Beginning on January 1, 2025, a new federal tax deduction will change how overtime pay is taxed. Under the One Big Beautiful Bill Act (OBBBA), eligible taxpayers may deduct a portion of their overtime wages on their federal income tax return. The deduction is available through 2028 and creates new planning considerations for both employees and employers.
What is the Overtime Tax Deduction?
Employees can deduct the amount of qualified overtime compensation that exceeds their regular rate of pay — specifically, the “half” portion of “time-and-a-half” pay required under the Fair Labor Standards Act (FLSA). Employers will continue to pay Federal Insurance Contributions Act (FICA) taxes on all wages, including overtime compensation. Qualified overtime must be reported on a Form W-2 or other IRS-approved statement.
Key limits of the deduction include:
- Maximum Deduction: $12,500 for individual filers; $25,000 for married couples filing jointly
- Income Phase-Out: Begins at modified adjusted gross income (MAGI) over $150,000 for individuals; $300,000 for joint filers.
Who Can Claim the Deduction?
The deduction is available to both itemizing and non-itemizing taxpayers. Married taxpayers must file jointly to claim the deduction (not available for Married Filing Separately status).
How Does the Deduction Work?
Employee X is a single taxpayer earning $90,000 annually. In 2025, they work 200 hours of overtime at $60 per hour (their regular rate is $40).
This results in:
- $12,000 in total overtime pay
- $8,000 of regular wages
- $4,000 in qualified overtime compensation (the deductible portion)
Because Employee X’s income is below the $150,000 phase-out threshold, they can deduct the full $4,000 on their 2025 federal return, reducing taxable income and potentially lowering their overall tax liability.
What Are the Reporting Requirements?
Employers must:
- Provide employees with statements showing the total qualified overtime compensation paid during the year.
- File information returns with the IRS or Social Security Administration. These reporting requirements are typically handled by payroll service providers.
How Can Employees Update Their Withholding?
Employees who want to account for this deduction in their withholding must submit a revised 2025 Form W-4, using the updated 2025 Deductions Worksheet. The IRS also encourages employees who update their withholding mid-2025 to review it again at the beginning of 2026.
Does the IRS Offer Guidance and Transition Relief?
The IRS will offer transition relief for the 2025 tax year to assist both taxpayers claiming the deduction and employers complying with the new reporting requirements.
Tax Guidance for OBBBA Compliance
Grassi’s Tax advisors can help employers and employees prepare for these new overtime deduction rules. For guidance on how this impacts your business or personal tax planning, contact your Grassi tax advisor today.
