On July 4, 2025, President Trump signed into law the formerly known as the One Big Beautiful Bill Act (OBBBA). This legislation implements major tax reforms, including a federal income tax deduction for overtime pay. This provision, effective from tax years 2025 through 2028, permits eligible workers to deduct part of their overtime earnings from their taxable income.

What the law says

Effective for 2025 through 2028, individuals who receive qualified overtime compensation may deduct the pay that exceeds their regular rate of pay, such as the “half” portion of “time-and-a-half” compensation, that is required by the Fair Labor Standards Act (FLSA) and that is reported on a Form W-2, Form 1099 or other specified statement furnished to the individual.

Eligible employees can claim an above-the-line deduction of up to $12,500 for overtime pay annually, or $25,000 for married couples filing jointly.

It’s important to note that this is a deduction, not an exemption; therefore, while it reduces taxable income, it does not eliminate taxes on overtime pay entirely. Payroll taxes (Social Security and Medicare) still apply.

The deduction phases out for individuals with a modified adjusted gross income (MAGI) exceeding $150,000 and joint filers exceeding $300,000, reducing by $100 for every $1,000 over these thresholds. To take the deduction, you will need a Social Security number.

Applicability to different overtime rates

The deduction applies to overtime pay required by the FLSA, which usually mandates that employers pay non-exempt employees at least one and a half times their regular rate for hours worked beyond 40 in a workweek. However, some employers provide double-time pay for certain hours or conditions. The IRS has not yet issued specific guidance on whether double-time pay qualifies for this deduction or the exact definition of overtime. Until such guidance is issued, it is safest to assume that only FLSA-mandated overtime pay is eligible.

Transitional rules allow employers to estimate this amount for tax year 2025 only.

Example: Jane Doe is a single employee who earns $60,000 in regular wages and $10,000 in qualified overtime pay in 2025. Her total income is $70,000. Under this provision:

• Jane can deduct the full $10,000 of qualified overtime pay from her taxable income at the end of the year.
• Her taxable income for federal purposes would include $60,000 of regular wages plus $10,000 of overtime, totaling $70,000. However, since the $10,000 is qualified overtime, she can claim a $10,000 deduction on her tax return. [$60,000 (regular wages) + $10,000 (overtime) - $10,000 (deduction for overtime)].

Guidance for tax professionals

1. Client eligibility assessment

• Employment status: confirm that the client is a non-exempt employee under the FLSA
• Income thresholds: ensure the client’s MAGI does not exceed the phase-out thresholds

2. Documentation and record-keeping

• Overtime tracking: advise clients to maintain accurate records of overtime hours worked and corresponding pay received
• Employer reporting: Employers are required to report overtime pay separately on Form W-2, necessitating updates to payroll systems to track and report this information accurately.

3. Tax planning

• Withholding adjustments: Clients might consider changing their withholding to match the expected deduction, potentially increasing their take-home pay over the course of the year.
• State taxes: notify clients that this federal deduction does not impact state income taxes unless their state has similar provisions

4. Employer considerations:

• Payroll systems: Employers should update payroll systems to accurately track and report overtime pay separately.
• Policy changes: Employers should be careful when restructuring compensation plans only to increase this deduction, since the IRS might closely scrutinize such changes for compliance.

Pending guidance

The IRS is expected to publish detailed guidance on implementing this deduction, including definitions of qualifying overtime pay and documentation requirements. Tax professionals should stay informed of these developments to provide accurate advice to clients.

Conclusion

The OBBBA’s provision for a federal income tax deduction on overtime pay allows eligible workers to lower their taxable income. Given this new law, tax professionals are essential in helping clients understand eligibility, maintain proper documentation and optimize tax strategies.

Note: This information is based on the current understanding of the OBBBA as of July 15, 2025. Tax professionals should consult the latest IRS guidance and official resources for the most up-to-date information.