By: Peter J. Halesey, Esquire
On July 4, 2025, the One Big Beautiful Bill (OBBB), containing a number of provisions related to taxes (or the removal thereof) on overtime payments was signed into law. Specifically, the OBBB contained several important changes as to how overtime compensation will be taxed over the next few years. Public sector employers must be aware of these provisions in order to ensure accurate payroll management and compliance.
The no tax on overtime provisions of the OBBB allow employees below certain income thresholds to deduct up to Twelve Thousand Five Hundred Dollars ($12,500), or Twenty-Five Thousand Dollars ($25,000) if filing on a joint return, in qualified overtime compensation on their federal taxes. Notably, the no tax on overtime provisions do not end all types of taxes on overtime pay. Federal payroll tax would still apply to overtime compensation.
The OBBB defines qualified overtime compensation as “overtime compensation paid to an individual required under Section 7 of the Fair Labor Standards Act (FLSA) that is in excess of the regular rate.” In plain terms, this means that only the overtime premium portion of the overtime compensation qualifies for the deduction. For example, if an employee is paid overtime at the rate of time and a half, it is only the additional amount paid above the employee’s straight time rate that qualifies for the deduction. Most importantly, the deduction does not apply to overtime premiums that are not required by Section 7 of the FLSA. This would include overtime premiums required under state law or pursuant to a contract such as a collective bargaining agreement.
For example, if an eligible employee works above forty (40) hours per week, the employee would qualify for overtime payments under the FLSA and, under these new provisions, the premium portion of that pay would qualify for the tax deduction. If, for example, a collective bargaining agreement requires an employer to pay overtime to an employee for hours worked above eight (8) in a day, those hours would not be subject to the deduction, unless it pushed the employee over the 40-hour threshold. Additionally, the overtime deduction is phased out for taxpayers with modified adjusted gross income over One Hundred and Fifty Thousand Dollars ($150,000) (Three Hundred Thousand Dollars ($300,000) for joint filers).
In order for hourly wage employees to be classified as eligible for the deduction, they must be classified as non-exempt employees under the FLSA and work for more than forty (40) hours per week at a rate not less than time and one-half of their regular rate of pay. Salaried employees could potentially qualify for the benefit; however they must be classified as non-exempt employees under the FLSA, the overtime compensation must meet federal guidelines for qualified overtime, and the salaried employee must make less than One Hundred and Fifty Thousand Dollars ($150,000) per year. Accordingly, some salaried workers in lower wage positions may be entitled to overtime compensation and could potentially qualify for the no tax on overtime provisions.
The provisions of the no tax on overtime legislation could create some issues for employers, particularly related to payroll administration and record keeping. In future tax years, employers should be prepared for potential changes in withholding requirements. In addition, employers need to keep detailed records of overtime hours and compensation to support potential employee tax deductions. The no tax on overtime provisions of the OBBB illustrate the importance of ensuring proper classification of employees and accurately tracking the number of hours worked beyond forty (40) in a week. As noted above, employers will have to distinguish between the types of overtime taken and ensure that they are accurately tracking FLSA overtime.
Takeaways
- The no tax on overtime provisions of the One Big Beautiful Bill allow certain eligible employees to claim tax deductions, up to Twelve Thousand Five Hundred Dollars ($12,500) for single filers and Twenty-Five Thousand Dollars ($25,000) for joint filers on qualified overtime compensation.
- Qualified overtime compensation only means premium pay for overtime payments for hours worked in excess of forty (40) per week. It does not include overtime payments made pursuant to state law or contracts such as collective bargaining agreements.
- Public sector employees should be aware of the new provisions and ensure they are accurately tracking qualified overtime payments in the event eligible employees claim the above-referenced deductions.
Bottom Line
The no tax on overtime provisions of the One Big Beautiful Bill created possible tax deductions for certain public sector employees who work overtime hours as those are defined under the FLSA. Campbell Durrant attorneys are available to answer questions you may have about the FLSA.
