OBBBA Overtime Pay Deduction: Up to $12,500 for Workers

#What the deduction is

OBBBA’s “No Tax on Overtime” provision creates a new above-the-line federal income tax deduction for qualified overtime compensation. The mechanics:

• The taxpayer reports overtime pay normally on the W-2 (box 1 wages)
• An offsetting deduction is claimed on the return, reducing taxable income by the qualified overtime amount
• The deduction is temporary — available only for tax years 2025, 2026, 2027, 2028. It expires automatically at the end of 2028 unless extended.
• The deduction caps at $12,500 single / $25,000 joint per tax year

The deduction was added via section [TBD] of OBBBA and is implemented via Schedule 1-A on the 2025 Form 1040 (the IRS created this new schedule specifically for OBBBA’s worker deductions).

#What counts as “qualified overtime compensation”

This is the most-misunderstood part of the deduction. Only the “half” portion of time-and-a-half pay qualifies — not the entire overtime hour’s wages.

Example: A worker has a regular hourly rate of $30 and works 10 hours of FLSA-required overtime in a week:

• Regular hourly rate: $30
• Time-and-a-half overtime rate: $30 × 1.5 = $45/hour
• Total overtime pay for 10 hours: $450
• “Half” portion (the premium above regular rate): $15/hour × 10 = $150

The qualified overtime amount for the deduction is $150, not the full $450.

For a worker earning $50,000 in regular wages plus $5,000 in overtime pay where the overtime is at time-and-a-half, the deductible portion is roughly $1,667 (one-third of $5,000) — assuming the entire overtime pay is at time-and-a-half rates and consists of half-rate premium.

This narrows the deduction’s actual dollar impact compared to the headline “$12,500” amount. To max out the $12,500 cap, a worker would need approximately $37,500 of qualified time-and-a-half overtime pay (because only 1/3 of that is the half-premium portion).

#Who’s covered

Qualified overtime compensation must be:

1. Required under Section 7 of the Fair Labor Standards Act (FLSA) — meaning the worker is non-exempt under FLSA and the overtime is mandatory time-and-a-half pay
2. In excess of the worker’s regular rate — only the “half” premium qualifies

Workers typically COVERED (FLSA non-exempt):

• Construction workers
• Manufacturing / production workers
• Trucking drivers (in some configurations)
• Retail employees
• Restaurant workers (varies by role)
• Service technicians
• Healthcare workers (in non-exempt roles)
• Most hourly workers

Workers typically NOT COVERED (FLSA exempt or otherwise):

• Salaried professional workers (the “white collar” FLSA exemption)
• Most managers + executives
• Some commissioned salespeople (special FLSA exemptions)
• Independent contractors (FLSA doesn’t apply)
• “Highly compensated employees” earning over the FLSA exemption threshold

For ETS clients, most owners + professionals aren’t covered. W-2 employees of ETS clients in non-exempt roles ARE covered if they earn overtime pay.

#Income phase-out

The deduction phases out for higher-income taxpayers:

• Single filer: phase-out begins at $150,000 MAGI
• Joint filer: phase-out begins at $300,000 MAGI

Above these thresholds, the deduction reduces proportionally. At sufficiently high MAGI, the deduction phases out completely.

For most ETS-client owners, the phase-out is academic — owners typically aren’t earning overtime. The phase-out matters for two-earner households where one spouse is an owner (above the phase-out) and the other is a W-2 worker earning overtime (potentially affected by the household’s joint MAGI).

#2025 reporting requirements

For 2025 W-2s, employers may (but aren’t required to) separately report qualified overtime compensation in box 14 of Form W-2. Box 14 is a generic “other” box used for various reportings.

If your employer reports box 14 with qualified overtime amount, that number flows directly to Schedule 1-A on your 1040.

If your employer doesn’t separately report, the worker can calculate the qualified overtime amount using methods described in IRS Notice 2025-69 and the Schedule 1-A instructions.

For 2026+, the IRS is expected to require more standardized employer reporting, but the 2025 transition rules give flexibility.

#What this means for ETS clients

#For ETS-client business owners

Owners of businesses with non-exempt employees should:

1. Update payroll reporting in Gusto / your payroll provider to capture qualified overtime separately in box 14 of W-2s. This makes employee tax filing easier and ensures the deduction is properly claimed.

2. Communicate the change to non-exempt employees. Many won’t know about the deduction. Helping them understand can be a real morale + retention factor.

3. Consider it in scheduling decisions. Pre-OBBBA, overtime had a clear marginal-tax disincentive at the worker level (overtime taxed at higher marginal rates). Post-OBBBA, that disincentive is reduced — workers may now be more willing to work overtime.

#For ETS clients with W-2 spouses earning overtime

If a spouse works in a non-exempt role and earns overtime, the deduction reduces household taxable income. Depending on MAGI, this can be a meaningful savings — but only on the “half” premium portion, capped at $25K joint.

#For ETS-client owners directly

Owners themselves typically don’t qualify (most owners are FLSA-exempt or self-employed, and self-employed workers aren’t covered by FLSA overtime rules in most cases). The deduction is mostly an employee benefit.

#Important limitations

1. FICA / Medicare still applies. Social Security + Medicare taxes apply to all overtime pay (including the “half” premium). The deduction is for federal income tax only.

2. State tax treatment varies. Federal deduction may or may not be mirrored at the state level depending on each state’s conformity rules.

3. Self-employed workers don’t qualify. Overtime is an FLSA concept that applies to W-2 employees. Self-employed contractors don’t have “overtime” in the FLSA sense.

4. Comp time isn’t overtime. Some employers offer comp time (additional paid time off in lieu of overtime pay). Comp time doesn’t generate overtime pay and therefore doesn’t qualify for the deduction.

5. Bonuses + commissions don’t qualify. Bonuses and commissions paid in addition to wages are separate from FLSA overtime. Only the time-and-a-half “half” portion of qualifying overtime hours counts.

#Common questions

Is this “No Tax on Overtime” that was promised? Sort of. The deduction removes the “half” portion of time-and-a-half overtime from federal income tax (subject to the cap and phase-out). It’s not a complete elimination of tax on overtime — the regular rate portion + FICA + state tax still apply.

Does double-time pay (2× regular rate) qualify? Yes — the “premium” portion above regular rate qualifies. For double-time, that’s the full 1× premium (the extra “1×” above regular rate).

Will the deduction be extended after 2028? Unknown. The current OBBBA structure ends the deduction at end of 2028. Whether Congress extends or makes permanent is a future legislative question.

Should I adjust my W-4 withholding to capture the deduction during the year? You can, if you expect significant qualified overtime. Without adjustment, you’ll see the benefit as a refund at filing rather than during the year.

What if my employer doesn’t separately report overtime in box 14? Use Schedule 1-A instructions + IRS Notice 2025-69 to calculate qualified overtime yourself based on pay stub data. Document the calculation in case of IRS questions.

Can I claim both the tip deduction and the overtime deduction in the same year? Yes — they’re separate deductions. A tipped worker who also works overtime can claim both, subject to each deduction’s separate caps and phase-outs.

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If you employ non-exempt workers and want to ensure payroll reporting captures the OBBBA overtime deduction correctly, the Discovery call is the right next step. For W-2 employees claiming the deduction on their personal returns, see Tax Returns service.