A budget reconciliation bill referred to as the “One Big Beautiful Bill” has been signed into law. The bill has some notable provisions, such as one that reduces federal taxation on tips. Another aspect of this bill eliminates the tax that employees are required to pay for overtime hours they work.
Let’s review some of the information to help you stay updated on this legislation.
The definition of overtime? And how does it currently get taxed?
Overtime pay is the amount which employers offer employees who work more than the standard number of hours over the specified time frame. For the majority of people, overtime is considered to be all hours that exceed 40 hours during a workweek.
Overtime pay as specified in the U.S. Department of Labor is a rate that’s not less than time and one-half of the employee’s regular rate of pay. The overtime earnings are put into the employees’ total income, which increases the amount they are taxable during the year. The income is then taxed at the federal level that is based on the tax brackets that are progressive, which means that higher incomes are taxed at a higher rate.
If overtime pay pushes the income of the employee to a higher tax bracket however, only the portion of their earnings that is in that bracket will be taxed at the higher rate, not the total income.
If employees reside in a state that has taxes on income, the overtime earnings will be subject to local and state income tax, based on the regulations specific to their locality and state.
What is the No Tax on Overtime bill?
As a part of the One Big Beautiful Bill, the No Tax on overtime provision permits employees to take the over-the-line deduction on their federal tax returns for the part of their wages that is overtime during a particular tax year. In simple terms the bill excludes those who earn the “half” portion of “time-and-a-half” pay which is the price paid during overtime hours from taxation on income earned by federal employees. Regular wages as well as the basic portion of overtime remain tax-exempt as usual which means that employees pay tax on their normal wages while also receiving an exemption from federal taxes specifically for earnings from overtime that are eligible.
The Senate version of the Big Beautiful Bill caps the deduction total that can be claimed to $12,500 (or $25,000 for joint returns). Furthermore, the Senate version provides the full deduction to individuals with adjusted gross earnings as high as $150,000 ($300,000 on joint return) and gradually reduces the amount that can be claimed by $100 for each $1000 of income that is above those thresholds.
This law will not completely end payroll taxes on Social Security and Medicare.
When will No Tax on Overtime begin?
As of today, after being approved by the law The No Tax on Overtime provision is in force and retroactive to January 1st, 2025.
A work-eligible Social Security number is required for the deduction to be claimed. The deduction is available for tax years 2025 to 2028.
How will no tax on Overtime impact employers?
Tax withholding and reporting of compensation for employees is still required, as well as overtime earnings will have to be identified separately on the Form W-2. Employers must be ready in the event that payroll systems and reporting systems could require updating to comply with these regulations.
It is also crucial for employers to be aware that the state overtime laws could differ from federal laws. Knowing how these laws relate will be essential for businesses that have to comply with these rules.
Making sure you are in compliance with the new overtime tax regulations
Employers must track and report overtime hours as well as the amount of tax imposed on overtime earnings as a separate item (if they haven’t already) so these figures can be provided to affected employees for their year-end filing
FAQ
Are overtime wages subject to tax?
Yes. overtime pay comes with the exact taxes that an employee pays on normal hourly wage.
Are overtime wages currently exempt from tax?
It’s a bit. Pay for overtime was taxed in the exact same way as hourly earnings that is earned during a typical 40-hour workweek. Individual tax payers are now able to take a deduction from their income up to the highest limit that is set in the law which is $12,500.
Will employers be obliged to change the way that they report overtime on W-2s?
It is highly probable that companies will have to report separately overtime hours when they issue the pay statement to their employees.
For the tax the year 2025 (i.e. the wages paid in 2025, and W-2s issued in the early 2026) In the tax year 2025, the IRS has stated that there will be no changes to the current W-2 form (i.e. there will be there will be no new form immediately). Employers must “continue with the current process” to report and withhold.
However, the draft guidelines for the year 2026 tax year indicates that W-2 (or the new version) will be accompanied by different reporting codes: e.g., Box 12 code “TT” for qualifying overtime compensation as well as box 12 code “TP” for tips that are qualified.
Do employees who are exempt benefit by this new law?
No. Exempt employees are defined in the Fair Labor Standards Act as being exempt from the overtime requirement. Since exempt employees don’t get paid more for hours that exceed 40 hours during a week, they won’t be able to gain.
How do you calculate overtime?
Overtime hours are deemed to be the hours in which employees work more than 40 hours per week. These extra hours are paid at a rate which is at minimum 1.5 times the normal hourly wage.
