New Federal Tax Deduction for Qualified Overtime Compensation

MCAA members should be aware of a significant tax change introduced by the “One Big Beautiful Bill Act” (OBBBA). The law creates an above-the-line federal income tax deduction for “qualified overtime compensation,” available for tax years 2025 through 2028. Here’s what it means for your business and employees:

What Is the Deduction?

The OBBBA “No Tax on Overtime” provision allows eligible employees to deduct up to:

• $12,500 annually
• $25,000 for married couples filing jointly

This deduction applies only to the overtime premium required under the federal Fair Labor Standards Act (FLSA)—the “half” in “time-and-a-half”—for hours worked beyond 40 in a week.

Example:
An employee earning $20/hour straight time and $30/hour overtime can deduct only the $10/hour premium portion for hours worked over 40 in a week.

What Does NOT Qualify?

The deduction does not apply to:

• Overtime under collective bargaining agreements that exceed FLSA requirements (e.g., daily overtime rules).
• Voluntary employer premiums not required by FLSA.
• Shift differentials, weekend premiums, or other non-FLSA overtime.
• Overtime required by state laws that go beyond FLSA (e.g., California daily overtime).

Income Limits

The deduction phases out for individuals with modified adjusted gross income (MAGI) over $150,000 ($300,000 for married filing jointly), reducing $100 for every $1,000 above the threshold.
Married taxpayers must file jointly and include both spouses’ SSNs.

Federal Tax Only

This deduction applies only to federal income tax. It does not affect payroll taxes (Social Security, Medicare) or state/local taxes.

Employer Reporting Requirements

Employers must track and separately report qualified overtime compensation on Form W-2:

• 2025: Treasury offers penalty relief and allows reasonable reporting methods (e.g., Box 14 on Form W-2).
• 2026 onward: Employers must maintain records distinguishing FLSA-required overtime from other premium pay for accurate W-2 reporting.

Ensure payroll systems are updated to track qualified overtime starting January 1, 2026.

Next Steps:
Refer to IRS resources and consult your tax advisor for guidance on applying this new law.

This material is for informational purposes only. The material is general and is not intended to be legal advice. It should not be relied upon or used without consulting a lawyer to consider your specific circumstances, possible changes to applicable laws, applicable CBAs, prime contracts, subcontracts, rules and regulations, and other legal issues. Receipt of this material does not establish an attorney-client relationship.