What Changed Under the One Big Beautiful Bill
The One Big Beautiful Bill Act (P.L. 119-21), signed in 2025, added a new federal income tax deduction for qualified overtime compensation. For tax years 2025 through 2028, workers who receive overtime pay required under the Fair Labor Standards Act can deduct the overtime premium — the extra half-time portion above their regular rate — from their federal taxable income.
The maximum deduction is $12,500 per year for single filers ($25,000 for married couples filing jointly). Like the companion no-tax-on-tips deduction, the overtime deduction is available whether or not you itemize — it is taken above-the-line on Schedule 1-A of Form 1040. For a full summary of all individual tax changes in the bill, see One Big Beautiful Bill: Individual Tax Changes for 2026.
What “Qualified Overtime Compensation” Actually Means
Not all overtime pay is qualified overtime compensation under this deduction. Per the IRS definition, it must be overtime pay required under Section 7 of the FLSA — not overtime paid voluntarily beyond FLSA requirements, not overtime required only by state law, and not overtime guaranteed solely by a collective bargaining agreement above the FLSA floor.
More importantly, the deductible amount is not your full overtime paycheck. It is only the overtime premium — the additional half-time portion above your regular rate.
Here is how the math works: if your regular hourly rate is $20, your FLSA overtime rate is $30 (time-and-a-half). For each overtime hour worked, the first $20 is regular wages taxed in full. The extra $10 — the half-time premium — is the qualified overtime compensation eligible for the deduction. Your employer is required to calculate and separately report the total qualified overtime paid to you each year.
Workers who typically do not qualify:
- FLSA-exempt employees (executives, administrative and professional employees, and workers earning above the current FLSA salary threshold of $684/week)
- Independent contractors and self-employed workers (FLSA does not cover them)
- Employees who earn overtime only under state law or union agreements that exceed FLSA requirements
Who Qualifies and Who Doesn’t
The deduction is available to FLSA non-exempt employees — the broad category of hourly and lower-salaried workers for whom the federal government mandates overtime at 1.5× after 40 hours in a workweek.
Typically eligible: hourly manufacturing workers, healthcare support staff (nursing assistants, phlebotomists, medical assistants), retail associates, construction laborers, warehouse and logistics workers, food service workers, and delivery drivers employed (not contracted) by a company.
Typically not eligible: salaried managers and supervisors, engineers and IT professionals earning above the FLSA threshold, licensed professionals (attorneys, CPAs, physicians), and anyone classified as an independent contractor.
Part-time workers who put in more than 40 hours in a given week also qualify for the deduction on the premium portion of those overtime hours.
How Much Can You Deduct
The ceiling is $12,500 per year for single filers and $25,000 for married couples filing jointly. You deduct the actual qualified overtime premiums you received — the cap is a maximum, not a guaranteed amount. If you earned $8,000 in overtime premiums, you deduct $8,000.
The deduction reduces your federal taxable income, not a credit against tax owed. Its value depends on your marginal tax bracket. A worker in the 22% bracket saves $2,200 in federal income tax on $10,000 of qualifying overtime premiums.
The Income Phase-Out: When Your Deduction Starts Shrinking
The deduction phases out for higher earners. The phase-out rate is $100 for every $1,000 of modified adjusted gross income (MAGI) above the threshold:
| Filing Status | Phase-Out Begins | Fully Phased Out |
|---|---|---|
| Single | $150,000 MAGI | $275,000 MAGI |
| Married Filing Jointly | $300,000 MAGI | $550,000 MAGI |
Example: A single filer with $170,000 MAGI is $20,000 over the $150,000 threshold. The deduction is reduced by $2,000 (20× $100), bringing the maximum from $12,500 down to $10,500.
For most overtime-earning workers — hourly manufacturing, healthcare support, retail, and construction — these thresholds will not be a concern. High-earning non-exempt employees (senior trades union members, some hourly tech workers) should calculate their MAGI before assuming they qualify for the full deduction.
Overtime costs squeezing your cash flow?
A business line of credit can bridge the gap while you stabilize staffing.
Check your funding options →What Still Gets Taxed
The deduction removes federal income tax from qualifying overtime premiums. It does not eliminate all taxes on that income.
FICA taxes still apply in full. Social Security (6.2%) and Medicare (1.45%) are withheld from every dollar of overtime, including the qualified premium. Your employer continues to pay matching FICA on overtime. Neither is reduced by this deduction.
State income taxes are not affected. The federal deduction does not flow through to your state return. Most states have not enacted a matching exclusion. If you work in California, New York, or another high-income-tax state, plan on paying full state income tax on your overtime earnings.
How to Claim It
Employers are required to report total qualified overtime compensation separately on annual wage statements. Watch for this amount on your year-end paperwork — it will be reported distinctly from regular wages.
The deduction is claimed on Schedule 1-A of Form 1040 — the same form used for the tip deduction, the car loan interest deduction, and the new senior deduction under the OBBBA. Tax software platforms have updated to include the Schedule 1-A entries; look for the overtime deduction input when you enter wage income.
If you need to update your withholding now that the deduction reduces your taxable income, the IRS Withholding Estimator has been updated to reflect OBBBA changes. The W-4 guide for 2026 walks through how to adjust your withholding accurately.
The deduction applies to tax years 2025 through 2028. Qualifying overtime you earned in 2025 is claimed on your 2025 return filed in 2026. No amended returns for prior years are needed.
How This Affects Small Business Owners Who Pay Overtime
The deduction belongs to the employee, not the employer. As a business owner paying overtime, you do not reduce your own taxable income through this provision — your labor expense deduction works the same as before.
What changes is the after-tax value of overtime for your hourly workforce. Employees who qualify may take home more of each overtime hour, which can improve their willingness to pick up extra shifts. For scheduling-intensive businesses — restaurants, healthcare practices, retail, construction — this may reduce friction around overtime scheduling without requiring higher nominal pay rates.
If overtime labor costs are creating cash flow pressure while you work through the right staffing mix, a business line of credit or working capital facility can bridge the timing gap. For a framework on managing the staffing-versus-overtime decision alongside funding, see Small Business Cash Flow Management in 2026.
For a full picture of what the One Big Beautiful Bill changed on the business tax side — Section 179 expensing, bonus depreciation, and the QBI deduction — see One Big Beautiful Bill: Small Business Tax Changes for 2026.
