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Part 1 – Overtime Pay and Income Tax Treatment
Overview
This Firm Insights post summarizes one provision of the "One Big Beautiful Bill" related to the tax treatment of overtime compensation and related employer wage reporting obligations.
Overtime Pay and Employee Tax Treatment
The Fair Labor Standards Act (FLSA) generally requires that overtime be paid to certain employees at a rate of one-and-a-half times their regular rate of pay after 40 hours in a workweek. There are exceptions.
For the years 2025 through 2028, employees who receive overtime pay may be able to deduct one-half of that overtime compensation from their income and thus not pay income taxes on that portion. The maximum deductible amount in any year is $12,500 ($25,000 for joint filers). The deduction begins to phase out at $150,000 of income ($300,000 for joint filers). The deduction may be taken whether or not the taxpayer itemizes deductions.
What Qualifies as Deductible Overtime Compensation
The deduction applies only to "qualified overtime compensation." This refers to overtime compensation that an employer is required to pay under the FLSA.
If an employer is not required to pay overtime under the FLSA but does so pursuant to its own policies, that pay is not qualified overtime compensation. Likewise, if an employer pays overtime at a rate higher than time-and-a-half, only the portion equal to the FLSA-required premium is eligible for the deduction.
For example, if an employee earning $10 per hour is paid $15 per hour for overtime, the $5 premium is deductible. If the employee is instead paid double-time at $20 per hour, only $5 of that $10 premium is deductible. The deductible amount is based solely on the FLSA-mandated time-and-a-half rate.
Overtime that arises solely from employer policies (such as holidays, weekends, or scheduled days off), state or local law, collective bargaining agreements, or other contractual arrangements does not qualify for the deduction.
Employer Reporting Obligations
The enactment of the new law did not allow sufficient time for all employers to retool their wage reporting systems to separately report qualified overtime compensation on 2025 Forms W-2. As a result, the IRS has granted transitional relief for 2025, meaning employers will not face penalties for failing to separately report overtime for that year.
For 2026 through 2028, the law contemplates separate reporting of qualified overtime compensation on employee W-2 forms.
What Comes Next
The overtime-related provisions discussed above represent only one component of the broader tax changes included in the "One Big Beautiful Bill." Employers and employees should continue to monitor how these provisions are implemented and consider how overtime pay, payroll reporting, and compensation strategies may be affected.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
