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You work the extra hours, you earn the overtime pay... and then the government takes a significant chunk of it.
But a new law set to reward American workers is changing that.
This change is significant: more than 60% of Americans work in occupations eligible for overtime pay, with about 20 million workers regularly receiving overtime hours.
The "No Tax on Overtime" rule, a key part of the One Big Beautiful Bill Act (OBBBA) signed into law on July 4, 2025, is designed to put money back into the pockets of those who clock extra time.
What Is the No Tax on Overtime Bill and Why Was It Introduced?
The No Tax on Overtime Bill was introduced as part of a broader tax reform effort to support working Americans.
The legislation aims to encourage productivity and reward workers who contribute extra hours.
By reducing the tax burden on overtime earnings, lawmakers sought to make overtime work more financially attractive to employees while supporting businesses that rely on flexible workforce scheduling.
It’s crucial to understand that this legislation doesn’t end taxes on all overtime pay; it provides a tax deduction that can reduce the federal income tax burden on specific overtime earnings.
When Does the No Tax on Overtime Start?
The start date is key, and the law is retroactive.
- The provision applies to all qualifying overtime earned on or after January 1, 2025.
- This means that even though the bill was signed on July 4, 2025, employees who worked overtime from the first day of the year can benefit.
- You will not see this change in your regular paychecks. Instead, you will claim the deduction when you file your 2025 federal income tax return in early 2026.
- The provision is currently set to last through December 31, 2028, aligning with the end of the presidential term, unless Congress votes to extend it.
Note: This is currently federal legislation. State tax treatment may differ, so employees should consult a tax advisor about their state's rules.
What’s Actually Tax-Free? Understanding the Deduction
It's crucial to know that it's not your entire overtime paycheck that is tax-free. The law provides a deduction for the overtime premium.
- The Overtime Premium: This is the "half" in "time-and-a-half." For hours worked over 40 in a week, you earn your regular rate plus a premium of 50% of that rate.
- Example Breakdown:
- Your standard pay rate: $20/hour
- Your overtime rate: $30/hour
- The portion that is still fully taxable: $20 (your regular wage)
- The portion that is now tax-deductible: $10 (the overtime premium)
How Much Can You Deduct? Know the Caps and Limits
Deduction Caps
- Single filers: Up to $12,500 per year
- Married filing jointly: Up to $25,000 per year
Income Limits
- Full benefit: MAGI under $150,000 (single) / $300,000 (joint)
- Phases out: up to $400,000 / $550,000
- Over those amounts: no benefit
This deduction has annual caps and phases out for higher earners. The table below summarizes the key income thresholds.
Who Qualifies for the Overtime Tax Break?
Not every worker will qualify. Eligibility is specific and depends on employment classification, income levels, and legal work status.
Who QUALIFIES?
- W-2 employees classified as non-exempt under the Fair Labor Standards Act (FLSA). This includes most hourly workers in fields like healthcare, hospitality, retail, manufacturing, and law enforcement.
- Some Salaried Employees: Salaried workers who are classified as non-exempt and eligible for overtime under FLSA may also qualify, provided they meet the income thresholds.
- The taxpayer must have a valid Social Security Number valid for work.
Who does NOT qualify?
- Self-employed individuals, independent contractors, and gig economy workers (e.g., Uber drivers, freelancers).
- Salaried, exempt employees (e.g., many managers, administrators).
- Those using the Married Filing Separately status.
- Workers without a valid SSN.
How Does It Work? The Mechanics for Employees
No Tax on Overtime operates as a federal income tax deduction on your annual return.
- For 2025, the law requires no change in income tax withholding from your paycheck. Your employer will still withhold taxes on all your earnings as usual.
- You will claim the deduction when you file your Form 1040 for the 2025 tax year. The IRS is expected to provide guidance on how to report this, potentially with a new form or worksheet.
- The deduction reduces your taxable income, leading to a larger refund or a lower tax bill when you file.
💡 Pro Tip from Mark, CPA:
*"While this deduction is claimed on your return, I'm advising my clients to review their W-4 in early 2026 if they expect a large refund from this change. You could potentially adjust your withholding for the rest of the year to get more money in each paycheck, rather than waiting for a giant refund. Just be careful not to under-withhold and end up with a bill."*
Is Overtime Pay Still Taxable? The Important Fine Print
Yes, most overtime pay is still taxable. This law creates a deduction for the premium, not a full exemption.
- Federal Income Tax: The overtime premium deduction reduces your taxable income, so you pay less federal income tax.
- Payroll Taxes: There is no exemption for Social Security and Medicare taxes (FICA). These are still withheld from your entire paycheck, including the overtime premium.
- State Taxes: This is a federal law. Your state may or may not conform to it. You may still owe state income tax on your overtime premium.
Real-World Examples: How Much Could You Save?
Example 1: Maria, the EMT (Below Phase-Out)
- Filing Status: Single
- 2025 MAGI: $85,000
- Regular Rate: $25/hour
- Overtime Premium: $12.50/hour ($25 x 0.5)
- Overtime Hours in 2025: 250 hours
- Total Overtime Premium Earned: 250 x $12.50 = $3,125
- Calculation: Since Maria is below the $150,000 threshold, she deducts the full $3,125.
- Tax Savings (22% bracket): $3,125 x 0.22 = $687.50
Example 2: David & Sophia (Within Phase-Out Range)
- Filing Status: Married Filing Jointly
- 2025 MAGI: $400,000
- Total Overtime Premium Earned: $18,000
- Calculation: Their MAGI is $100,000 over the $300,000 phase-out start. The phase-out range is $250,000 ($550k - $300k). Their benefit is reduced by ($100k / $250k) = 40%.
- Reduced Deduction: $18,000 * (1 - 0.40) = $10,800 (but capped at $25,000, so full $10,800 is deductible).
- Tax Savings (35% bracket): $10,800 x 0.35 = $3,780
Note: The IRS phases out benefits using a precise formula. Our example uses a simplified proportional method for clarity. The actual calculation on your tax return will be more precise, but this provides a very close estimate.
What This Means for Employers
The new legislation creates important considerations for businesses:
- Payroll Administration: For 2025, no changes to withholding are required. However, employers should prepare for potential system updates for future years.
- Record Keeping: Employers must keep detailed records of overtime hours and compensation to support employee tax deductions and in case of IRS audit.
- Workforce Management: The tax benefit may make overtime work more attractive to employees, potentially affecting scheduling and workforce strategy.
Ready to Take Action?
- For Employees: Bookmark this page and set a calendar reminder for January 2026 to gather your documents. Use the calculator to estimate your savings and plan your finances.
- For Business Owners & Payroll Managers: Audit your record-keeping systems now to ensure you can track and report overtime premiums separately. Consider consulting with your payroll provider.
- For Everyone: Share this guide with your network; a coworker, friend, or family member who works overtime will thank you for the information.
Don't leave money on the table.
While this guide provides a comprehensive overview, tax law is complex.
For the most accurate filing tailored to your situation, consider consulting with a qualified tax professional next year.
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