No Tax on Overtime

by Tom Yamachika, President, Tax Foundation Hawaii

By now, most of us have heard that President Trump signed the One Big Beautiful Bill Act into law and some of the tax changes it makes will be effective this year.  We’ll dive a little deeper into one of them, “No Tax on Overtime,” this week.

The benefit of the new provision is pegged to “Qualified Overtime Compensation,” which the Act defines as “paid to an individual required under section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate.”  Here’s what that means.  Suppose you get paid $10 an hour, you work 50 hours in a week, and for every hour over 40, you get paid time-and-a-half, which is what FLSA requires.  Your qualified overtime isn’t $500, which is what you got paid.  It isn’t $150, which is what you got paid for your overtime hours.  It’s $50, which is what you were paid in excess of straight time.

Suppose you are unionized and your union contract says you get paid double time for every hour in excess of 35 in a week.  Your qualified overtime is still $50, which is the extra pay required by FLSA, even if your contract entitled you to more. 

What about if you worked 8 hours on a holiday and earned double time, or $160?  Your qualified overtime is zero, because the FLSA doesn’t require that workers be paid more on holidays.

And what if you’re a bartender and get a bunch of tip income on those days you worked overtime?  Tips don’t count toward qualified overtime.  But they may trigger another provision in the new law relating to “no tax on tips.”

By the way, this is critical information for employers too, because employers will have to figure out how much qualified overtime a worker was paid and report it on W-2 forms.

One beneficial feature of the new deduction is that it is taken “above the line,” which is tax practitioner jargon meaning that you don’t have to itemize deductions to take it, and that it reduces “adjusted gross income,” the statistic that limits, or makes you ineligible for, many different deductions and credits.  Indeed, many of the tax breaks in the Act are phased out or denied based on how much AGI you made.  (Actually, many of the deductions and credits in the act use Modified Adjusted Gross Income, or MAGI, to limit eligibility or phase out benefits.  MAGI is adjusted gross income plus any foreign income that you might have excluded, so for most people MAGI and AGI will be the same.)

The deduction for qualified overtime is also limited.  The limit is $25,000 for a married couple filing a joint return, and $12,500 otherwise.  Furthermore, the limit decreases once you hit a certain level of — you guessed it — MAGI.  The threshold MAGI amount is $300,000 for married filing jointly, and $150,000 otherwise.  Once the threshold is reached, the limit gets knocked down $100 for each $1,000 in MAGI above the threshold.

And lastly, don’t get used to this tax benefit.  It’s only temporary.  It applies to calendar years 2025, 2026, 2027, and 2028.  The last year, 2028, just happens to be the year of the next Presidential election.