Federal Tax Deduction for Overtime Pay

Beginning in the 2025 tax year, a new federal tax provision will allow eligible workers to deduct certain overtime earnings from their taxable income. This change, introduced under Section 70202 of the One Big Beautiful Bill Act (OBBBA), represents a significant adjustment to how overtime compensation is treated for federal income tax purposes.

Overview of the Provision

Under Section 70202, qualified individuals will be permitted to deduct a portion of their overtime pay from their federal taxable income. The deduction is capped at $12,500 for individuals and $25,000 for married couples filing jointly. This adjustment aims to reduce the federal income tax liability for workers who receive overtime wages.

Eligibility Criteria

To be considered “qualified overtime pay,” the income must meet specific conditions:

• It must be paid in accordance with the Fair Labor Standards Act (FLSA).

• It must be compensation for hours worked in excess of a standard workweek, paid at a rate higher than the employee’s regular hourly wage.

• It must be in the form of wages; tips and other non-wage compensation do not qualify.

  
  

Income Limitations

The deduction is subject to income-based phaseouts. For individuals with annual income exceeding $150,000 and for married couples filing jointly with income over $300,000, the available deduction is reduced. The phaseout is calculated at a rate of $100 for every $1,000 in income above the respective thresholds. Individuals with income significantly above these limits may not qualify for the deduction.

Reporting and Documentation

Beginning in 2025, Form W-2 will include a designated field (Box 19) to report qualified overtime pay. For independent contractors and self-employed individuals, similar overtime reporting will be required on Form 1099. To claim the deduction, taxpayers must:

• File a federal tax return using a valid Social Security number.

• File jointly if married and seeking the full joint deduction.

• Accurately report the qualifying overtime amount as indicated on their wage or income statements.

  
  

Implementation Timeline

The deduction will be available for tax years beginning on or after January 1, 2025. As currently enacted, the provision is set to expire on December 31, 2028. Unless renewed or extended through future legislation, this deduction will apply only to tax years within that four-year period.

Considerations and Limitations

It is important to note that this deduction affects only federal income tax. Overtime earnings remain subject to payroll taxes, including Social Security and Medicare (FICA). Employers will continue to withhold these taxes from employee paychecks, and the deduction will not reduce the amount withheld throughout the year. The benefit of the deduction will be realized when filing annual tax returns.

Next Steps for Workers and Employers

Employers should prepare to incorporate the new reporting requirement into their payroll systems starting in 2025. Employees and independent contractors are encouraged to maintain detailed records of overtime hours and corresponding pay. Consulting with a tax professional ahead of the 2025 filing season may help individuals understand how this deduction applies to their circumstances and whether any adjustments to withholding or estimated payments are warranted.

Conclusion

Section 70202 of the One Big Beautiful Bill Act introduces a temporary but potentially impactful change to federal tax policy for workers earning overtime pay. By allowing a portion of overtime wages to be deducted from taxable income, the provision is intended to reduce the tax burden for qualifying individuals over a defined period. Those eligible for the deduction are encouraged to stay informed about reporting requirements and to seek guidance as needed to ensure compliance and maximize the potential benefit.

The information provided in this blog post is intended for general informational purposes only and should not be construed as legal or tax advice. While every effort has been made to ensure the accuracy of the information, tax laws and regulations are subject to change, and individual circumstances may vary. For personalized advice and to ensure compliance with current tax laws, it is strongly recommended that you consult with a qualified tax professional, financial advisor, or legal counsel. The author and publisher of this blog assume no responsibility for any errors or omissions, or for any actions taken based on the information contained herein.