What Employers Should Know About the “No Tax on Overtime” Provisions

The “no tax on overtime” provisions are included in Section 70202 of the One Big Beautiful Bill Act (OBBB), which was signed into law on July 4, 2025. These provisions have generated considerable confusion among employers and employees. This blog explores how these new provisions impact Washington State employers and their employees.

Overview of the OBBB’s No Tax on Overtime Provisions

This new law allows non-exempt hourly employees under the Fair Labor Standards Act (FLSA) to take a federal income tax deduction for the total amount of “qualified overtime compensation” received. Eligible employees can claim the deduction on their federal tax returns starting with the tax year 2025 through 2028.

Qualified overtime compensation applies to the portion of overtime pay that is a bonus or premium over regular wages under FLSA. When an employee receives FLSA overtime compensation for hours worked over 40 hours in a week—also known as “time-and-a-half” pay—the deduction only applies to the “and-a-half” portion. For example, if an employee regularly makes $20 an hour and $30 an hour for overtime, only the $10 per hour premium for overtime is eligible for the new tax deduction.

The OBBB has a maximum deduction of $12,500 of qualified overtime compensation per employee ($25,000 if married filing jointly) from federal taxable income. The deduction phases out for employees with a modified adjusted gross income over $150,000 ($300,000 for joint filers).

If an employee seeks this deduction on their federal tax return, the employee’s federal income tax liability may be reduced by the total amount of qualified overtime compensation received under FLSA. However, if an employee fails to take this tax deduction, they will pay taxes on this income.

Regardless, employees must pay Social Security, Medicare, and any applicable state and local taxes on overtime since these taxes were not exempted under the OBBB.

All Overtime is Not Treated Equally

While ‘‘no tax on overtime” sounds all encompassing, it is not. The OBBB does not apply to all types of employee overtime—only the FLSA-required overtime is deductible.

Overtime not required by FLSA is ineligible for the tax deduction. Non-FLSA overtime includes more generous overtime required under state law, a union collective bargaining agreement, or paid voluntarily by the employer. Additionally, other forms of non-FLSA compensation, such as stand-by or on-call pay, are not eligible.

In order to comply with the OBBB, it is critical for agencies to identify and properly report qualified overtime compensation under FLSA. Employers should maintain records distinguishing FLSA-required overtime from other types of additional pay to support accurate W-2 reporting.

Employer Reporting

Since the no tax on overtime deduction applies retroactively to tax year 2025, the OBBB includes a transition rule that allows employers to use “any reasonable method” specified by the U.S. Secretary of the Treasury to estimate the amount of qualified overtime for 2025.

As noted in a November 5, 2025, news release, the Internal Revenue Service (IRS) encourages employers to provide employees with separate accountings of qualified overtime compensation for tax year 2025. The IRS states that employers may make this information available by including it in Box 14 of employees’ W-2 form, through an online portal, in additional written statements, or by other secure methods.

The IRS also stated that it recognizes employers may not have the required information or procedures in place to be able to correctly file the additional information and provide it to employees. Accordingly, the IRS designated tax year 2025 as a transition period for IRS enforcement and administration of the OBBB’s information reporting requirements.

With respect to the tax year 2026, the IRS published a draft W-2 form, with new instructions directing employers to use Box 12 to report the employee’s total amount of qualified overtime compensation using code “TT.”  Since this is a draft form, it is subject to change before it is finalized for reporting.

The image below is an example of how the draft W-2 form for tax year 2026 would be filled out by employers.

Additionally, the IRS updated the employee deductions worksheet for changes to tax withholdings with an employer to reflect qualified overtime compensation (see section 1b of Form W-4).

To stay updated on the constantly evolving guidance from the IRS on the OBBB, sign up for the IRS e-News subscription.

Key Takeaways

MRSC highly encourages agency leadership, human resources staff, and agency attorneys to work together to develop a plan on how the agency will comply with the OBBB. Here are a few suggestions:

• An agency should ensure it has the capability to separately track FLSA-required overtime from other types of pay for W-2 reporting.
• An agency should determine how it will report the total amount of qualified overtime compensation each employee earned under FLSA for tax year 2025.
• An agency should identify what payroll changes need to be implemented to separately track and report qualified overtime compensation under FLSA for tax year 2026 in anticipation of the new W-2 reporting requirements.
• An agency should continue to monitor IRS guidance for any updates regarding the implementation of the OBBB and tax form changes.

Finally, employers should be prepared to field questions from employees about the OBBB. If employees have specific questions about how the deduction may impact their tax liability, refer them back to their own tax professional. The employer is obligated only to report qualified overtime compensation under FLSA for each tax year to employees. Employers should not provide any tax advice to their employees.

Happy tax season!