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Read our blog post to learn the essentials you need to know about the “No Tax on Overtime” provision of the recent budget reconciliation bill. This exemption retroactively begins on Jan. 1, 2025, and will remain in place through 2028. Catch up on some quick definitions and learn about reporting and compliance topics employers will need to take into account in the coming years.
A budget reconciliation bill known as the “One Big Beautiful Bill” was recently signed into law. This bill contains notable provisions, including one which eliminates federal taxes on tips. Another part of this bill eliminates the taxes paid by employees on overtime hours worked.
Let’s go over some information that will help you stay informed about this legislation.
What is overtime pay and how is it currently taxed?
Overtime pay is the premium that employers pay employees for working longer than a standard number of hours within a specified period. For most employees, overtime is considered to be any hours worked in excess of 40 hours in a workweek.
Overtime pay, as defined by the U.S. Department of Labor, is a rate that’s not less than time and one-half of the employee’s regular rate of pay. These overtime earnings are then added to the employee’s gross income, increasing their total taxable income for the year. This income is then subject to federal income tax based on the progressive tax bracket system, where higher income levels are taxed at higher rates.
If overtime pay pushes the employee’s total income into a higher tax bracket, only the portion of their income that falls within that higher bracket is taxed at the increased rate, not their entire income.
For employees residing in a state with income tax, overtime pay will also be subject to state and local income taxes, depending on the specific regulations of their state and locality.
What is the No Tax on Overtime bill?
As a part of the One Big Beautiful Bill, the No Tax on Overtime provision creates an above-the-line deduction on the taxpayer’s tax return for overtime pay during a given taxable year. In simpler terms, the bill would exempt the “half” portion of “time and a half” from federal tax. The employee would still be taxed at normal rates on their regular rate of pay.
The Senate version of the Big Beautiful Bill caps the total deduction that can be claimed at $12,500 (or $25,000 for a joint return). Additionally, the Senate version allows the full deduction for individuals with adjusted gross incomes up to $150,000 ($300,000 for joint returns) and slowly reduces the allowable amount of deduction by $100 for every $1,000 of income over those thresholds.
This provision will not eliminate payroll taxes for Social Security and Medicare.
When does No Tax on Overtime start?
Now having been signed into law, the No Tax on Overtime provision is now in effect and retroactive to Jan. 1, 2025.
A work-eligible Social Security number is required to claim the deduction. The deduction is allowed from tax years 2025 through 2028.
How will No Tax on Overtime affect employers?
Tax withholding and reporting of employee compensation is still required, and overtime wages will need to be separately identified on Form W-2. Employers should be prepared for the possibility that their payroll and reporting systems may need to be updated to meet these requirements.
It will also be important for employers to note that state overtime laws may be different from federal laws. Understanding how these different laws interact will be important for employers that need to implement these rules.
Staying compliant with the new overtime tax rules
Employers will need to track and report overtime hours and how much is taxed on overtime pay as a separate category (if they aren’t already) so these figures can be provided to affected employees for their year-end filing.
No Tax on Overtime: FAQ
Is overtime pay taxable?
Yes. Overtime pay is subject to the same taxes an employee pays on their normal hourly wages.
Is overtime pay currently exempt from taxes?
Sort of. Overtime pay was previously taxed at the same rate as hourly pay that occurs within a regular, 40-hour workweek. Individual taxpayers can now claim a deduction on that income up to the maximum limit set forth in the legislation: $12,500.
When will the new federal tax exemption on overtime take effect?
Now that this legislation has been signed into law and is retroactive to Jan. 1, 2025, it is in effect now.
Will employers be required to adjust how overtime is reported on W-2s?
It is very likely that employers will need to separately report overtime hours when giving pay statements to their employees.
Will exempt employees benefit from this law?
No. Exempt employees are defined by the Fair Labor Standards Act as being exempt from overtime requirements. Because exempt employees aren’t paid at a higher rate for hours worked in excess of 40 hours in a workweek, they will not benefit.
How is overtime calculated?
Overtime hours are considered to be those hours that an employee works in excess of 40 hours in a workweek. Those excess hours are then paid at a rate that is at least 1.5 times the employee’s normal hourly rate.
Is there a cap on how much overtime income can be tax-exempt?
The Senate version of the Big Beautiful Bill caps the total deduction that can be claimed at $12,500 (or $25,000 for a joint return). Additionally, the Senate version allows the full deduction for individuals with adjusted gross incomes up to $150,000 ($300,000 for joint returns) and slowly reduces the allowable amount of deduction by $100 for every $1,000 of income over those thresholds.
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