One of the most newsworthy federal tax updates of 2025 is the qualified overtime compensation deduction, introduced under the One Big Beautiful Bill Act. This new deduction effectively exempts certain overtime pay from federal income tax.
How the Overtime Deduction Works
The deduction allows up to $12,500 of qualified overtime compensation for individual filers. Married taxpayers may deduct up to $25,000 if they file jointly.
The deduction begins to phase out once modified adjusted gross income exceeds:
- $150,000 for individual filers
- $300,000 for joint filers
Eligible taxpayers will report the deduction on Schedule 1-A of Form 1040.
Employer Reporting Requirements
Beginning in tax year 2026, employers must separately report qualified overtime compensation. They will do so on Form W-2 or Form 1099-NEC, when applicable. For tax year 2025, the IRS has issued transition relief. Employer reporting is encouraged but not required. As a result, many employees will need to calculate their own qualified overtime pay for the 2025 filing season.
What Counts as Qualified Overtime Compensation?
Employees and employers should understand several key rules when calculating qualified overtime compensation.
FLSA Coverage Is Required
Qualified overtime compensation must meet the requirements of Section 7 of the Fair Labor Standards Act (FLSA). Specifically, the compensation must:
- Be paid to an individual covered by the FLSA
- Exceed the individual’s regular rate of pay
Employees who are exempt from the FLSA do not qualify.
The 40-Hour Rule Still Applies
Under FLSA rules, overtime generally applies to hours worked over 40 in a single workweek. Employers must pay those hours at least 1.5 times the employee’s regular rate. Some employers or state laws require overtime after fewer hours. However, only overtime paid for hours exceeding 40 in a week qualifies for the federal deduction.
Only the Overtime Premium Qualifies
For deduction purposes, only the premium portion of overtime pay qualifies.
For example:
- If an employee earns time-and-a-half, only the 0.5 premium above the regular rate counts.
- If an employer pays double time, the deduction still applies only to the first 0.5 premium.
The regular rate portion of overtime pay does not qualify for the deduction.
Key Takeaway for 2025 Filings
This new deduction provides meaningful tax relief for individuals earning qualified overtime pay. However, it also introduces complexity, particularly for 2025, when employer reporting is optional. Employees may need to rely on their own records to calculate eligible amounts accurately. If you have questions about how this deduction applies to your situation, please contact us.
