Is Overtime Pay Taxed Under the One Big Beautiful Bill?

Introduction

Overtime pay is an integral part of many workers' compensation packages, offering earnings for putting in extra hours beyond the standard workweek. While employees may appreciate the boost to their paychecks, questions often arise about how overtime earnings are taxed, especially after the passage of the One Big Beautiful Bill in July 2025.

Understanding the tax treatment of overtime pay is essential for managing your finances and avoiding unexpected tax bills. The new legislation introduces significant changes to how overtime pay is treated at tax time, providing opportunities for eligible employees to reduce their taxable income.

In this comprehensive guide, we'll break down how overtime pay is taxed under the One Big Beautiful Bill, what the new deduction rules mean for you, and how to maximize your tax benefits.

What is Overtime Pay?

Overtime pay refers to the additional compensation employees receive when they work more than the standard number of hours defined by their employer or labor laws. In the United States, the Fair Labor Standards Act (FLSA) generally mandates that non-exempt employees be paid at least 1.5 times their regular rate for hours worked beyond 40 in a workweek.

Let's look at an example. If an employee earns $20 per hour and works 45 hours in a week, they'll receive $20 per hour for the first 40 hours and $30 per hour for the additional 5 hours. This results in $150 in overtime pay. Overtime is particularly common in industries like healthcare, retail, manufacturing, and transportation, where demand for services often requires employees to work extended hours.

Key Points:

FLSA requires 1.5x pay for hours over 40 per week
Only applies to non-exempt employees
Common in healthcare, retail, manufacturing, and transportation

How is Overtime Pay Taxed After the One Big Beautiful Bill?

From a payroll perspective, overtime pay is taxed like regular income. It is subject to the same federal income tax, state and local taxes (where applicable), and payroll taxes (Social Security and Medicare). However, under the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduces a major change to how overtime pay is treated at tax time.

Important Changes:

Overtime pay is still taxed at the time of payment
New deduction available when filing tax returns
Only applies to FLSA-qualified overtime
Retroactive to January 1, 2025

The key difference is that while your paychecks won't be any bigger, you can now deduct a portion of your overtime earnings when you file your tax return, potentially increasing your refund or reducing your tax liability.

The "No Tax on Overtime" Rule

Overtime pay is still taxed under the OBBBA and your paychecks will not be any bigger. However, the bill does allow eligible employees to deduct up to $12,500 of their overtime earnings from their federal taxable income each year. Married couples filing jointly can deduct up to $25,000.

Deduction Limits:

Single Filers

$12,500

Maximum deduction per year

Joint Filers

$25,000

Maximum deduction per year

It's crucial that taxpayers understand that this deduction only covers the "half‑time premium" portion of your pay. In other words, you can only deduct the "half" in "time-and-a-half." Let's say your regular hourly wage is $20. When you work overtime, you're paid time-and-a-half, so $30 per hour. The deduction only applies to the extra $10 you earn per overtime hour (the "half-time premium"), not the full $30.

Example Calculation:

If you worked 100 overtime hours in a year:

Regular rate: $20/hour
Overtime rate: $30/hour
Premium portion: $10/hour
Deduction: 100 hours × $10 = $1,000

Important Restrictions:

The deduction begins to phase out at AGI of $150,000 (single) or $300,000 (joint)
Only applies to federal income tax, not payroll taxes
Not available for Married Filing Separately status
Temporary provision: 2025-2028 only

Withholding Requirements

Even with the federal deduction in place, employers must still withhold taxes on overtime wages as if they are fully taxable. This includes federal income tax, Social Security (6.2% on wages up to $176,100 in 2025), Medicare (1.45% on all wages), and state and local income taxes where applicable.

What Employers Must Withhold:

Federal income tax
Social Security (6.2% up to $176,100 in 2025)
Medicare (1.45% on all wages)
State and local income taxes (where applicable)

The deduction is claimed at tax time, meaning it does not reduce your tax withholding throughout the year. As a result, some employees may choose to update their W-4 forms to better reflect their lower expected taxable income.

Important Note:

Your paychecks will not be any bigger due to this deduction. The benefit comes when you file your tax return, potentially increasing your refund or reducing your tax liability.

Other Taxes Applied to Overtime Pay

In addition to federal and state income taxes, overtime pay is also subject to Social Security and Medicare taxes, collectively known as FICA taxes.

Social Security Tax

The Social Security tax rate is 6.2% on earnings up to a wage base limit, which is $176,100 in 2025. Overtime pay contributes to your total wages. If your annual income exceeds the wage base limit, earnings above this threshold are not subject to Social Security tax.

Example:

If your base wages are $150,000 and you earn $30,000 in overtime, only $26,100 of the overtime would be taxed for Social Security.
$176,100 – $150,000 = $26,100

Medicare Tax

The Medicare tax rate is 1.45% on all earnings with no wage cap. An additional 0.9% Medicare tax applies to income above $200,000 for single filers or $250,000 for joint filers. The overtime deduction does not apply to these payroll taxes.

State Income Tax

States have their own tax rules, and the federal deduction does not automatically apply at the state level. For example, a worker in California earning $90,000 in base pay and $10,000 in overtime can deduct up to $10,000 for federal taxes, but their full $100,000 remains subject to California's progressive income tax.

How to Maximize Your Overtime Tax Benefits

To get the most out of the new overtime deduction, consider these strategies:

1. Update Your W-4 Form

Since the deduction reduces your taxable income, you may be able to reduce your withholding by updating your W-4 form. This could result in larger paychecks throughout the year.

2. Increase Pre-Tax Contributions

Consider increasing your 401(k) or IRA contributions. Since the deduction reduces your taxable income, you might be able to contribute more to retirement accounts while staying in the same tax bracket.

3. Track Your Overtime Hours

Keep detailed records of your overtime hours and earnings. This will help you calculate the exact amount you can deduct and ensure you don't miss any eligible overtime pay.

4. Consider State Tax Implications

Check if your state has similar overtime deductions. If not, you may need to adjust your state tax planning accordingly.

Remember: The overtime deduction is temporary and will expire after 2028, so make the most of it while it's available.

Conclusion

Under the One Big Beautiful Bill, overtime wages are still taxed at the time of payment, but eligible employees can now deduct up to $12,500 ($25,000 for joint filers) when they file their federal tax returns. This change provides a meaningful opportunity to reduce taxable income and boost tax refunds.

Understanding how the deduction works, its limitations, and strategies to maximize benefits can help you make the most of this new tax provision. Remember that the deduction is temporary and will be in effect from 2025 through 2028, so it's important to take advantage of it while it's available.

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