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The One Big Beautiful Bill introduced a new federal tax deduction allowing employees to deduct qualified overtime earnings from their federal income tax return.
Beginning in the 2025 tax year and continuing into 2026, the law changes how overtime earnings must be tracked and reported by employers.
For payroll teams, this introduces new requirements around overtime classification, earnings codes, and W-2 reporting. Netchex payroll software helps employers prepare for these changes and stay compliant with evolving tax regulations.
What Changed with the Overtime Tax Deduction
Key rules:
- Only the overtime premium (the extra half-time above the regular rate)
qualifies - Only overtime required by the Fair Labor Standards Act (FLSA) qualifies
- The deduction applies only to federal income tax
- Paychecks do not change immediately
- Employees receive the benefit when filing their annual tax return
2025 Transition Guidance
Because the legislation was passed mid-year, the IRS provided transition relief for employers for the 2025 tax year. Employers are encouraged to provide a reasonable estimate of qualified overtime earnings to employees through:
- Final pay stub of the year
- W-2 Box 14
- A separate written statement
How Netchex Supported Employers in 2025
Netchex automatically provided estimated qualified overtime earnings to simplify compliance. For the 2025 W-2:
- Netchex includes estimates in Box 14
- Reporting code used: OBBBOT
- Hourly overtime premium calculated by subtracting regular pay
- Flat-dollar overtime included in full when separation is not possible
- State-specific overtime included during the transition year
2026 Payroll Reporting Requirements
Beginning with the 2026 W-2, additional reporting is required. Employers must:
- Report qualified overtime in Box 12 using Code TT
- Track FLSA overtime separately from other overtime types
- Separate state overtime rules
- Avoid flat-dollar overtime earnings codes
FAQs
No. Overtime earnings will still be taxed normally in the paycheck. Employees receive the benefit when they deduct eligible overtime earnings on their federal tax return.
No. The IRS acknowledges the legislation passed mid-year and employers may not have fully tracked overtime splits according to these rules. Transition relief is provided for 2025, with stricter enforcement beginning in 2026.
Taxpayers can deduct up to $12,500 as a single filer or $25,000 if married filing jointly for qualified overtime earnings.
Yes. Income limits are based on modified adjusted gross income (MAGI). Phase-out begins at $150,000 for single filers and $300,000 for married filing jointly.
For single filers, when MAGI exceeds $150,000, the maximum $12,500 deduction decreases by $100 for every $1,000 above the threshold.
The overtime deduction is an above-the-line deduction and does not affect whether a taxpayer uses the standard deduction or itemized deductions.
No. Social Security and Medicare taxes remain unchanged. Only federal income tax allows the overtime deduction.
No. Overtime premiums required by union contracts or employer policy do not qualify unless also required under FLSA Section 7.
Only compensatory time earned under FLSA rules qualifies. Other compensatory time under non-FLSA standards do not qualify.
No. Only overtime required by the Fair Labor Standards Act (FLSA) qualifies.
Employers must track federal and state overtime separately to ensure proper W-2 reporting.
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