No Tax on Overtime: What the New Federal Deduction Means for Employers

An hourly employee hears “no tax on overtime” on the news and asks payroll why their check still shows withholding on it. The short answer: the benefit is real, but it isn’t a payroll exemption. It’s a deduction employees claim on their own tax return.

Last updated: July 2026

What Is the “No Tax on Overtime” Provision?

The One Big Beautiful Bill Act (OBBBA), signed into law in July 2025, created a temporary federal income tax deduction for qualified overtime pay, available for tax years 2025 through 2028. It’s commonly called “no tax on overtime,” but that name overstates it: the deduction reduces federal income tax owed on overtime earnings, it doesn’t eliminate payroll withholding, and it doesn’t touch Social Security or Medicare tax at all.

Employers still withhold federal income tax, FICA, and applicable state and local taxes from overtime pay exactly as before. The deduction is something the employee claims when they file their annual tax return, similar to how other above-the-line deductions work.

Who Qualifies?

The deduction applies to overtime pay required under the federal Fair Labor Standards Act (FLSA), which generally means non-exempt, hourly employees who receive time-and-a-half for hours worked beyond 40 in a workweek. Exempt, salaried employees who aren’t entitled to FLSA overtime in the first place don’t have qualifying overtime to deduct.

Only the premium portion of overtime pay qualifies, meaning the extra half of “time-and-a-half,” not the full overtime paycheck. If an employee’s regular rate is $20 an hour and they’re paid $30 an hour for overtime, only the $10 premium per hour is the qualifying amount, not the full $30.

How Much Can Employees Deduct?

For tax years 2025 through 2028, eligible employees can deduct up to $12,500 of qualifying overtime pay if filing as a single taxpayer, or $25,000 for married couples filing jointly. The deduction phases out for higher earners, starting to reduce above $150,000 in income, meaning higher-income employees may receive a reduced benefit or none at all.

What Employers Actually Need to Do

Since this is a deduction claimed on the employee’s tax return rather than a payroll withholding change, employers don’t stop withholding tax on overtime pay. What employers do need to handle is separately tracking and reporting the qualifying overtime premium amount, since the IRS requires this figure to be identifiable so employees can claim the deduction accurately. Payroll and W-2 reporting requirements around this have continued to be clarified since the law passed, so employers should confirm their payroll provider is tracking qualifying overtime premium pay correctly rather than assuming existing overtime reports already isolate it.

Employers should also expect employee questions, since the “no tax on overtime” framing in the news doesn’t match what actually shows up on a pay stub. Setting expectations that this is a year-end tax benefit, not a paycheck-level change, avoids a lot of confused conversations with payroll and HR.

Why Accurate Tracking Matters

Because the deduction only applies to the overtime premium and phases out based on income, employers need payroll systems that can isolate and report the qualifying amount correctly, for every employee, every pay period. Getting this wrong doesn’t create employer tax liability the way a withholding error would, but it does create real problems for employees trying to file an accurate return, and for HR fielding the resulting questions.

Netchex tracks the overtime premium separately from base and regular overtime pay, so the qualifying amount is available for year-end reporting without a manual reconstruction of a year’s worth of pay data.

Frequently Asked Questions

This guide reflects publicly available IRS and legislative guidance as of July 2026. This is a developing area of tax law; confirm current requirements with the IRS or a tax professional before relying on these figures. Netchex does not give legal, tax, or accounting advice.

Disclaimer: Any product roadmap or future plans provided herein are for informational purposes only. They do not represent a commitment to deliver any material, code, feature, or functionality. Plans may change without notification. The development, release and timing of any features or functionality described remain at the sole discretion of Netchex, its affiliates, and partners. Netchex does not give legal, tax, or accounting advice. You are responsible for ensuring your use of Netchex product meets your individual business and compliance requirements.

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