Overtime Tax Deduction — How it Works

TL;DR

• The federal overtime tax deduction applies to the premium portion of FLSA overtime — retroactive to January 1, 2025.
• Paycheck withholding has not changed. Taxes still come out upfront — the benefit is claimed when the annual return is filed.
• Strict MAGI phaseouts apply. The deduction caps at USD 12,500 for single filers and USD 25,000 for joint filers — disappearing entirely at USD 275k and USD 550k respectively.

The overtime tax deduction is a federal income tax deduction created by the One Big Beautiful Bill Act (OBBBA, P.L. 119-21) — effective January 1st of 2025.

You put in the extra hours. You heard about the overtime tax deduction. Then your paycheck arrived — and looked identical to every paycheck before the law passed. 

Frustrating. Suspicious. 

Completely understandable.

With OBBBA, payroll withholding did not change. You will still see federal taxes pulled from every check. The benefit comes when the annual return is filed — not at the register.

The paycheck is not broken. Your employer did not make a mistake. The process just works in a different way.

What is the overtime tax deduction — and what does it cover?

The overtime tax deduction is a “below-the-line” federal income tax deduction. It lowers the taxable income at filing time. It simply does not shrink withholding on individual paychecks.

The deduction covers tax years 2025 through 2028. It is scheduled to expire December 31st of 2028 — unless Congress extends it.

One Big Beautiful Bill Act Explained

The One Big Beautiful Bill Act — formally P.L. 119-21, signed into law in 2025 — created this deduction from scratch. There was no equivalent federal benefit that existed before this law. Congress designed it particularly to lower the income tax burden on hourly workers regularly working beyond 40 hours per week in accordance with the Fair Labor Standards Act.

2025 was a transition year for employers. The IRS did not penalize businesses for failing to separately report overtime premiums on W-2s. With 2026 tax documents, the IRS has proposed using Box 12, Code "TT" on the W-2 to report qualified overtime pay — part of the broader updating payroll reporting requirements employers will need to implement.

FICA still runs. Withholding still runs. What changed is your end-of-year federal income tax liability — if you qualify.

Who qualifies for the OBBBA tax deduction?

Eligibility criteria have 2 indicators:

• the type of overtime worked 
• your income level

Both are critical and neither can be skipped.

FLSA Premium Pay vs Regular Wages

Only the premium portion of FLSA-mandated overtime qualifies. That is the 0.5x extra — not the entire 1.5x hourly rate.

The numbers make this concrete. A worker earning USD 27 per hour earns a gross overtime rate of USD 40.50 per hour in line with the FLSA. Only the USD 13.50 premium above the base rate is deductible under OBBBA. The USD 27 base wage for that overtime hour remains fully taxable as ordinary income — same as always.

At USD 13.50 per premium hour, a single filer would hit the USD 12,500 annual deduction cap after approximately 925 overtime hours — assuming their MAGI is below USD 150,000.

State-mandated daily overtime or contractual double-time may not qualify. Do not assume broader coverage without checking with a tax professional.

MAGI Phaseout Limits

MAGI determines how much of this deduction you actually keep. There is a gradual phaseout: for every USD 1,000 the MAGI exceeds the threshold, the deduction shrinks by USD 100.

Married Filing Separately filers receive zero deduction — without exceptions & workarounds.

The paycheck surprise: why overtime supplemental withholding hasn't changed

Your employer is still legally required to withhold federal income taxes and FICA on all wages — including overtime. That obligation did not change with OBBBA. The law adjusted the annual tax liability — not your employer's payroll mechanics. The math remains the same.

Think about buying a TV with a mail-in rebate. The full price is still paid at the register. The discount does not happen at checkout. It arrives weeks later, once you mail in the form and the check comes back. Your withholding is the register price. The tax return is the rebate check.

Or think of it as a security deposit. The employer withholds taxes the same way a landlord holds a deposit upfront. The IRS holds it. At year-end, if the OBBBA deduction applies to your situation, that deposit comes back — as a larger refund or a reduced balance due.

If you want to lower the gap between what is withheld and what you actually owe, adjusting the withholding strategy through a revised W-4 is a legitimate option worth modeling before the next tax year.

FICA, State Taxes and Upfront Withholding

Social Security (6.2%) and Medicare (1.45%) still apply to all wages from hour one. The deduction only impacts the federal income tax liability. 

State income tax is its own issue entirely. OBBBA is a federal statute. Whether your state allows a corresponding deduction depends on that state's rolling conformity rules — and they vary across jurisdictions. 

How to claim the overtime deduction on your tax return

The deduction is claimed on Schedule 1-A when filing the annual tax return. It is not applied automatically. You — or your preparer — must perform the following actions:

• calculate eligible premium pay
• confirm it does not exceed the filing status cap
• verify your MAGI does not trigger a phaseout reduction

For 2025 returns, many workers will need pay stub records to reconstruct overtime premiums. Because employers were simply not required to break out that figure on the W-2 during the transition year. From 2026 forward — Box 12 Code "TT" should simplify this — but only if the employer implements the new reporting correctly.

Alexander Accountants can resolve this before you file

If you worked meaningful overtime in 2025 and you are unsure whether you have the documentation to claim the deduction — or whether your employer's W-2 will mirror the premium breakdown correctly — this is not the year to guess.

Schedule a consultation with Alexander Accountants. Our professionals stand ready to calculate your OBBBA deduction eligibility, verify the MAGI position, and confirm your Schedule 1-A is filed correctly before filing. 

One conversation now is worth more than an amended return later.

Overtime Tax Questions: Direct Answers

What is overtime pay for USD 27 an hour?

Under FLSA, standard overtime is 1.5 times the base hourly rate. At USD 27 per hour, the gross overtime rate is USD 40.50 per hour. For OBBBA purposes, only the USD 13.50 premium above the base rate qualifies for the overtime tax deduction. The USD 27 base wage on each overtime hour is still taxed as ordinary income — the same as any straight-time hour.

How much overtime is enough to not get taxed more?

For single filers, the phaseout begins at USD 150k MAGI and the deduction disappears entirely at USD 275k. For married filing jointly, the range is USD 300k to USD 550k. One point worth flagging: FICA still applies from hour one regardless of income level, so overtime is never entirely free of payroll tax at the check level — even for workers well below the phaseout threshold. Consult a CPA to model your specific deduction position.