The Internal Revenue Service (IRS) and Treasury Department recently released a Frequently Asked Questions (FAQs) Fact Sheet to help taxpayers understand the new tax deduction for qualified overtime compensation. The “No Tax on Overtime” deduction is available for tax years 2025 through 2028 and is designed to exclude a portion of qualifying overtime pay from federal income tax.
Generally, the deduction applies to qualified overtime compensation, which generally means the “half” portion of time-and-a-half pay required under federal law for overtime. The overtime pay must be in excess of the normal full-time pay rate. For example, if an employee earns $18 per hour and is paid $27 per hour for overtime, only the additional $9 per hour for overtime pay is deductible.
Under the One Big Beautiful Bill Act (OBBBA), the qualified overtime exclusion is allowed for up to $12,500 ($25,000 for joint filers) of overtime compensation. The overtime exclusion applies to taxpayers with modified adjusted gross income (MAGI) of up to $150,000 ($300,000 for a joint return). There are phaseouts on the deduction above those levels. The deduction will reduce federal taxable income, but it does not impact the taxation of wages for purposes of Social Security, Medicare or state and local income tax.
Eligible taxpayers may claim the deduction regardless of whether they itemize or take the standard deduction. Employees and certain independent contractors can qualify if their overtime meets certain rules under the Fair Labor Standards Act (FLSA). The IRS FAQs include tools to help taxpayers determine if the overtime they receive is qualified under federal standards.
For the 2025 tax year, the IRS is offering penalty relief for employers as payroll systems are updated to track qualified overtime amounts. Full reporting requirements begin for tax year 2026. Updated 2026 W-2 and 1099 forms will include a dedicated field for qualified overtime compensation. Prior IRS notices have covered how an employee can report overtime compensation if an employer does not separately report the amount of qualified overtime compensation.
