What Employers Need to Know About the New Overtime Tax Deduction Under the One Big Beautiful Bill Act
On the heels of significant federal tax reform, the One Big Beautiful Bill Act (HR 1) has officially been signed into law—and with it comes sweeping changes for both employers and employees. One of the most talked-about provisions is the new “no tax on overtime” rule, found in Section 70202 of the legislation. While the concept may sound simple, the implementation is anything but, and much of the guidance we need is still forthcoming from the IRS.
Here’s what we know so far—and what you should be doing to prepare.
Important Note: This blog post is for informational purposes only and should not be considered tax advice. Individuals and organizations should consult with a qualified tax professional for guidance specific to their situation.
A New Federal Overtime Tax Deduction
The new law creates IRC Section 225, which allows employees to deduct their qualified overtime compensation from their taxable income when filing their federal tax returns.
But let’s be clear:
This deduction only applies to federal income tax.
Employees will still owe Social Security, Medicare, and applicable state and local taxes on their overtime pay.
This new deduction applies to the 2025 tax year through 2028, and employees will be able to claim it when they file Form 1040, regardless of whether they itemize or take the standard deduction. The deduction is limited to:
- $12,500 for single filers
- $25,000 for those filing jointly
These limits begin to phase out once a taxpayer’s modified adjusted gross income (MAGI) exceeds:
- $150,000 for single filers
- $300,000 for joint filers
The deduction will shrink by $100 for every $1,000 a taxpayer’s MAGI exceeds those thresholds.
What Employers Need to Do Now
Although the law is already in effect, employers should continue to withhold federal income tax on all overtime pay for now. This is because:
- The IRS has not yet issued detailed guidance on how this deduction will be handled operationally.
- Overtime amounts will need to be reported on the Form W-2 starting with tax year 2025, which will be filed in early 2026.
- The specific box on the W-2 form for reporting overtime pay has not been announced.
When Will We Know More?
This is the big question for payroll and HR teams across the country.
The IRS is expected to release guidance in the coming months, which will clarify:
- How to identify and calculate “qualified overtime compensation”
- Which W-2 box should be used for reporting
- How to handle voluntarily enhanced overtime rates beyond FLSA minimums
- What methods can be used under the transition rule for 2025 reporting
Until that guidance is issued, employers should not make any structural changes to payroll systems or withholding practices.
Prepare for W-2 Changes in 2026
While we await further instruction from the IRS, it’s wise to begin internal discussions about how your organization will capture and track overtime pay separately from base wages.
Once IRS guidance is published, we’ll be in a better position to determine how to report overtime on the 2026 Form W-2 and ensure employees can claim their tax deduction with confidence.
Final Thoughts
This new overtime tax deduction represents a significant change in the tax code and will require coordination between HR, payroll, and tax professionals. It also reinforces the importance of staying compliant with FLSA overtime definitions, as the law specifically ties eligibility to the standard time-and-a-half rule for hours worked over 40 per week.
Keep a close eye on IRS announcements in the months ahead. We’ll continue to monitor updates and provide further insight once more concrete instructions are released.
Stay tuned—we’ll help you navigate these changes every step of the way.