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New Overtime Tax Deduction

August 28, 2025

A newly enacted tax deduction will reduce income taxes on certain overtime wages starting with the 2025 tax year. While the change could benefit millions of American workers, the eligibility rules are narrower than expected and may create compliance challenges for both employees and employers.

 

Overview of the New Deduction

The deduction applies to the additional compensation required under the federal Fair Labor Standards Act (FLSA)—commonly referred to as the “half” in “time-and-a-half” pay for hours worked over 40 in a week. This provision is part of a broader legislative package and is expected to deliver significant tax savings for qualifying workers.

 

The deduction caps are set at $12,500 for individuals and $25,000 for married couples filing jointly. Depending on income, this could reduce tax liability by as much as $6,000. The benefit is available to both itemizing and standard deduction filers, though it begins to phase out at $150,000 (single filers) and $300,000 (joint filers).

 

It’s important to note that this deduction only applies to income tax. Payroll taxes for Social Security and Medicare still apply to overtime wages.

 

Eligibility Is Limited by Federal Rules

Despite broad public interest in the deduction, many types of overtime pay do not qualify. The deduction is tied strictly to the FLSA’s definition of overtime, which excludes:

 

  • Workers covered by other federal labor laws (e.g., airline and railroad employees)
  • Overtime structures mandated under state laws, such as California’s daily overtime rule
  • Employees exempt from FLSA overtime provisions due to job classification or salary level

 

As a result, workers in similar roles across different employers or jurisdictions could be treated differently under the new rules.

 

Payroll and Reporting Considerations

Implementation of the deduction will not be immediate or automatic. For 2025, Form W-2 will remain unchanged, and qualifying overtime amounts will likely be tracked through supplemental payroll statements. Employers will need to separate total overtime paid from amounts eligible for the deduction under the new law.

 

The Treasury Department is expected to issue guidance soon to clarify compliance requirements and may offer transitional relief from penalties during the initial rollout. Employers should begin assessing payroll systems now to ensure they can accurately report qualifying amounts in time for 2025 tax filings.

 

Tax Planning and Broader Impacts

While many workers may see increased refunds as a result of the deduction, failure to adjust paycheck withholding could delay those savings. Eligible workers should consult tax professionals to understand how the new rule affects their personal situation.

 

Beyond individual tax filings, the deduction may influence how employers approach overtime compensation and employee classification. Distinctions between FLSA-covered workers and exempt employees, or between employees and independent contractors, may take on added importance.

 

There are also early signs of political and labor pressure to expand eligibility criteria in future legislation, particularly from sectors excluded under the current law.

 

Preparing for 2026 and Beyond

Although the new overtime deduction offers meaningful tax relief for qualifying employees, the law introduces added complexity for businesses and payroll providers. Employers should begin preparing now for updated tracking, documentation, and employee communications.

 

For questions about how the overtime deduction may impact your workforce or your personal tax planning, please reach out to your LMC professional.

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