The “No Tax on Overtime” deduction, approved as part of the One Big Beautiful Bill, allows eligible employees to deduct the overtime premium portion of their pay from federal income taxes. This new deduction applies to the extra 0.5x “premium” pay earned for hours worked beyond 40 in a week.
In this blog, we explain how the “No Tax on Overtime” deduction works, outline which types of overtime pay qualify or don’t, and provide real-world examples of how the deduction applies across different work scenarios.
This tax deduction applies specifically to federally recognized overtime earnings, those paid at the time-and-a-half rate for hours worked beyond 40 in a single workweek. This ensures that the policy aligns with the Fair Labor Standards Act (FLSA) definition of overtime and targets the additional compensation employees earn for extended hours.
Under this rule, the overtime premium portion, not the entire overtime payment, is eligible for the deduction from federal income tax. The premium represents the difference between the employee’s standard hourly rate and the 1.5x overtime rate required by law. Regular wages, shift differentials, bonuses, or other premium payments do not qualify for this tax deduction.
The $125 represents the federally mandated overtime premium and qualifies for the deduction.
The $90 premium is the qualifying, tax deductible portion. The rest remains subject to regular taxation.
Example 3: Union Construction Worker (FLSA-Compliant Overtime)
The $120 premium portion qualifies as a deduction because it meets FLSA overtime requirements, hours worked beyond 40 per week. However, if the union contract defines overtime below the 40-hour threshold (e.g. daily overtime after 8 hours), that additional pay is not federally mandated and therefore not eligible for this deductible under the new law.
To qualify for the "No Tax on Overtime" deduction, the payment must be directly tied to FLSA-mandated overtime hours and reflect the premium rate difference, not the total overtime wages.
While the "No Tax on Overtime" deduction offers a meaningful benefit to eligible workers, not every type of overtime qualifies. The law specifically targets overtime earnings that meet the federal definition under the Fair Labor Standards Act (FLSA). These are hours worked beyond 40 in a workweek that include a time-and-a-half premium.
Overtime pay not tied to the FLSA 40-hour rule, such as bonuses, daily overtime, or contractual premiums, does not qualify for the new tax deduction.
Payments that fall outside this standard do not qualify for the tax deduction. These examples below fail the eligibility test because:
A retail employee receives a $200 "overtime" bonus during busy weeks, even when total hours do not exceed 40. This payment is not eligible because it's a discretionary bonus, not FLSA-mandated overtime pay.
A California nurse works 10 hours per day for five days, 50 hours total. State law requires overtime after eight hours in a day, but the FLSA only mandates overtime after 40 hours per week. Only the 10 hours beyond 40 qualify for the deduction, the rest does not qualify for the new tax deduction.
A registered nurse earns 1.5x pay after 36 hours per a union contract. Since FLSA defines overtime as hours worked over 40, none of this overtime qualifies for the deduction. Contract-based thresholds below 40 hours do not meet federal standards for an overtime tax.
A technician works eight hours on a holiday and earns double time ($44/hour instead of $22). The extra $22/hour includes $11 in overtime premium and $11 in holiday premium. The $11/hour overtime premium qualifies only if the worker exceeds 40 hours that week. If not, none of the double-time pay is eligible for a deduction.
A union warehouse worker earns an extra $3/hour for night shifts but doesn't exceed 40 hours for the week. This pay is not deductible, as it's premium pay for conditions or scheduling, not overtime pay under FLSA.
Throughout these examples, only the federally mandated overtime premium for hours worked beyond 40 per week qualifies for the new federal tax deduction. Anything outside that rule, such as bonuses, daily overtime, contract-specific thresholds, or premium rates, does not qualify for the new tax deduction.
The chart below outlines common pay scenarios and whether they qualify for the deduction, along with brief explanations for each.
| Scenario | Types of Pay | Does it Qualify? | Explanation |
| Time-and-a-half after 40 hours per week | FLSA-mandated overtime premium | Yes | Only the premium portion (the extra 0.5x rate) paid for hours worked beyond 40 in a workweek qualifies for the deduction |
| Bonus or flat "extra" for a long week | Discretionary bonus or lump-sum extra pay | No | Not tied to hours worked, treated as regular taxable wages, or a bonus, not FLSA overtime |
| Contract-mandated OT after 38 hours | Union or employer agreement below the FLSA threshold of 40 hours | No | Contractual overtime not required by FLSA does not qualify for the federal deduction |
| Overtime triggered by state daily limits | State-mandated daily overtime | Partially | Only hours beyond 40 for the week qualify under federal rules. Daily overtime before 40 hours does not qualify for the new tax deduction |
| Shift differentials (Nights/Weekends) | Premium pay for inconvenient hours | No | Added rate for scheduled type, not for hours beyond 40. This premium pay does not qualify for the new tax deduction |
| Holiday double time that pushes weekly hours over 40 hours | A combination of holiday and overtime pay | Partially | The portion representing the overtime premium above the regular rate for hours beyond 40 qualifies. The holiday premium does not qualify for the new tax deduction |
The “No Tax on Overtime” deduction applies only to verified overtime hours paid as wages for the time worked beyond 40 hours in a workweek. Payments must meet the FLSA definition of overtime and include the federally mandated time-and-a-half premium rate.
Bonuses, stipends, shift differentials, and other forms of premium pay remain taxable income, as they are not directly tied to FLSA overtime hours. Employers should maintain accurate overtime records and stay informed on evolving IRS and DOL guidance to ensure compliance with federal reporting standards.
The “No Tax on Overtime” deduction introduces new financial opportunities for employees and compliance considerations for employers. For employees, these changes provide a potential tax benefit by allowing them to deduct the overtime premium portion of their earnings when filing their federal income taxes. While it doesn’t increase take-home pay on each paycheck, it can reduce overall taxable income at year-end.
For employers, the focus remains on accurate payroll reporting, proper FLSA classification, and transparent communication about how this deduction applies. As IRS and DOL guidance continues to evolve, clear reporting and well-maintained overtime records will be essential for compliance. CoAdvantage will continue to monitor these updates and provide further information as new guidance becomes available.
As businesses adapt to this change, partnering with an experienced HR partner like a Professional Employer Organization (PEO) can help simplify compliance and streamline reporting. Fill out the form below to connect with CoAdvantage and learn how our team can help your business navigate the One Big Beautiful Bill and No Tax on Overtime policy with confidence.
**The information provided on this website is for general informational purposes only and does not constitute legal advice. While we strive to ensure the accuracy and completeness of the information, we make no guarantees about its correctness, completeness, or applicability to your specific circumstances. Laws and regulations are subject to change, and you should consult a qualified legal professional before making any decisions based on the information provided here.