If an exempt employee receives straight pay for overtime over 40 hours, is that overtime considered taxable wages?
Executive summary
If an exempt employee (one not covered by the Fair Labor Standards Act overtime rules) is paid extra for hours over 40, available sources do not discuss that exact scenario; the new federal “no tax on overtime” deduction applies to qualified overtime paid to non‑exempt employees under the FLSA and allows deduction of the overtime premium (generally the half‑time portion of time‑and‑a‑half) for tax years 2025–2028 (deduction caps $12,500 single / $25,000 joint; phaseout starts at $150,000/$300,000) [1][2][3]. Treasury/IRS guidance and reporting rules treat “qualified overtime” as FLSA‑required overtime and offer transition rules for 2025 [4][5].
1. What the law actually covers — overtime for non‑exempt workers
The One Big Beautiful Bill Act created a deduction for “qualified overtime compensation” effective for tax years 2025 through 2028; that deduction is expressly tied to overtime required by the Fair Labor Standards Act (FLSA) and is intended for non‑exempt hourly workers who receive the overtime premium (for example, the half‑time premium in time‑and‑a‑half pay) [1][6]. Multiple payroll and tax guides reiterate that only FLSA non‑exempt employees qualify for this overtime deduction [7][8].
2. Exempt employees: sources don’t treat their extra pay as the covered “qualified overtime”
The guidance and coverage in the available sources repeatedly frame the deduction around FLSA non‑exempt overtime and the statutory overtime premium; they list common exempt categories (executive, administrative, professional, outside sales, highly compensated) as generally ineligible [9][10]. Available sources do not mention that an exempt employee’s additional straight pay for hours over 40 would be eligible as “qualified overtime” under the new deduction; they consistently tie the relief to FLSA‑required overtime pay [1][8].
3. Tax treatment still applies unless the payment matches “qualified overtime” rules
Even where the deduction applies, it covers the portion of pay that exceeds the regular rate (the premium) and is reported as qualified overtime — not every extra dollar an employer might call “overtime” [1][6]. Employers must report qualified overtime separately on W‑2s (transition rules for 2025; Box 12 code proposed for 2026) and the IRS issued guidance to help taxpayers reconstruct qualified overtime where employers did not separately report it in 2025 [5][4]. If an employer gives an exempt worker additional straight pay that is not an FLSA overtime premium, the available reporting and deduction guidance does not classify that amount as “qualified overtime” [1][4].
4. Payroll taxes and state taxes remain unaffected by the federal deduction
Sources emphasize the deduction reduces federal income tax liability on qualifying overtime but does not eliminate payroll taxes: Social Security and Medicare withholding still apply, and state/local tax treatment varies by state [2][7]. The federal provision is a limited, above‑the‑line deduction for federal income tax years 2025–2028 and does not alter wage‑and‑hour responsibilities under the DOL [1][9].
5. Practical implications for employers and employees
Employers should track and distinguish FLSA‑required overtime premiums from other pay so that W‑2 reporting and employee claims are supportable; the IRS allowed a “reasonable method” for 2025 transition reporting given system lags [5][11]. Because employers might not immediately break out qualified overtime on paystubs or W‑2s for 2025, the IRS guidance shows taxpayers options to compute the qualified portion when they file [4][3].
6. Competing viewpoints and limitations in coverage
Most reporting and IRS statements converge: the deduction targets non‑exempt, FLSA overtime premiums and includes caps and phaseouts [2][3]. Some advocacy/practice notes and one bill variant mention different limits or formulas (for example, H.R.561 language cited a 20% cap of regular wages) — illustrating that legislative proposals and commentary differ and that readers should watch final agency rules and employer reporting practices [12]. Available sources do not address novel employer practices such as paying salaried‑exempt employees “straight overtime” and calling it eligible — that precise fact pattern is not discussed in current reporting (not found in current reporting).
Bottom line: the new federal overtime deduction applies to qualified FLSA overtime for non‑exempt employees; if an employee is truly exempt and simply receives extra straight pay for hours over 40, the published guidance and reporting rules do not describe that pay as qualifying for the “no tax on overtime” deduction [1][9].