IS OVERTIME PAY TAX FREE?
What Employer's Who Pay and Employee's Who Earn Overtime Should Know for 2025 Taxes:
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It's a Deduction, Not an Exemption: The IRS provision does not eliminate taxes on your paycheck. Employers must still withhold federal income tax, Social Security, and Medicare taxes on all overtime earnings as usual. The tax benefit is realized when you file your annual federal income tax return, where you can claim a deduction to reduce your overall taxable income.
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Only the "Premium Portion" Qualifies: The deduction is limited to the extra half-time pay (the premium portion) for overtime required under the Fair Labor Standards Act (FLSA), which is generally for hours worked over 40 in a single workweek.
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Example: If your regular rate is $20 per hour, your FLSA overtime rate is $30 per hour. Only the $10 per hour premium qualifies for the deduction. The regular $20 per hour portion of that pay remains fully taxable.
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Deduction Limits: The maximum annual deduction is $12,500 for single filers and $25,000 for those married filing jointly.
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Income Phase-Outs: The deduction begins to phase out for taxpayers with a modified adjusted gross income (MAGI) over $150,000 (single filers) or $300,000 (married filing jointly).
What Does Not Qualify
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Non-FLSA Overtime: Overtime pay required only by state or local laws (e.g., daily overtime after 8 hours in a day, or working a seventh consecutive day), union contracts, or paid voluntarily by an employer does not qualify for the federal deduction.
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Other Taxes: The deduction only applies to federal income tax. Social Security and Medicare (FICA) taxes, as well as any applicable state and local income taxes, still apply to all overtime pay.
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Exempt Employees: Salaried workers or other employees exempt from FLSA overtime requirements are not eligible for this deduction.
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Bonuses or Shift Differentials: Other forms of premium pay, such as shift differentials or bonuses, are not eligible for this specific deduction.
For Employees
You can claim this deduction when you file your annual tax return (using Form 1040), even if you take the standard deduction. Your employer is responsible for tracking and reporting your qualified overtime compensation on your Form W-2 or a separate statement. Because this provsion was made retroactive for 2025, your employer can report the deductible portion of your overtime in several ways. For 2025, this does NOT have to be reported on your W-2 and for most people it will not be since this is a transition year. Any reasonable method of providing employees with this information is acceptable for 2025 tax reporting.