Key Takeaways:
- The Overtime Deduction has a retroactive start date of January 1, 2025, and it will expire on December 31, 2028.
- Under the One Big Beautiful Bill, eligible employees can deduct up to $12,500 in overtime pay from their federal taxable income ($25,000 for joint filers).
- The deduction applies only to FLSA-qualified overtime and phases out for high earners with MAGIs above $150,000 (single) or $300,000 (joint).
- Overtime earnings are subject to Social Security and Medicare taxes withheld from your gross pay, which contribute to your retirement and healthcare benefits, as well as applicable state income taxes unless your state enacts similar deductions.
- Employers must still withhold full taxes from overtime pay; the deduction is applied when you file your tax return, potentially increasing your refund.
- Contractors do not qualify for the deduction, and income reclassification is not permitted.
- Employees can maximize benefits by adjusting W-4s, increasing pre-tax contributions, and tracking overtime hours accurately.
Overtime pay is an integral part of many workers’ compensation packages. While employees may appreciate the boost to their paychecks, questions often arise about how overtime earnings are taxed. This is especially true after the passage of the One Big Beautiful Bill in July 2025. Understanding the tax treatment of overtime pay is essential for managing your finances and avoiding unexpected tax bills.
What is Overtime Pay?
Overtime pay refers to the additional compensation employees receive when they work more than the standard number of hours defined by their employer or labor laws. In the United States, the Fair Labor Standards Act (FLSA) generally mandates that non-exempt employees be paid at least 1.5 times their regular rate for hours worked beyond 40 in a workweek.
Let’s look at an example. If an employee earns $20 per hour and works 45 hours in a week, they’ll receive $20 per hour for the first 40 hours and $30 per hour for the additional 5 hours. This results in $150 in overtime pay. Overtime is particularly common in industries like healthcare, retail, manufacturing, and transportation, where demand for services often requires employees to work extended hours.
How is Overtime Pay Taxed After the One Big Beautiful Bill?
From a payroll perspective, overtime pay is taxed like regular income. It is subject to the same federal income tax, state and local taxes (where applicable), and payroll taxes (Social Security and Medicare). However, under the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduces a major change to how overtime pay is treated at tax time.
The “No Tax on Overtime” Rule
Overtime pay remains fully subject to payroll taxes and withholding, so your paychecks won’t increase under the OBBBA. However, eligible employees can take advantage of a new overtime tax deduction. The deduction is available for FLSA-qualified overtime pay up to $12,500 for individuals and $25,000 for joint filers, phasing out for MAGIs above $150,000 (single) or $300,000 (joint). This above-the-line deduction is retroactive to January 1, 2025, continues through 2028.
The deduction begins to phase out for modified adjusted gross income (MAGI) exceeding $150,000 for single filers and $300,000 for joint filers. Individuals must also have a valid Social Security number to qualify. Importantly, this deduction applies only to federal income tax and does not affect payroll taxes or state/local taxes unless a state adopts a similar provision. Some additional considerations include:
- Overtime earnings remain subject to state income taxes (if applicable), Social Security, and Medicare taxes.
- The deduction is not available for those using the Married Filing Separately status.
- This deduction is an above-the-line deduction, reducing your taxable income before AGI and can be claimed whether or not you itemize.
- This deduction is temporary and will be in effect from 2025 through 2028.
Half-Time Premium Deduction
It’s crucial that taxpayers understand that this deduction applies only to the “half-time premium” portion of overtime pay as defined by the Fair Labor Standards Act (FLSA). In other words, you can deduct only the extra half of your “time-and-a-half” overtime pay above your regular hourly wage. For example, if your regular wage is $20 per hour and your overtime pay is $30 per hour, the deduction applies to the additional $10 earned per overtime hour—not the full $30. If you work 100 overtime hours, you may deduct $1,000 (100 hours × $10) from your federal taxable income. You may do so as an above-the-line deduction at tax time, not during payroll withholding.
No Special Overtime Rate
It’s important to note that overtime pay does not have its own unique tax rate. Instead, overtime is taxed like your regular income, using the same federal, state, and local rates that apply to your other wages. If your total income, including overtime, pushes you into a higher tax bracket, only the portion of income within that bracket is taxed at the higher rate, instead of all of your earnings. In other words, overtime itself doesn’t trigger extra taxation; it simply contributes to your overall taxable income.
Does This Mean Overtime Isn’t Taxed at All?
No. Here’s how taxes still apply.
Federal Income Tax
Previously, all overtime pay was fully taxable as regular income. Now, under the OBBBA, qualified employees can reduce their taxable income by claiming the overtime deduction. For example, if an employee earns $60,000 in base wages and $10,000 in overtime, and $5,000 of that overtime represents the half-time premium, they may deduct up to $5,000 (subject to the $12,500 individual cap) from their federal taxable income. Federal payroll taxes and withholding remain unchanged, and the deduction does not affect state or local taxes unless those jurisdictions adopt a similar rule.
State Income Tax
States have their own tax rules, and the federal deduction does not automatically apply at the state level. For example, a worker in California earning $90,000 in base pay and $10,000 in overtime can deduct up to $10,000 for federal taxes, but their full $100,000 remains subject to California’s progressive income tax. Meanwhile, workers in states like Texas or Florida won’t owe state income tax regardless.
Is Overtime Still Withheld from My Paycheck?
