How Does No Tax on Overtime Work?
Quick answer: You may have heard about a new "no tax on overtime" law—but overtime isn't actually tax-free. The 2025 law lets employees deduct part of their overtime pay when filing tax returns, which can mean bigger refunds. For you as an employer, nothing changes: you still withhold Social Security, Medicare, and federal income tax from overtime paychecks.
Here's how it works: The One Big Beautiful Bill Act creates a tax deduction that employees claim at tax season. They can deduct up to $12,500 (single filers) or $25,000 (married couples) of their overtime premium—the extra 50% above regular pay. You'll still withhold all the usual taxes from paychecks. The benefit shows up when employees file their returns.
Is Overtime Taxed or Tax-Free?
Many employees assume the new law eliminates taxes on overtime entirely, so this section helps clear up that misconception. Overtime is taxed. The new law creates a deduction employees use when filing returns, similar to charitable donations.
Think of it like this: Even when employees work a big overtime week, taxes are still withheld as usual. The savings only show up at tax time, when they deduct part of that overtime premium from their taxable income. So the paycheck isn’t tax-free—the benefit comes later.
This matters because some employees might expect tax-free paychecks. The benefit comes later, not immediately, so it's worth explaining this to your team.
How Is Overtime Pay Taxed?
Overtime still follows the same tax rules as regular wages, but withholding formulas can make it look more heavily taxed. Social Security stays at 6.2% for both you and your employee, while Medicare remains at 1.45% each, according to the IRS Employer’s Tax Guide.
Here's where it gets confusing: Your payroll management system projects each paycheck across the full year. When someone works overtime, their bigger paycheck gets treated as if they'll earn that much every pay period, temporarily bumping them into higher withholding brackets.
For example, if your cook normally earns $600 per week but makes $900 with overtime, the system calculates withholding as if they'll earn $46,800 annually instead of $31,200. This makes overtime look more heavily taxed, but it's just cautious withholding.
When employees file their annual returns, this evens out. Overtime and regular pay use identical tax rates—the withholding during the year just creates an illusion of higher taxes.
What Does the No Tax on Overtime Law Actually Cover?
The law doesn’t make overtime tax-free — it lets employees deduct part of their overtime premium at tax time. So paychecks stay the same, but taxable income may be lower when they file.
The deduction is narrow and has specific eligibility rules, so it helps to break down exactly what counts and what doesn’t.
Here’s what the deduction includes: Only the overtime premium counts, and employees can deduct up to $12,500 if single or $25,000 if filing jointly. The deduction phases out once income passes $150,000 for single filers or $300,000 for joint filers, decreasing $100 for every $1,000 above those thresholds. Married Filing Separately filers can’t claim it. And for 2025, because the law is retroactive, the IRS is allowing any “reasonable method” to estimate eligible overtime for W-2s.
The rule applies to tax years 2025 through 2028. It’s a narrow deduction, but understanding the limits makes it easier to explain to your team.
Who Qualifies for the Overtime Tax Deduction?
Eligibility depends on both job classification and filing status, which determines who can actually benefit from the new deduction Most employees who work overtime can claim this deduction, as long as their income and filing status meet the rules. It’s meant for typical wage earners—not high-income employees or exempt roles.
Here’s who’s eligible: Employees qualify if they earn below the income phase-out thresholds and receive federally required overtime pay. Hourly and salaried non-exempt workers can claim it, while exempt employees and independent contractors can’t. The deduction begins to shrink once income exceeds $150,000 for single filers or $300,000 for joint filers, based on the IRS Fact Sheet for the One Big Beautiful Bill Act, and anyone filing as Married Filing Separately isn’t eligible at all.
The bottom line is that the deduction is limited to non-exempt employees with qualifying overtime and the right filing status. Keeping those basics in mind makes it easier to explain who can actually use the benefit.
Does No Tax on Overtime Apply in All States?
Because this rule is federal, it applies nationwide — but it doesn’t change any state tax or overtime laws—it affects federal taxable income only, not state withholding.
How it works across states: Employees can claim the overtime deduction on their federal return, whether they live in California, Texas, New York, or anywhere else. It doesn’t change your state’s overtime laws or state income-tax rules, and employees still pay state taxes on their full overtime wages just as they do now.
In other words, the deduction is universal at the federal level, but state requirements stay exactly the same. It’s simply one more factor employees can use when filing their federal return.
What Do Employers Need to Know About No Tax on Overtime?
For employers, the biggest change is simply how overtime gets reported at the end of the year—not how you run payroll week to week.
Here’s what that means for you: You’ll need to track the overtime premium separately so it can be included on employees’ W-2s. Most payroll providers are rolling out updates to handle this automatically, but it’s worth checking with yours to make sure everything is set up correctly. Day-to-day payroll doesn’t change at all; tax withholding, rates, and calculations stay exactly the same. You’re really just adding an extra reporting line when W-2 season comes around.
It’s a small adjustment, but keeping that overtime premium organized now will make year-end filing a lot smoother.
How Does Homebase Help Track Overtime Tax Deductions?
Since accurate overtime tracking feeds directly into W-2 reporting, having the right tools in place makes this new requirement simpler. When your overtime is tracked accurately throughout the year, you’re already set up for an easier filing process.
Homebase automatically identifies overtime hours and calculates the overtime premium, and when you use Homebase Payroll, those totals flow straight into payroll and year-end forms without extra steps. Everything stays in one place—no spreadsheets, no exports, no wondering whether your provider has updated its system for the new rules.
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Sources and Methodology
At Homebase, we rely on up-to-date, authoritative sources to ensure every Question Center article reflects accurate guidance for small business owners. We begin with primary information from the IRS and federal legislation, verify details using official tax publications and employer guidance, and rely on reputable compliance resources only to supplement—not replace—those rules.
For this piece, we referenced federal law under the One Big Beautiful Bill Act, IRS publications and employer tax guides, official IRS notices on the 2025 overtime deduction, and W-2 reporting instructions.