Gold Star Taxes Blog

For millions of Americans who put in extra hours, overtime pay is a crucial part of their income. But what if that hard-earned “time-and-a-half” could also give you a significant break on your federal taxes?

Starting with the 2025 tax year, it can.

Thanks to the new “One Big Beautiful Bill Act” signed into law in July 2025, a groundbreaking tax deduction is now available for non-exempt employees. This is one of the biggest changes for hourly workers in years, but it comes with specific rules and a few complexities for its first year.

Here’s a complete breakdown of what you need to know about the new overtime tax deduction.

💸 What Is the New Overtime Tax Deduction?

In short, this new law allows eligible taxpayers to deduct a portion of their overtime pay from their federal income.

This is an “above-the-line” deduction, which is fantastic news. It means you can claim this tax break even if you don’t itemize and take the standard deduction. It directly reduces your Adjusted Gross Income (AGI), which can lower your overall tax bill and potentially help you qualify for other credits and deductions.

This new rule is temporary and is currently effective for tax years 2025 through 2028. The first time you’ll be able to claim it is when you file your 2025 taxes in 2026.

✅ Who Qualifies for the Deduction?

This deduction is specifically targeted at hourly and non-exempt workers. To be eligible, you must:

Be a W-2 employee.
Be classified as a “non-exempt” employee under the Fair Labor Standards Act (FLSA). This generally includes most hourly workers who are legally entitled to overtime pay.
Receive overtime pay for working more than 40 hours in a week.

Unfortunately, not everyone is eligible. You cannot claim this deduction if you are:

An exempt, salaried employee (e.g., most managers or professionals who don’t receive overtime pay).
An independent contractor or gig worker (1099 worker).
Filing with a “Married Filing Separately” status.

💰 How Much Can You Actually Deduct?

This is the most important—and slightly complicated—part. You don’t get to deduct your entire overtime paycheck.

You can only deduct the “premium” portion of your overtime pay.

The FLSA requires that overtime be paid at “time-and-a-half.” This new law lets you deduct the “half.”

Here’s a simple example:

Your regular pay rate is $20 per hour.

Your overtime pay rate (time-and-a-half) is $30 per hour.

The “premium” portion is the extra amount you get for working overtime: $30 (OT rate) – $20 (regular rate) = $10 per hour.

This $10 “half” is the amount that is eligible for the deduction.

So, if you worked 100 hours of overtime in 2025, you could deduct $1,000 (100 hours x $10 premium).

Deduction Limits and Income Caps

There are caps on how much you can deduct and who can claim it:

Deduction Cap: The total deduction is capped at $12,500 for single filers and $25,000 for married couples filing jointly.
Income Phase-out: The deduction starts to phase out if your Modified Adjusted Gross Income (MAGI) is over $150,000 (for single filers) or $300,000 (for married couples filing jointly).

❗️ Important: What to Expect for the 2025 Tax Season

Since this law was passed mid-way through 2025, this first year will be a “transition year,” and there’s a major catch.

1. Your Paycheck Won’t Change in 2025

Your employer will continue to withhold federal income tax from your overtime pay just like normal. This deduction is something you claim back on your tax return in 2026—it doesn’t make your overtime “tax-free” at the time you earn it.

2. FICA Taxes Still Apply

This deduction only applies to federal income tax. You will still pay the full FICA taxes (Social Security and Medicare) on all of your overtime wages.

3. The Big Reporting Challenge (Form W-2)

To claim the deduction, you need to know the exact amount of your “qualified overtime premium pay.” The law requires employers to report this on your Form W-2.

However, the IRS has issued transition relief (Notice 2025-62) for the 2025 tax year.

This means:

Employers will not be penalized if they don’t separately report this number on your 2025 W-2.
Your 2025 Form W-2 will not have a new, dedicated box for this.
Your employer is “encouraged” to provide this number to you, perhaps in Box 14 (“Other”) or on a separate statement, but it’s not guaranteed to be there or easy to find.

📋 What You Should Do Now

Be Proactive: Don’t assume this will be calculated for you. Start tracking your own overtime hours and pay stubs now.
Contact Your Employer: As we get closer to tax season (Jan-Feb 2026), ask your HR or payroll department how they plan to report the “qualified overtime compensation” for your 2025 W-2.
Talk to a Tax Professional: This is a new and complex rule. When you file your 2025 taxes, working with a tax advisor is the best way to ensure you are calculating the deduction correctly and getting the full benefit you’ve earned.

This new deduction is a real win for hard-working Americans. By understanding the rules and being prepared for the 2025 transition year, you can make sure you don’t leave any money on the table.