“They say politicians campaign in poetry, but they govern in prose.” Jeremy Wells, EA, CPA, opens Episode 37 of Tax in Action with that line, and it frames the new overtime deduction well.
“No tax on overtime” is the poetry. IRC Section 225 is the prose.
Overtime isn’t exempt from tax. For tax years 2025 through 2028, eligible taxpayers may deduct a limited portion of qualified overtime compensation. The deduction requires a Social Security number (SSN) and comes with income limits, filing-status rules, and strict reporting criteria. Here is what tax professionals need to know.
“No tax” is really a limited deduction
Qualified overtime compensation is still part of gross income and subject to federal income tax withholding, Social Security and Medicare taxes, federal unemployment tax, and applicable state taxes.
But Section 225 created a temporary deduction on Schedule 1-A. Clients can claim it whether they itemize or take the standard deduction, but it doesn’t reduce adjusted gross income.
The main limits are:
- $12,500 for single and head-of-household filers
- $25,000 for married couples filing jointly
- A reduction of $100 for each full $1,000 of modified AGI above $150,000, or $300,000 for joint filers
- No inflation adjustment or carryforward for unused amounts
- No deduction for married filing separately
- An SSN valid for employment, issued before the return’s due date (including extensions), for each person whose overtime supports the deduction; an ITIN doesn’t qualify.
For this purpose, modified AGI adds back income excluded under Sections 911, 931, and 933. The income phaseout applies after the filing-status cap.
But before applying those limits, we must identify the qualifying compensation.
The tax answer starts with federal labor law
Qualified overtime compensation is the amount required under Section 7 of the Fair Labor Standards Act (FLSA) that exceeds an employee’s regular rate. For a covered, nonexempt employee, the FLSA generally requires time-and-a-half pay for hours over 40 in a workweek.
Under the usual time-and-a-half calculation, only the extra half-time premium qualifies. The employee’s regular wages for those hours don’t. Special rules apply to certain employees whose overtime is calculated under alternative provisions of FLSA Section 7.
Under the usual FLSA rules, each workweek stands alone. If an employee works 30 hours one week, 50 the next, and 35 the third, the employer can’t average the weeks. The 10 hours above 40 in the second week create the overtime obligation.
Voluntary premiums and amounts required only by state or local law don’t qualify beyond the federal minimum. Qualified tips, as defined in Section 224(d), are excluded from qualified overtime compensation, whether or not the taxpayer claims the tips deduction.
FLSA coverage is also a facts-and-circumstances question. Common exemptions include certain executive, administrative, professional, outside-sales, and computer roles. If an employee disputes their classification, refer the client to an employment attorney or HR professional. Our role is to understand the tax treatment and check the reporting.
Payroll labels can hide the qualifying amount
Jeremy’s examples involving an employee named Eve show why we can’t rely on the word “overtime” alone. Assume Eve is eligible for FLSA overtime, all listed amounts relate to hours subject to the usual federal overtime requirement, and the pay multiples use her FLSA regular rate. Under those assumptions, each record produces the same $5,000 qualifying amount:
- $5,000 labeled as the FLSA overtime premium: Use $5,000
- $15,000 of total time-and-a-half pay: Divide by three. Only $5,000 is the half-time premium.
- $10,000 described as the premium above regular pay under a double-time plan: Divide by two
- $20,000 of total double-time compensation: Divide by four
The FLSA regular rate isn’t necessarily the employee’s base hourly wage. It generally includes nondiscretionary bonuses, commissions, and other compensation unless a statutory exclusion applies. Employers and payroll providers don’t always use these terms consistently. Confirm whether the number represents total overtime pay, the full premium above regular wages, or the FLSA half-time premium.
Separate reporting becomes mandatory with tax year 2026
Because the law passed mid-2025, the IRS offered transition relief for that year only. Employers were encouraged, but not required, to identify qualified overtime separately. Employees could use pay stubs, Form W-2 Box 14, or one of the reasonable methods in Notice 2025-69.
For 2026, employers must report qualified overtime on Form W-2, Box 12, Code TT. A pay stub or Box 14 entry isn’t enough. In rare cases involving a worker treated as an independent contractor for income tax purposes but as an employee under labor law, the amount may appear in Form 1099-NEC Box 1d or Form 1099-MISC Box 14.
If an employer reports too little, the taxpayer must request Form W-2c. If the employer won’t provide a correction, the taxpayer cannot use the omitted amount to calculate the deduction. Form 4852 cannot substitute for employer reporting for this purpose. If the employer reports too much, the taxpayer still can’t deduct more than the qualifying overtime actually paid.
That makes payroll review an essential part of tax preparation.
The final deduction may be smaller than clients expect
The calculation follows three steps: determine qualified overtime compensation, apply the filing-status cap, and then apply the modified-AGI phaseout.
Jeremy’s examples show the result:
- A single taxpayer with $15,000 of qualified overtime and $75,000 of modified AGI may deduct $12,500
- At $175,000 of modified AGI, the same taxpayer’s deduction falls to $10,000
- Joint filers with $15,000 of qualified overtime and $250,000 of modified AGI may deduct the full $15,000
- At $450,000 of modified AGI, the phaseout reduces that couple’s deduction to zero
Because the deduction doesn’t reduce AGI, it doesn’t change premium tax credit calculations, IRMAA, taxable Social Security, net investment income tax thresholds, or other AGI-based provisions. It also doesn’t reduce FICA or self-employment tax. However, because it reduces taxable income, it can affect the qualified business income deduction’s taxable income limitation and thresholds.
Replace the slogan with a review process
Section 225 is a narrow, temporary deduction, not tax-free overtime. For each affected client:
- Identify the FLSA-required half-time premium
- Check filing status, modified AGI, and SSN eligibility
- Reconcile payroll records with Form W-2, Box 12, Code TT
- Request a corrected form when the reporting is wrong
- Explain what the deduction will and will not change
Political slogans are memorable. Our job is to translate them into the numbers that go on the return. For Jeremy’s complete walkthrough, listen to Episode 37 of Tax in Action.