OBBBA No Tax on Overtime: How the New $12,500 Deduction for FLSA Premium Pay Works Through 2028

If you worked 50 hours a week last year and watched your overtime check shrink under the weight of federal withholding, the One Big Beautiful Bill Act (OBBBA) just changed the math. For tax years 2025 through 2028, a new above-the-line deduction lets eligible workers shave up to $12,500 ($25,000 for joint filers) of qualified overtime premium pay off their adjusted gross income. The catch: the deduction covers only a slice of your overtime check, only certain kinds of overtime qualify, and most employees who try to claim it on their own will compute the wrong number.

Here is exactly what counts, who is eligible, how the phase-out works, and what employers must put on the new W-2 line item starting with tax year 2026.

What Is "Qualified Overtime Compensation" Under OBBBA?

The deduction is created by new Internal Revenue Code Section 225. The statute defines "qualified overtime compensation" narrowly: it is the portion of your overtime pay that exceeds your regular rate and is required under Section 7 of the Fair Labor Standards Act (FLSA).

Read that twice, because the second clause is where most workers stumble.

Only the "Half" of Time-and-a-Half Counts

If you earn $20 per hour and work an FLSA overtime hour at $30 (the standard "time-and-a-half"), only the $10 premium counts as qualified overtime compensation. The base $20 stays taxable like any other wage.

In practical terms:

• Regular rate: $20/hour
• Overtime rate: $30/hour
• Qualified overtime per hour: $10
• 200 overtime hours in 2025 → $2,000 deductible (not $6,000)

The IRS calls this the "premium portion" or "half" portion. Confuse it with total overtime pay and you will overstate the deduction, trigger a math-error notice, and possibly delay your refund.

It Must Be FLSA-Mandated Overtime

Federal law requires time-and-a-half for non-exempt employees who work more than 40 hours in a workweek. Only that federally required premium qualifies. Premium pay you receive from any of the following sources is excluded:

• State daily overtime (e.g., California's rule for hours over 8 in a day, Alaska's daily threshold, Colorado's 12-hour rule). If the state requires it but FLSA does not, the premium is not qualified.
• Collective bargaining agreement provisions that exceed FLSA (e.g., overtime after 35 hours, double-time on holidays).
• Contractual or discretionary overtime that the employer offers voluntarily.
• Shift differentials, on-call pay, or holiday premium that is not tied to crossing the 40-hour weekly FLSA threshold.

If you live in a state with stricter overtime rules, your paystub may show a much bigger premium than what is actually deductible. Employers will need to bifurcate the two on Form W-2 starting in tax year 2026.

How Much Can You Deduct?

The Caps

• Single filers: up to $12,500 of qualified overtime per year
• Married filing jointly: up to $25,000 per year (combined, both spouses)
• Married filing separately: not eligible — you must file jointly to claim

The deduction is above-the-line, meaning you can claim it whether you itemize or take the standard deduction. It directly reduces adjusted gross income, which can ripple through other AGI-tied phase-outs (student loan interest, Roth IRA contribution limits, IRMAA brackets, ACA premium credits) in your favor.

The Phase-Out

The deduction begins to disappear once your modified adjusted gross income (MAGI) crosses the threshold:

• $150,000 single
• $300,000 joint

For every $1,000 over the threshold, you lose $100 of deduction. So the deduction zeroes out at MAGI of roughly $275,000 single ($12,500 ÷ $100 × $1,000 + $150,000) and $550,000 joint ($25,000 ÷ $100 × $1,000 + $300,000).

A quick worked example for a married couple with $360,000 MAGI and $18,000 of combined qualified overtime:

• Excess over threshold: $360,000 − $300,000 = $60,000
• Phase-out reduction: $60,000 ÷ $1,000 × $100 = $6,000
• Maximum deduction: $25,000 − $6,000 = $19,000
• Actual qualified overtime: $18,000
• Deduction claimed: $18,000 (the lower of the two)

What the Deduction Does Not Do

This is a federal income-tax deduction. It does not exempt your overtime from:

• Social Security tax (6.2% on both employee and employer)
• Medicare tax (1.45% each, plus the 0.9% additional Medicare tax on wages over $200,000/$250,000)
• Federal Unemployment Tax (FUTA) — paid by the employer
• State income tax (unless your state separately conforms, which most have not as of mid-2026)

So when politicians say overtime is "tax-free," they really mean "free from federal income tax, up to the cap, subject to phase-out, for FLSA-required premium pay only, for tax years 2025-2028."

Eligibility Requirements You Cannot Miss

Social Security Number

The taxpayer must have a Social Security number valid for employment. Filers using an Individual Taxpayer Identification Number (ITIN) are not eligible, and the IRS treats a missing SSN as a math or clerical error — meaning the agency can adjust your return without going through deficiency procedures.

If you are married filing jointly, both spouses must have valid SSNs to claim the full $25,000 cap.

Joint Return for Married Filers

A married worker who files separately cannot claim the deduction at all. This is unusual — most income deductions allow MFS at half the joint amount — but the OBBBA statute is explicit. If you are separated or in the middle of a divorce, this provision becomes a planning consideration.

W-2 Employees and Independent Contractors

The deduction primarily benefits W-2 employees. Independent contractors generally do not receive FLSA overtime, so most 1099 workers will not have qualified overtime compensation to report. That said, some misclassified workers and certain hybrid arrangements may produce 1099-NEC or 1099-MISC reporting of overtime starting in 2026, and the IRS updated those forms to allow it.

Highly Compensated and Exempt Employees

If you are FLSA-exempt — most salaried professionals, executives, and outside sales staff — you are not entitled to FLSA overtime in the first place, so you have nothing to deduct. Exempt employees who receive extra pay for long hours can call it "bonus" or "extra straight time," but it is not qualified overtime compensation.

