Section 70202 in the recently passed legislation, H.R.1, or the One Big Beautiful Bill Act, which was signed into law in 2025, includes a federal tax deduction that could significantly impact overtime-eligible workers and their employers. The “no tax on overtime” provision allows eligible employees to reduce their year-end federal adjusted gross income (AGI) by up to $12,500 ($25,000 for joint filers) when they file their taxes for years 2025 – 2028.
What you’ll learn
What you’ll learn
Updated: August 11, 2025
This article is authored by OnPay, a top-rated payroll provider for small businesses with more than 30 years of experience in payroll, taxes, and small business compliance.
Key takeaways
- New tax deduction allows employees to reduce federal adjusted gross income by up to $25,000 on overtime premium pay — but only applies to the extra 0.5x portion of FLSA overtime, not all overtime compensation
- Employers must implement new W-2 reporting requirements, which means tracking and separately reporting qualified overtime premium earnings, while continuing normal tax withholding on all other overtime pay
- Complex compliance for multi-state businesses — must distinguish between federal FLSA overtime (which qualifies) and state/local overtime rules (which generally don’t qualify) for proper deduction reporting
For employers with hourly, overtime-eligible workers, this change introduces new reporting requirements and compliance considerations. Here’s everything you need to know about how this deduction works and what it means for your business operations.
Overtime overview
Before we get into what’s changed, let’s quickly touch on how overtime works. According to the U.S. Department of Labor, under the FLSA (Fair Labor Standards Act), most workers in the United States must be paid overtime for hours worked over 40 in a workweek at a rate of at least one and a half times their regular pay. This means that for every hour worked over 40, an employee gets paid one and a half times their normal hourly rate.
The no tax on overtime deduction: what changed
This new federal income tax deduction specifically targets the premium portion of overtime pay — or the additional 0.5x regular rate that employees earn for hours worked beyond 40 in a workweek. The deduction applies only to federal income tax withheld from this overtime premium, not regular pay-rate compensation.
Key features
- Maximum deduction: Up to $12,500 per individual ($25,000 if filing jointly)
- Effective period: Tax years 2025 through 2028 (the tax return filed in 2029)
- Deduction type: Above-the-line federal income tax deduction
- Retroactive application: Applies to qualified overtime earned starting January 1, 2025
Who qualifies for this deduction
The overtime tax deduction is designed explicitly for hourly, non-exempt workers who are eligible for overtime compensation under federal law.
Eligibility requirements
- Must be an hourly, non-exempt worker under the Fair Labor Standards Act (FLSA)
- Must be eligible for overtime compensation under federal law
- Must have worked more than 40 hours in a workweek
- Must have a valid Social Security number
- Income phase-out begins at $150,000 adjusted gross income ($300,000 for joint filers)
Income phase-out details
Similar to the tips deduction, for every $1,000 of income above the threshold, the deduction is reduced by $100, ensuring benefits target middle and lower-income workers.
What qualifies as “overtime” for this deduction
Understanding what counts as qualifying overtime is something employers should have on their to-do list, as not all overtime policies qualify for this federal deduction.
FLSA-defined overtime only
- Qualifying: Time worked above 40 hours in a workweek as defined by the Fair Labor Standards Act
- Non-qualifying: Overtime defined under state or local laws (such as daily overtime after 8 hours)
- Non-qualifying: Company overtime policies that exceed federal requirements
- Non-qualifying: Seventh consecutive day overtime (not over 40 hours) or other non-FLSA provisions
Premium pay focus
The deduction applies only to the overtime premium portion of pay—the additional 0.5x regular rate—and does not apply to the regular-rate portion of overtime compensation. To illustrate how this could work, let’s look at an example:
If an employee’s regular rate is $20/hour and they work 50 hours:
- Regular pay: 40 hours × $20 = $800
- Overtime pay: 10 hours × $30 ($20 + $10 premium) = $300
- Deduction applies only to tax withheld from the $100 premium portion (10 hours × $10)
What tax qualifies for the deduction
The deduction is specifically limited to federal income tax withheld from overtime premium compensation.
Eligible for deduction
- Federal Income Tax (FIT) withheld from overtime premium pay only
Not eligible for deduction
- Social Security and Medicare taxes
- State and local income taxes
- Federal income tax withheld from regular wages or the regular-rate portion of overtime
- Any other payroll taxes or deductions
With many headlines making waves about no tax on overtime, employers may be wondering the following.
Should employers continue withholding taxes for overtime?
The answer is yes, employers need to continue withholding federal income tax on all overtime earnings. Payroll taxes are unchanged as Social Security and Medicare taxes (7.65% each) still apply to all overtime earnings. The “no tax on overtime” deduction is then taken by the employee on their individual income tax return, Form 1040.
New reporting requirements
Employers must now track and report overtime premium pay separately to enable employees to claim this deduction.
Form W-2 updates
- Must report eligible overtime premium earnings separately
- Updated forms will eventually include new fields for qualified overtime premium compensation
- Required for employees to claim the deduction on their tax returns
If your business operates in states with local overtime laws (such as California’s daily overtime), you must:
- Track FLSA overtime separately from state/local overtime
- Report only the federally-qualified overtime premium for the deduction
- Maintain separate records for different overtime types
System and process considerations
Payroll system updates
- May need modifications to track overtime premium separately
- Must distinguish between FLSA and non-FLSA overtime
- Ensure proper reporting on year-end tax forms
Special considerations for 2025
- Employers may “approximate” qualifying FLSA overtime using a “reasonable method” (to be defined by the Treasury Secretary)
- Must account for qualified overtime retroactive to January 1, 2025
- Additional guidance expected from federal agencies
“OnPay is very user-friendly and a great value for small businesses. Because it takes care of all of your calculations for overtime, bonuses, taxes, etc., it frees up so much more time for other important tasks.”
— Alisha Baur, Disaster MD Restoration Services
What stays the same
Despite this new deduction, core overtime obligations remain unchanged.
For employers
- Continue calculating overtime at 1.5x regular rate for FLSA purposes
- Maintain existing record-keeping requirements under FLSA
- Pay overtime premiums according to federal and state laws
- Withhold all applicable taxes on overtime earnings
For employees
- Must still work over 40 hours/week to earn overtime premium
- Pay Social Security and Medicare taxes on all overtime earnings
- Follow existing timekeeping and reporting procedures
Future considerations
The federal government is expected to provide additional implementation guidance, including:
- Specific “reasonable methods” for approximating 2025 qualified overtime
- Updated Form W-2 reporting procedures
- Clarification on multi-state employer requirements
- Guidance on tracking overtime premium vs. regular-rate compensation
Action items to consider
- Review current overtime tracking and reporting systems
- Identify any needed upgrades to separate FLSA from non-FLSA overtime
- Prepare for updated Form W-2 requirements
- Monitor Treasury Department announcements for implementation details
Keep an eye on no tax on overtime
While the “no tax on overtime” deduction provides meaningful tax relief for eligible workers through 2028, it introduces new operational complexities for employers. By understanding these requirements and preparing your systems now, you can ensure compliance while helping your employees maximize their tax benefits.
As with many payroll compliance challenges, leveraging modern HR and payroll software can help automate the complex tracking and reporting requirements introduced by this temporary but impactful tax change.
The OnPay editorial team covers payroll, benefits, and HR-related topics to deliver practical insights for growing businesses.