Which types of overtime pay are excluded from federal income tax?
Executive summary
A new federal provision—part of the One Big Beautiful Bill Act (OBBBA) enacted in 2025—creates a temporary federal income tax deduction for “qualified overtime compensation” (the time-and‑one‑half premium), effective for overtime earned starting January 1, 2025 and scheduled through 2028 (with caps and phaseouts) [1] [2]. The deduction applies only to federal income tax; overtime remains subject to Social Security and Medicare payroll taxes and may be treated differently by states [3] [4].
1. What the law actually excludes: the “half” of time‑and‑a‑half
Congress’ change creates an above‑the‑line deduction that excludes the premium portion of FLSA‑required overtime from federal taxable income — essentially the “half” in “time and a half” when overtime is paid under federal law (qualified overtime compensation) [2] [5]. Multiple payroll and tax guides summarize that only the premium required by the Fair Labor Standards Act (FLSA) is the target of the deduction, not all extra pay [2] [5].
2. Who qualifies and who does not: FLSA non‑exempt workers only
The deduction is aimed at nonexempt, W‑2 employees who receive FLSA‑required overtime for hours worked over 40 in a workweek. Pay that is not required under the FLSA — for example, extra pay to managers or otherwise FLSA‑exempt employees — does not qualify as “qualified overtime” for the deduction [1] [6].
3. Limits, phaseouts and reporting mechanics you must watch
The deduction is limited by dollar caps and income phaseouts: guidance and summaries cite caps such as up to $12,500 for single filers and $25,000 for joint filers and MAGI phaseouts (examples noted in practitioner writeups) [7] [5] [8]. Employers must separately report qualified overtime on W‑2s (with a transition in 2025 and clearer W‑2 reporting starting in 2026), and Treasury/IRS guidance will define acceptable methods for approximating 2025 qualified overtime [3] [7] [9].
4. Payroll taxes and state treatment remain unchanged
Every source is explicit that this change affects only federal income tax. Social Security and Medicare withholdings (FICA) still apply to overtime wages, and many states may not conform — so your state income tax bill could still include overtime unless your state law changes [3] [4] [10].
5. Common pitfalls and areas of confusion
Reporting and qualification are the major frictions: taxpayers may assume “no tax on overtime” means no withholding or no reporting, but employers generally will still withhold and remit federal income tax during 2025 and employees must claim the deduction when filing [7] [11]. The legal text and IRS notices explicitly exclude overtime paid to FLSA‑ineligible (exempt) employees from qualifying, which will surprise some salaried workers who sometimes receive extra pay [6].
6. Competing legislative versions and ambiguity about duration
Some analyses and bills cited in the reporting note different time horizons or alternate caps (for example, H.R. 561 versions and earlier proposals show varying end dates and percentage limits), so the statutory details and effective years can differ between sources and drafts — check the final enacted statute and IRS guidance for the controlling terms [12] [13]. Several published explainers nonetheless converge on the OBBB as the vehicle that instituted the 2025–2028 deduction [13] [10].
7. Practical advice for workers and employers
Save pay stubs showing overtime and confirm how your employer will report overtime on the 2025 W‑2; employers should be ready to track and distinguish FLSA overtime from other premium pay and to use IRS‑approved “reasonable methods” for retroactive 2025 reporting [7] [2]. Tax preparers warn that without clear payroll reporting taxpayers may face work reconstructing qualifying amounts [6].
Limitations and final note: available sources consistently describe a federal income tax deduction for qualified FLSA overtime from 2025 (retroactive to Jan 1, 2025) through at least 2028, but state treatment, exact implementation details and any future legislative extensions remain matters for subsequent IRS rules and Congress — available sources do not mention post‑2028 permanence or exact W‑2 box codes beyond transitional guidance [2] [7] [9].