What the OBBBA Did
The One Big Beautiful Bill Act (OBBBA) was signed into law in July 2025. Among other provisions, it created a federal income tax deduction for the premium portion of qualified overtime pay, available whether or not you itemize. The deduction applies to tax years 2025 through 2028 and is claimed on the employee's individual federal return.
This is a deduction, not a wage exclusion. The full overtime amount is still wages — still subject to FICA, still subject to ordinary income tax withholding through the year. Employees recover the federal income tax on the premium portion at filing time when they claim the deduction.
What's Actually Deductible
This is the part most write-ups get wrong. The deduction covers only the premium half-time portion of overtime pay — not the full 1.5× rate. If an hourly employee earning $20/hr works 8 hours of overtime, the gross OT pay is $20 × 1.5 × 8 = $240. Of that:
- $160 is straight-time wages (the $20 base × 8 hours) — fully taxable, not deductible.
- $80 is the premium half-time portion (the extra $10 × 8 hours) — this is what qualifies for the deduction.
The deduction is capped at $12,500 per year for single filers and $25,000 for married filing jointly. It phases out for higher earners: after the cap is applied, the deduction is reduced by $100 for every $1,000 of modified AGI above $150,000 (single) or $300,000 (married filing jointly), but not below zero.
What's Required: FLSA Overtime, Not "Working Overtime"
Only overtime required by the federal Fair Labor Standards Act qualifies; overtime owed only under state law does not. Voluntary "OT" arrangements between an employer and a salaried-exempt employee — for example, a flat extra payment for working a holiday — do not count. The trigger is the employee's nonexempt status under FLSA and the work crossing the 40-hour weekly threshold.
What Payroll Teams Need to Track
Payroll systems must report the qualifying premium portion separately so employees can claim the deduction. For tax year 2025 the IRS granted transition relief: separate reporting was not required, and employers who disclosed it voluntarily generally used Form W-2 Box 14 or a comparable statement. That relief has expired. For tax year 2026 and later, separate reporting is mandatory and the premium goes in Box 12 under code TT — see W-2 Box 12 code TT for how the figure is built, and employer reporting obligations for 2026 for the configuration checklist. Confirm with your payroll platform how it identifies and reports the premium.
Withholding mechanics for 2025–2026 stayed essentially unchanged: employees can either let the deduction true up at filing, or adjust their W-4 Step 4(b) to claim a deduction in advance. The 2026 Form W-4 Deductions Worksheet now includes a line for qualified overtime.
FLSA Regular Rate Interaction
FLSA and OBBBA operate independently. The premium portion is still wages for FLSA purposes, still factors into the regular rate, and still gets the 0.5× premium calculation when bonuses or other remuneration are included. Nothing about the FLSA's "regular rate of pay" math changes — the OBBBA deduction simply changes how a portion of the resulting wages is taxed at the federal level.
State income tax treatment varies. This deduction comes after federal AGI on Form 1040, so a state that starts from federal AGI does not pick it up unless it adopts the deduction itself; check your own state's rules (California, New York and Pennsylvania in particular need separate analysis).
What to Do Right Now
Confirm your payroll system is identifying and reporting the premium half-time portion correctly for tax year 2026. Review your employee communications — many workers expect the OBBBA to mean "no withholding on overtime checks," and they'll be surprised when their paycheck looks the same. Run a sample calculation for your workforce using the No Tax on Overtime Calculator to estimate the actual deduction amount per employee, and use that in employee-facing communications so the messaging is accurate.