How does the Section 225 overtime deduction phase out with higher AGI and what are the exact caps for 2025?
Executive summary
The One Big Beautiful Bill Act created an above‑the‑line deduction for “qualified overtime compensation” effective for tax year 2025, allowing individuals to deduct up to $12,500 (single) or $25,000 (married filing jointly) of the overtime premium above their regular rate of pay (for example, the half of time‑and‑one‑half) reported on a payee statement (Form W‑2/1099) [1] [2]. That deduction is available in full for taxpayers with adjusted gross income (AGI) or modified AGI at or below $150,000 for single filers ($300,000 for joint filers) and then phases out by $100 for every $1,000 of MAGI above those thresholds until it is fully eliminated at set upper limits in 2025 [3] [4].
1. How the statutory phase‑out formula works in plain terms
The Internal Revenue Code §225 reduces the allowable overtime deduction by $100 for every $1,000 (or fraction thereof) that a taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 for single filers ($300,000 for joint filers), meaning the deduction falls in a linear, income‑based taper rather than an abrupt cutoff [3] [5]. MAGI for this purpose is AGI increased by specified exclusions such as foreign earned income exclusions, so practitioners must apply the MAGI definition in the statute and guidance when computing the reduction [5].
2. Exact numeric caps and elimination points for 2025
The statutory maximum deduction in 2025 is $12,500 for single filers and $25,000 for married filing jointly; those amounts are available in full to taxpayers with MAGI at or below $150,000 (single) and $300,000 (joint) [2] [6]. Because the deduction phases out at $100 per $1,000 of MAGI above the thresholds, the single‑filer maximum is entirely phased out after $125,000 of excess MAGI (12,500 ÷ 100 × $1,000), producing a cutoff at $275,000 MAGI; for joint filers the full $25,000 requires $250,000 of excess MAGI, producing a cutoff at $550,000 MAGI [7] [3].
3. Practical examples that illustrate the math
A taxpayer with $160,000 MAGI (single) who has $15,000 of qualified overtime could claim up to the statutory $12,500 cap but must reduce the deduction because their MAGI is $10,000 over the $150,000 threshold; under the $100 per $1,000 rule the deduction is reduced by $1,000, leaving a maximum deductible amount of $11,500 for that filer (this example mirrors illustrations used by practitioner alerts) [7] [8]. Similarly, married filers with MAGI modestly above $300,000 will see a stepwise reduction at the same rate, constrained by the $25,000 joint cap [4] [9].
4. Reporting, compliance and the caveats that complicate the calculation
Although the law requires payors to report qualified overtime on information returns, the IRS provided transition relief for tax year 2025 and did not mandate a separate Form W‑2 box entry for qualified overtime for that year, meaning taxpayers often must reconstruct qualified overtime from paystubs, employer statements, or reasonable employer estimates—adding practical complexity for claimants and advisors [10] [11] [1]. Treasury and IRS guidance also clarifies what constitutes “qualified overtime” under FLSA §7 and sets substantiation rules, but the dual objectives—worker tax relief and preventing abuse—create administrative burdens on employers and taxpayers alike [11] [3].
5. Competing perspectives and implicit policy tradeoffs
Proponents frame the deduction as targeted relief for hourly workers who earn overtime, but tax professionals and public‑employer groups warn that the phase‑out mechanics, MAGI definition, reporting gaps, and employer payroll changes could limit takeup and produce compliance costs that dilute the intended benefit [4] [7] [9]. The IRS and Treasury emphasize anti‑abuse rules and transition relief while practitioners press for clearer employer reporting; both positions reflect tradeoffs between taxpayer simplicity, administrative feasibility, and revenue safeguards [3] [12].