The One Big Beautiful Bill Act, signed into law on July 4, 2025, introduces several tax changes aimed at benefiting working Americans. One of the most impactful provisions for payroll professionals is the new federal income tax deduction for overtime premium pay. Starting with the 2025 tax year, eligible employees can deduct up to $12,500 in qualifying overtime premium wages from their taxable income. For married couples filing jointly, the deduction increases to $25,000. This provision is currently set to apply to tax years 2025 through 2028
What Is Overtime Premium Pay?
Under the Fair Labor Standards Act (FLSA), non-exempt employees must be paid at least 1.5 times their regular rate of pay for all hours worked over 40 in a workweek. This is commonly referred to as “time-and-a-half.”
- The 1.0x portion (straight time) is still subject to federal income tax.
- The 0.5x portion (the “premium”) is now eligible for a federal income tax deduction, up to the annual cap.
For example, if an employee earns $20/hour and works 10 hours of overtime in a week:
- Straight time: 10 hours × $20 = $200 (taxable)
- Premium: 10 hours × $10 = $100 (deductible under the new law)
It’s important to note that this deduction only applies to federal income tax; Social Security and Medicare taxes still apply.
How Do Workers Claim the Deduction?
For tax year 2025, employees will claim the deduction when filing their federal tax returns in early 2026. However, employers are responsible for providing the total amount of overtime premium pay earned during the year.
- For 2025: The IRS has not yet finalized how this information should be provided to employees. Employers should monitor IRS guidance expected later this year.
- Starting in 2026: Employers must report the total overtime premium pay on Form W-2, Box 12 using Code TT.
What Payroll Professionals Should Do Now
To prepare for this change, payroll teams should take proactive steps to ensure compliance and accurate reporting:
- Audit Earnings Codes
Confirm that all overtime earnings codes are correctly configured to calculate time-and-a-half, including any coefficient-based overtime. - Separate Premium Pay
Ensure that your payroll system distinguishes between straight time and premium pay. This separation is critical for accurate reporting and employee tax deductions. - Correct Historical Data
Review and correct any past payroll entries where overtime was not properly split between straight and premium components. - Build Custom Reports
Develop a report that tracks overtime premium pay by employee. This will be essential for year-end reporting and employee communication. - Plan for Year-End Distribution
Once IRS guidance is released, finalize your process for delivering 2025 overtime premium totals to employees, especially those who terminate before year-end. - Educate Your Team and Clients
Make sure your HR, finance, and tax teams understand the new requirements. If you manage payroll for clients, proactively communicate these changes and offer support.
Final Thoughts
The “No Tax on Overtime” provision in the One Big Beautiful Bill Act is a significant shift in payroll and tax reporting. While it offers a valuable benefit to employees, it also places new responsibilities on employers and payroll professionals.
If you have questions about how to implement these changes, need help auditing your payroll setup, or want to ensure your reporting is compliant, we’re here to help. Reach out to discuss how we can prepare your business for this new legislation.