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

#What the deduction is

OBBBA created a new deduction for qualified overtime pay. You can take it even if you use the standard deduction. It lowers your taxable income, but it does not lower your AGI. Here is how it works:

• You report overtime pay normally on the W-2 (box 1 wages)
• You claim an offsetting deduction on the return. This reduces taxable income by the qualified overtime amount
• The deduction is temporary. It is 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. If you are married, you must file jointly to claim it. You need a Social Security number that is valid for work. The deduction drops by $100 for every $1,000 of income over $150,000 ($300,000 joint)

The deduction sits in a new tax code section, IRC §225, added by section 70202 of P.L. 119-21, for tax years 2025 through 2028. You claim it on Schedule 1-A of 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. The entire overtime hour’s wages do not count.

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.

Say a worker earns $50,000 in regular wages, plus $5,000 in overtime pay at time-and-a-half. The deductible portion is roughly $1,667 (one-third of $5,000). This assumes 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 needs about $37,500 of qualified time-and-a-half overtime pay. Why? 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). This means 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
• Some truck drivers are exempt from federal overtime rules. If your pay does not come from the federal overtime rule, it does not count.
• 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 and professionals are not 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 shrinks on a sliding scale. At high enough MAGI, the deduction disappears completely.

For most ETS-client owners, the phase-out is academic. Owners typically are not 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. That worker may be affected by the household’s joint MAGI.

#W-2 reporting requirements

For 2025 W-2s, employers may (but are not 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. Does your employer report box 14 with the qualified overtime amount? Then that number flows directly to Schedule 1-A on your 1040. Does your employer not separately report it for 2025? Then you can calculate the qualified overtime amount yourself. Use the methods in IRS Notice 2025-69 and the Schedule 1-A instructions.

Starting with 2026 wages, this is no longer optional. Employers must separately report qualified overtime compensation on Form W-2, box 12, using code TT. This follows IRS Fact Sheet FS-2026-13, which replaced the 2025 transition guidance. For tax year 2026 and later, you can only deduct the amount your employer actually reports under code TT. There is no longer an IRS-accepted way to reconstruct an unreported figure from your own pay stubs. Is code TT blank, or does it look low on your 2026 W-2? Ask your employer for a corrected Form W-2c before you file.

#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 or your payroll provider, to capture qualified overtime separately. Box 14 was the optional method for 2025 wages. 2026 and later wages require box 12, code TT. This makes employee tax filing easier, and makes sure the deduction is properly claimed.

2. Communicate the change to non-exempt employees. Many will not know about the deduction. Helping them understand can be a real morale and retention factor.

3. Consider it in scheduling decisions. Before OBBBA, overtime had a clear marginal-tax disincentive at the worker level (overtime taxed at higher marginal rates). After OBBBA, that disincentive is smaller. 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 it applies only to the “half” premium portion, capped at $25K joint.

#For ETS-client owners directly

Owners themselves typically do not qualify. Most owners are FLSA-exempt or self-employed, and self-employed workers are not 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. The 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 do not have “overtime” in the FLSA sense.

4. Comp time isn’t overtime. Some employers offer comp time, additional paid time off in place of overtime pay. Comp time does not generate overtime pay, so it does not 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 is not a complete elimination of tax on overtime. The regular rate portion, FICA, and state tax still apply.

Does double-time pay (2× regular rate) qualify? Only up to the same premium the FLSA actually requires. The Fair Labor Standards Act requires time-and-a-half, not double time. So only the 0.5x premium (the amount that would apply under ordinary time-and-a-half) is qualified overtime compensation. Say an employer pays double time voluntarily, or under a state law, union contract, or company policy. The extra 0.5x above the FLSA-required premium does not qualify for the deduction, even though it is taxed the same as any other wages.

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 will see the benefit as a refund at filing, rather than during the year.

What if my employer doesn’t separately report my overtime? For 2025 wages, use the Schedule 1-A instructions and IRS Notice 2025-69 to calculate qualified overtime yourself from pay stub data. For 2026 wages and later, your employer must report the figure on Form W-2, box 12, code TT. You can only deduct what is reported there. Ask for a corrected W-2c, rather than substituting your own calculation.

Can I claim both the tip deduction and the overtime deduction in the same year? Yes. They are 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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Do you employ non-exempt workers? Want to make sure 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.