Even with the federal deduction in place, employers must still withhold taxes on overtime wages as if they are fully taxable. This includes:
- Federal income tax
- Social Security (6.2% on wages up to $176,100 in 2025)
- Medicare (1.45% on all wages, plus an extra 0.9% for high earners)
- State and local income taxes, where applicable
The deduction is claimed at tax time, meaning it does not reduce your tax withholding throughout the year. As a result, some employees may choose to update their W-4 forms to better reflect their lower expected taxable income.
Other Taxes Applied to Overtime Pay
In addition to federal and state income taxes, overtime pay is also subject to Social Security and Medicare taxes, collectively known as FICA taxes.
Social Security Tax
The Social Security tax rate is 6.2% on earnings up to a wage base limit, which is $176,100 in 2025. Overtime pay contributes to your total wages. If your annual income exceeds the wage base limit, earnings above this threshold are not subject to Social Security tax. For example, if your base wages are $150,000 and you earn $30,000 in overtime, only $26,100 of the overtime would be taxed for Social Security.
$176,100 – $150,000 = $26,100
Medicare Tax
The Medicare tax rate is 1.45% on all earnings with no wage cap. An additional 0.9% Medicare tax applies to income above $200,000 for single filers or $250,000 for joint filers. The overtime deduction does not apply to these payroll taxes.
Does Overtime Pay Affect Tax Refunds or Owed Taxes?
Yes, potentially. Employers withhold taxes on the full amount of overtime wages, which can result in higher overall tax withholding if your increased earnings place you in a higher tax bracket. However, this withholding is just an estimate, and eligible employees can claim deductions on their federal tax return to reduce their taxable income from overtime pay, which may result in a larger refund or lower final tax bill. If withholding was underestimated or you don’t qualify for the full deduction due to high income, you could still owe additional taxes.
Strategies to Maximize the New Overtime Tax Break
This deduction provides a unique opportunity to rethink your tax strategy:
Adjust Your W-4
Update your W-4 form to account for lower taxable income. The IRS Withholding Estimator can help determine if you’re over-withholding based on your new overtime treatment.
Automate a Tax Savings Account
Direct 20–25% of each overtime check into a dedicated savings account. Automate the transfer so you never have to think about it.
Boost Pre-Tax Contributions
Increase contributions to a 401(k), HSA, or FSA. Pre-tax deposits reduce your taxable income and counteract “bracket creep” from overtime.
Track Overtime Closely
Maintain accurate records of FLSA-qualified overtime.
Consult a Professional
A CPA or enrolled agent can project your full-year tax picture, including overtime, and recommend precise withholding or estimated payment tweaks.
Special Considerations
Overtime pay, while financially beneficial, may influence various aspects of your tax situation beyond just the amount owed to the IRS. Understanding these nuances can help you make informed decisions.
Tax Credits and Eligibility
Overtime earnings can affect eligibility for tax credits like the Earned Income Tax Credit (EITC). While the federal deduction lowers taxable income, it doesn’t reduce gross income used to calculate some credits, so be sure to check qualification thresholds.
Household Tax Brackets
Married filers must consider how overtime income affects the combined AGI and whether it triggers a phase-out of the deduction or changes tax credit eligibility.
Labor Market and Policy Considerations
The One Big Beautiful Bill’s overtime provision has sparked debate.
Supporters claim it incentivizes hard work and puts money back into workers’ pockets. Opponents warn it may:
- Discourage base wage increases in favor of tax-free overtime.
- Encourage employers to overuse overtime instead of hiring additional staff.
- Open loopholes for high earners to reclassify income as “overtime” to avoid taxes.
Whether this deduction will remain after 2028 is unclear. Its renewal will likely depend on fiscal outcomes and political support.
Frequently Asked Questions
How does no tax on overtime work in the Big Beautiful Bill?
The One Big Beautiful Bill Act lets eligible workers deduct up to $12,500 in overtime pay from their federal taxable income ($25,000 for joint filers) for tax years 2025 through 2028. This deduction lowers the amount of income subject to federal income tax but does not affect payroll or state taxes.
Can I reclassify regular wages as overtime to avoid tax?
No. Attempts to game the system may result in audits or penalties. Employers are responsible for correctly categorizing pay.
Is overtime taxed more for Social Security and Medicare?
No. Overtime earnings are subject to the same FICA rates, which is 6.2% for Social Security (up to the wage base) and 1.45% for Medicare (with an additional 0.9% on high earners), as regular wages.
Is overtime taxed at the state level?
Overtime is taxed under your state’s regular income-tax rules. If your state has progressive brackets, the additional income may be taxed at a higher bracket, but there’s no special “overtime rate.”
Is overtime taxed more when I’m a contractor or freelancer?
As a contractor, you don’t get FLSA overtime but do pay self-employment tax (15.3% total FICA) on all earnings. There’s no extra income-tax surcharge specifically for overtime.
Tax Help in 2025
Under the One Big Beautiful Bill, overtime wages are still taxed at the time of payment, but eligible employees can now deduct up to $12,500 ($25,000 for joint filers) when they file their federal tax returns. This change provides a meaningful opportunity to reduce taxable income and boost tax refunds, but it doesn’t alter how employers calculate and withhold taxes throughout the year. Optima Tax Relief is the nation’s leading tax resolution firm with over a decade of experience helping taxpayers with tough tax situations.
If You Need Tax Help, Contact Us Today for a Free Consultation