How Employers Must Report It

Tax Year 2025: Penalty Relief, Best-Effort Reporting

Because OBBBA was signed mid-year and the law applies retroactively to January 1, 2025, the IRS granted transition relief. Employers are not penalized for failing to separately report qualified overtime on 2025 Forms W-2 (issued in January 2026). Many payroll providers added a voluntary supplemental statement to help workers figure their deduction.

For 2025, workers can compute the deduction using:

• Paystubs and year-end summaries
• The employer's voluntary supplemental statement if provided
• A reasonable allocation method (e.g., total FLSA overtime hours × half the regular rate)

Tax Year 2026 Onward: Mandatory W-2 Box 12, Code TT

Starting with wages paid in 2026 (Forms W-2 issued in January 2027), employers must separately report qualified overtime compensation in Box 12 with Code TT. This is the dedicated reporting line the IRS designated for this provision.

Employers will need to:

1. Configure payroll systems to track FLSA-required overtime premium separately from state daily overtime, contractual overtime, and other premiums.
2. Compute the half-premium component for each affected employee at the end of each pay period.
3. Accumulate the year-to-date premium and populate Box 12 Code TT on every W-2 for any employee who received qualified overtime, even if the amount is small.
4. Train HR and payroll staff to answer employee questions about why the figure may differ from what the worker sees on a paystub.

Forms 1099-NEC and 1099-MISC were updated with parallel reporting boxes for the rare cases where overtime is paid to a non-employee.

What Employers Should Do Now

1. Audit your payroll system today. Confirm it can separate FLSA-required overtime premium from other forms of premium pay. Most legacy systems lump them together.
2. Update employee handbooks and onboarding documents to reference the new federal tax treatment without overpromising — the deduction is not automatic, and not all overtime qualifies.
3. Coordinate with your tax counsel on multi-state employees, where state daily overtime adds complexity.
4. Plan for cross-functional review with HR, finance, and IT before December 31, 2026 to validate Box 12 Code TT reporting in your year-end payroll close.

How Workers Claim the Deduction

The IRS released Schedule 1-A for tax year 2025 returns. Workers compute their qualified overtime, apply the income phase-out, and carry the result to Schedule 1 as an adjustment to income.

The basic workflow:

1. Total your qualified overtime premium for the year (the "half" portion of FLSA time-and-a-half).
2. Look up your modified AGI before the deduction.
3. Apply the phase-out formula if MAGI exceeds the threshold.
4. Enter the result on Schedule 1-A and transfer to Schedule 1.

If your employer provides Box 12 Code TT for 2026 and later, that number is your starting point. For 2025, you may need to dig through paystubs.

Common Mistakes to Avoid

Mistake 1: Deducting the Full Overtime Check

You cannot deduct $30 for that $30 overtime hour. You can only deduct the $10 premium. Workers who claim the full overtime amount as "qualified overtime compensation" will trigger a math-error notice and may face accuracy-related penalties.

Mistake 2: Counting State Daily Overtime

California's daily 8-hour rule, Colorado's 12-hour rule, and similar state-mandated overtime are not FLSA-required. The premium is taxable like any other wage. This is the single biggest source of confusion for West Coast workers.

Mistake 3: Double-Counting Tips as Overtime

OBBBA also created a "No Tax on Tips" deduction. The two deductions cannot apply to the same dollars — the statute specifically forbids using tips to inflate qualified overtime. Tipped overtime workers should compute each deduction separately on the correct schedule.

Mistake 4: Forgetting the SSN Rule

If your dependents or spouse lack valid SSNs, you may lose part or all of the deduction. Verify SSNs on file with your employer before the year-end W-2 is generated.

Mistake 5: Missing the Filing Status Trap

A married worker filing separately gets zero deduction, even if they earned tons of qualified overtime. If a separation is in progress, weigh this against other MFS planning considerations before the year ends.

Mistake 6: Assuming It Reduces Withholding Automatically

For 2025, the IRS did not adjust withholding tables. Workers who expect a fatter paycheck mid-year will not see it; the benefit arrives as a larger refund (or smaller balance due) at tax time. For 2026 onward, the IRS may issue updated withholding tables.

Why Accurate Records Matter More Than Ever

The new deduction makes a clean separation between FLSA-required overtime premium and all other premium pay essential — both for employees claiming the deduction and for employers issuing W-2s. If your bookkeeping system lumps all overtime into a single "OT" account, you will be reconstructing the year at filing time.

Practical recommendations:

• Track regular rate, hours, and FLSA premium by pay period.
• Reconcile to gross wages monthly so year-end W-2 figures match general ledger.
• Keep contemporaneous records of which premiums are FLSA-required vs. state-mandated vs. contractual. The audit trail is what survives an IRS examination.
• Reconcile your records to Box 12 Code TT in January 2027 and resolve any discrepancies with payroll before filing.

The deduction sunsets after December 31, 2028, unless Congress extends it. Workers and employers who set up clean processes now will be positioned to keep claiming the benefit for the next three filing seasons and avoid the larger compliance burden of an end-of-period catch-up.

Keep Your Wage and Overtime Records Audit-Ready

Whether you are a worker reconstructing 2025 overtime from paystubs or an HR leader configuring payroll to populate Box 12 Code TT, the new OBBBA rules reward clean, transparent records. Beancount.io provides plain-text accounting that gives you complete control over how wages, overtime premium, and payroll taxes are tracked — every line is human-readable, version-controlled, and AI-ready. Get started for free and see why developers, finance professionals, and small employers are switching to plain-text accounting.