The “No Tax on Overtime” rule, part of the One Big Beautiful Bill Act passed in July, has created a temporary federal income tax deduction for qualified overtime pay. The deduction—which applies retroactively to overtime pay earned beginning January 1, 2025, and extends through December 31, 2028—imposes new reporting and compliance requirements on employers. Below are some key details of the new law, followed by the steps employers will need to take to ensure compliance for 2025 and beyond.
“No Tax on Overtime” Key Points
- For tax years 2025 through 2028, employees may deduct up to $12,500 (for single filers) or $25,000 (for joint filers) of “qualified overtime compensation” from their taxable income. Married couples filing jointly may deduct up to $25,000 from their combined taxable income, even if only one spouse earns qualified overtime pay.
- “Qualified overtime compensation” is defined as the “half” portion of overtime pay required under the FLSA (Fair Labor Standards Act). Anything beyond the half (i.e. double time or more) is not subject to the deduction.
- Note that the deduction applies only to the premium portion of overtime pay. For example, if an employee’s regular hourly rate is $20 per hour and the overtime rate is $30 per hour, only the $10 premium portion of overtime pay qualifies for the deduction.
- The deduction applies to the federal definition of overtime, which is hours worked over 40 in a week—not over 8 hours in a day.
- The deduction begins to phase out for taxpayers with a modified adjusted gross income (MAGI) above $150,000 for single filers and $300,000 for joint filers. The deduction phases out completely when MAGI reaches $275,000 for single filers and $550,000 for joint filers.
- Tax forms (W-2s and 1099s) for 2025 will not reflect separate reporting of overtime compensation.
- The IRS has announced transition penalty relief for tax year 2025, so employers will not be penalized for failing to separately report qualified overtime compensation amounts for 2025. However, employers are encouraged to track and report overtime pay as accurately as possible for 2025, so that employees can still claim the deduction.
- New mandatory reporting requirements will take effect for the 2026 tax year.
Short-Term Employer Action Items
Overtime Pay Tracking and Reporting
- For 2025, continue using current Forms W-2, 1099, and 941, as the IRS will NOT update these forms to reflect the new deduction this year.
- Ensure payroll systems can accurately identify and track the “qualified overtime compensation” (the FLSA-mandated premium portion) for each employee.
- The IRS encourages employers to provide employees with a separate accounting of qualified overtime pay for 2025 to help them claim the new deduction. This information can be provided to employees via an online portal, additional written statements, or in box 14 of the employee’s Form W-2.
- Monitor IRS guidance for new or revised forms and reporting procedures for 2026.
Employee Communication
- Consider notifying employees about the new deduction and the importance of accurate overtime reporting, as this may affect their tax filings.
Coordination with Payroll Providers
- If you use a third-party payroll provider, confirm that they are aware of the new requirements and are updating their systems and processes accordingly. Some payroll preparers have stated that they will report qualified overtime amounts in box 14 of employee W-2s.
Next Steps
Now is the time to start reviewing your current payroll and reporting systems to ensure compliance with the new rules. Stay alert for further IRS guidance, especially regarding new forms and procedures for 2026 and beyond. If you have any questions about implementation or compliance, please don’t hesitate to reach out to our team at RBT CPAs. Together, we can be remarkably better.