No Tax on Overtime Pay: Overtime Tax Exemption 2025 Updates

A budget reconciliation bill known as the One Big Beautiful Bill Act retroactively went into effect on Jan. 1, 2025. This bill contains notable provisions, including one that eliminates federal taxes on tips. Another part of this bill creates a deduction for the taxes paid by employees for a portion of overtime hours worked.

Plus, these new reporting requirements may be seen as an understandably abrupt shift for many employers. In November 2025, the IRS announced through Notice 2025-62 that, in certain circumstances, no penalties would be imposed on employers for not filing correct information returns and not providing correct payee statements to employees and other payees for the 2025 tax year.

Not entirely sure what this law could mean for your workforce? Let’s dive deeper into this legislation to help you and your team stay informed.

What is overtime pay and how is it currently taxed?

Overtime pay is the premium that employers pay employees for working longer than a standard number of hours within a specified period. For most employees, overtime is considered to be any hours worked in excess of 40 hours in a workweek.

Qualified overtime pay, as defined under the Fair Labor Standards Act (FLSA), is overtime compensation paid to a worker that exceeds their regular hourly rate. These overtime earnings are then added to the employee’s gross income, increasing their total taxable income for the year. This income is then subject to federal income tax based on the progressive tax bracket system, where higher income levels are taxed at higher rates.

If overtime pay pushes the employee’s total income into a higher tax bracket, only the portion of their income that falls within that higher bracket is taxed at the increased rate, not their entire income.

For employees residing in a state with income tax, overtime pay could also be subject to state and local income taxes, depending on the specific regulations of their state and locality.

What is the No Tax on Overtime bill?

As a part of the One Big Beautiful Bill Act, the No Tax on Overtime provision creates an above-the-line deduction on the taxpayer’s tax return for a portion of overtime pay during a given taxable year. In simpler terms, the provision would allow for a deduction of the “half” portion of “time and a half” from federal tax. The employee would still be taxed at normal rates on their regular rate of pay.

The Senate version of the One Big Beautiful Bill Act caps the total deduction that can be claimed at $12,500 (or $25,000 for a joint return). Additionally, the Senate version allows the full deduction for individuals with adjusted gross incomes up to $150,000 ($300,000 for joint returns) and slowly reduces the allowable amount of deduction by $100 for every $1,000 of income over those thresholds.

This provision will not eliminate payroll taxes for Social Security and Medicare.

Who is eligible for No Tax on Overtime?

To qualify for No Tax on Overtime, an employee must be:

• nonexempt according to the Fair Labor Standards Act (FLSA), which includes being eligible for general overtime pay and receiving a Form W-2 or Form 1099 (additionally, nonexempt employees are typically paid hourly)
• a taxpayer filing individually, jointly or as the head of household — married couples filing separately can’t claim the deduction
• earning a modified adjusted gross income (MAGI) of less than $275,000 if filing individually, or less than $550,000 if filing jointly*

*If a FLSA nonexempt taxpayer’s MAGI is more than $150,000 individually or $300,000 jointly, their deduction is reduced by $100 for every $1,000 above each of those thresholds.

Of course, an eligible worker must also earn overtime pay, or time-and-a-half pay awarded for working more than a regular 40 hours in a given week.

In general, most exempt employees and independent contractors won’t qualify for No Tax on Overtime. Additional premiums for earned bonuses don’t apply for this deduction, either.

When did No Tax on Overtime start?

The No Tax on Overtime provision retroactively went into effect on Jan. 1, 2025.

A work-eligible Social Security number is required to claim the deduction. The deduction is allowed from tax years 2025 through 2028.

How will No Tax on Overtime affect employers?

Tax withholding and reporting of employee compensation is still required, and eligible overtime wages will need to be separately identified on Form W-2. Employers should be prepared for the possibility that their payroll and reporting systems may need to be updated to meet these requirements.

For example, HR professionals should now pay even closer attention and track eligible overtime for their entire nonexempt workforce. While designating 2025 as a transitional year does provide some leniency and protection against fines and other penalties, organizations shouldn’t rely on that relief or cite it as a reason not to comply outright.

It will also be important for employers to note that state overtime laws may be different from federal laws. Understanding how these different laws interact will be important for employers that need to implement these rules.

For example, W-2 reporting will likely grow more complex, as No Tax on Overtime introduces another requirement employers must consider. This means it’s absolutely vital for organizations to regularly, accurately and effectively conduct self-audits over payroll, especially as it relates to employees’ overtime.

Paycom’s compliance and reporting tools exist in our truly single-database software, allowing you to easily build and automate reports in their government-required formats. And pivoting payroll reports to adapt to No Tax on Overtime or another relevant local, state or federal law is simple and intuitive.

Plus, Paycom’s single-database architecture ensures everything impacting an employee’s pay — including overtime hours — flows seamlessly from time and attendance to payroll and beyond. No need for HR, a manager or another administrator to manually calculate overtime and import it into payroll. Employees enjoy a simplified, accurate way to track their hours with little to no training required, and HR receives much-needed flexibility and customization to account for this new compliance requirement.

Staying compliant with the new overtime tax rules

Employers will need to track and report overtime hours and how much is taxed on eligible overtime pay as a separate category (if they aren’t already), so these figures can be provided to affected employees for their year-end filing.

No Tax on Overtime: FAQ

Is overtime pay taxable?

Yes. Overtime pay is subject to the same taxes an employee pays on their normal hourly wages.

Is overtime pay currently exempt from taxes?

Qualified overtime pay is not exempt, but it is eligible for a tax deduction. Qualified overtime pay was previously taxed at the same rate as hourly pay that occurs within a regular, 40-hour workweek. Taxes will generally still be withheld for overtime pay on an employee’s paycheck; however, individual taxpayers can now claim a deduction on that income up to the maximum limit set forth in the legislation: $12,500 (or $25,000 if filing jointly).

When will the new federal tax exemption on overtime take effect?

This legislation retroactively went into effect on Jan. 1, 2025.

Will employers be required to adjust how overtime is reported on W-2s?

There are certain reporting requirements that employers should become familiar with, such as providing a separate statement or accounting of eligible overtime to their employees.

Will exempt employees benefit from this law?

No. Exempt employees are defined by the Fair Labor Standards Act as being exempt from overtime requirements. Because exempt employees aren’t paid at a higher rate for hours worked in excess of 40 hours in a workweek, they will not benefit.

Whether an individual is covered by and not exempt under the FLSA is a fact-specific determination that depends on the individual’s occupation, work activities and earnings. See this recently released fact sheet from the IRS to help determine if an employee is eligible for the deduction.

How is overtime calculated?

Overtime hours are considered to be those hours that an employee works in excess of 40 hours in a workweek. Under Section 7 of the FLSA, qualified overtime compensation is overtime compensation paid to a worker that exceeds the employee’s regular hourly rate.

Is there a cap on how much overtime income can be tax-exempt?

The Senate version of the One Big Beautiful Bill Act caps the total deduction that can be claimed at $12,500 (or $25,000 for a joint return). Additionally, the Senate version allows the full deduction for individuals with adjusted gross incomes up to $150,000 ($300,000 for joint returns) and slowly reduces the allowable amount of deduction by $100 for every $1,000 of income over those thresholds.

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DISCLAIMER: The information provided herein does not constitute the provision of legal advice, tax advice, accounting services or professional consulting of any kind. This is not a legal analysis and is intended for informational purposes only. The information provided herein should not be used as a substitute for consultation with professional legal, tax, accounting or other professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation and for your particular state(s) of operation.