What the OBBBA Did
The One Big Beautiful Bill Act (OBBBA) was signed into law in July 2025. Among other provisions, it created an above-the-line federal income tax deduction for the premium portion of qualified overtime pay. 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 also phases out at higher incomes.
What's Required: FLSA Overtime, Not "Working Overtime"
Only overtime required by the federal Fair Labor Standards Act (or analogous state law) qualifies. 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 (or applicable state daily threshold).
What Payroll Teams Need to Track
Payroll systems must report the qualifying premium portion separately so employees can claim the deduction. The IRS has issued transitional guidance for 2025 allowing employers to report this on Form W-2 Box 14 or in a comparable disclosure, with a more formal reporting code expected for 2026 W-2s. Major payroll platforms (ADP, Paychex, Workday, UKG) have rolled out updates — confirm your platform's specific configuration.
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 W-4 worksheet was updated in late 2025 to incorporate the new line.
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. Most states tied to federal AGI will follow the deduction automatically; states with their own conformity rules (California, New York, Pennsylvania) require 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.