, 2026, 2027, and 2028. After that, overtime pay is fully taxable at the federal level again unless Congress passes new legislation to extend it.

1
Internal Revenue Service. One, Big, Beautiful Bill Act: Tax Deductions for Working Americans and Seniors
2
Office of the Law Revision Counsel. 26 USC 225 – Qualified Overtime Compensation
3
Internal Revenue Service. Questions and Answers About the New Deduction for Qualified Overtime Compensation
4
U.S. Department of Labor. Overtime Pay
5
U.S. Department of Labor. Fact Sheet 17A: Exemption for Executive, Administrative, Professional, Outside Sales, and Computer Employees
6
Internal Revenue Service. 2025 Schedule 1-A (Form 1040) Additional Deductions
7
Internal Revenue Service. What to Know About the No Tax on Overtime Deduction
8
Alabama Department of Revenue. NOTICE Overtime Exemption Ends June 30, 2025
9
Internal Revenue Service. Treasury, IRS Provide Penalty Relief for Tax Year 2025 for Information Reporting on Tips and Overtime Under the One, Big, Beautiful Bill