No tax on overtime, explained

The One Big Beautiful Bill Act created a deduction for “qualified overtime compensation” for tax years 2025 through 2028. It is claimed on Schedule 1-A of Form 1040 and is available whether or not you itemize. The details decide whether it is worth a few hundred dollars or nothing at all, and they are not the ones most headlines suggest.

Only the premium counts

When you work more than 40 hours in a workweek, the Fair Labor Standards Act requires your employer to pay at least 1.5 times your regular rate for the extra hours. At $26.00 an hour, an overtime hour pays $39.00. Of that, $26.00 is straight-time pay you would have earned for any hour, and $13.00 is the premium. The deduction covers the premium only.

So a worker who earns $19,500 of overtime pay in a year does not deduct $19,500. In the example below, the qualified amount is a third of that.

Three other limits narrow it further:

• FLSA overtime only. Overtime that federal law requires is qualified. Overtime paid because of a union contract, a company policy, or a state law that goes beyond the FLSA is not, even though it shows up on the same pay stub line.
• Non-exempt employees only. Salaried workers who are exempt from the FLSA’s overtime rules have no qualified overtime, even if their employer pays something for extra hours.
• You need a valid Social Security number, and married couples must file jointly. Married filing separately gets no deduction at all.

A worked example in Texas

A warehouse lead in Texas earns $26.00 an hour and works 50 hours a week, five days of ten hours, for 50 weeks of the year. A typical week pays $1,430.00, and the year comes to $71,500 of wages. The premium on 10 overtime hours a week is the qualified overtime: $6,500 for the year.

That is under the cap, and the worker’s income is far below the phase-out, so the full $6,500 is deductible. Filing single, it cuts federal income tax by $1,280.

The saving is smaller than the deduction times the worker’s top rate because the deduction pulls income down through the top of the 22% bracket and into the 12% bracket below it. That is typical. The marginal rate guide explains why a deduction is worth the rate of the income it removes, not a single headline rate.

The cap and the phase-out

The deduction is capped at $12,500 a year for single filers and heads of household, and $25,000 on a joint return, however much overtime either spouse works. It shrinks by $100 for every full thousand dollars of modified adjusted gross income above $150,000 ($300,000 joint).

For a single filer with $15,000 of qualified overtime and $180,000 of income, the cap brings the deduction down to $12,500 and the phase-out takes it to $9,500. A single filer at the cap loses the deduction completely at $275,000, and a joint filer at $550,000.

Joint filers share one cap but get a higher income limit. For a married couple where one spouse earns the Texas wages above and the other earns $60,000, the deduction is still $6,500, but it saves $780 because the couple’s income sits in a lower bracket.

State daily overtime is paid, but not deducted

California pays overtime after 8 hours in a day, and double time after 12, on top of the federal weekly rule. Alaska and Nevada have daily rules too, and Colorado pays overtime after 12 hours in a day. Daily overtime raises pay, but the extra premium is required by state law, not the FLSA, so it is not qualified overtime.

Take the same $26.00 rate and 50 hours in California, worked as four long days instead of five. The week pays $1,560.00, and the year $78,000. Of the premiums, $6,500 is the FLSA premium on the hours over 40 a week and is deductible. The other $5,200 comes from California’s daily rule and is not. The deduction saves $1,430 here, more than in Texas, because the higher wages put all of it in the 22% bracket.

What it does not touch

The deduction is an income tax deduction. It does not change:

• Social Security and Medicare. All overtime pay is FICA wages. On the qualified overtime alone, the worker still pays $497 at the combined rate of 7.65%.
• State income tax, unless your state adopts the deduction itself. A few states have announced their own versions; most have not, and a state paycheck page shows the state’s current treatment.
• Your adjusted gross income. It is taken below the line, so it does not lower AGI for other purposes such as student loan repayment plans or premium tax credits.

Getting the saving in your paycheck

Payroll does not apply the deduction automatically. Withholding tables treat overtime like any other wages, so without a W-4 change the saving arrives as part of your refund the following spring.

If your overtime is steady, you can claim it during the year. Enter the expected deduction in Step 4(b) of Form W-4. For the Texas worker, entering $6,500 lowers federal withholding from $265.38 to $216.15 a paycheck, or $49.23 more take-home every two weeks. If your overtime is irregular, leave the W-4 alone and take the deduction on the return; overestimating Step 4(b) turns a refund into a bill.

What to keep for your records

Employers are expected to report qualified overtime separately, on the W-2 or in a statement, so you can fill in Schedule 1-A. Early years have had gaps, so keep your own records:

• pay stubs that show overtime hours and the rate paid;
• your regular rate, including shift differentials and non-discretionary bonuses, which raise the regular rate and so raise the premium;
• for state daily overtime, which hours were over 40 in the workweek and which were daily only.

If the W-2 shows total overtime pay instead of the premium, the qualified amount is one third of the overtime pay for time-and-a-half hours under the FLSA, as in the diagram above. Our calculator works it out from your hours and rate.

Every figure on this page is computed by the same code as our calculators. How we calculate.