Last updated: September 2026

Is Overtime Tax Free? What the OBBBA Deduction Actually Does

Overtime is not tax free. The One Big Beautiful Bill Act created a deduction claimed on your federal tax return. It is not an exemption from tax, and it is not a change to your paycheck. The IRS states that qualified overtime is not excluded or exempted from wages for income tax withholding, Social Security, or federal unemployment tax purposes.

Your employer withholds the same amount it always did. Your W-2 still reports overtime as taxable wages. The benefit arrives when you file, as a larger refund or a smaller balance due.

Only the overtime premium qualifies, not the whole overtime payment

This is where most readers lose money in either direction. The deduction covers the extra half that the Fair Labor Standards Act requires, not the full time and a half payment.

At a $20 regular rate, an overtime hour pays $30. The straight time portion is $20 and the premium is $10. Only the $10 is qualified overtime. A worker who earns $9,000 in overtime pay across a year at time and a half has roughly $3,000 of qualified overtime, not $9,000.

Where an employer pays more than the FLSA requires, only the amount needed to satisfy the FLSA qualifies. The IRS worked example uses a $20 rate and double time for 10 overtime hours: the employee receives $200 of straight time plus a $100 premium, and the qualified overtime is $100.

Our no tax on overtime calculator applies this split for a 2025 return.

The cap and the phase out

The deduction is capped at $12,500 on a single return and $25,000 on a joint return. It is available for tax years 2025 through 2028.

Above $150,000 of modified adjusted gross income, or $300,000 filing jointly, the deduction is reduced by $100 for every $1,000 above that figure. The reduction applies to the capped amount, not to the overtime you actually earned, which matters more than it sounds. A single filer at the full $12,500 reaches zero at $275,000. A single filer with $5,000 of qualified overtime reaches zero at $200,000.

Modified adjusted gross income is not the same as adjusted gross income. Schedule 1-A builds it from your adjusted gross income plus certain foreign earned income and housing exclusions.

Married taxpayers must file jointly to claim it. A Social Security number valid for employment is required, issued before the due date of the return including extensions.

Who qualifies

Only hours that count as overtime under the FLSA qualify, meaning hours beyond 40 in a workweek for nonexempt employees. Overtime required by state law, a union contract, or employer policy but not by the FLSA does not qualify, regardless of what your state requires.

Salaried exempt employees do not qualify, because they do not earn FLSA overtime. Independent contractors, gig workers, and anyone paid on a 1099 do not qualify either.

One rule catches owners of small businesses. An employee holding a bona fide 20 percent equity interest who is actively engaged in management is treated as a bona fide executive under the FLSA, and therefore has no qualified overtime.

Your employer decides whether you can claim it

This is the part of the law that gets the least attention and does the most damage.

For tax years after 2025, you may not deduct any amount greater than what your employer reported in box 12 of your Form W-2 under code TT. The reasonable estimation methods the IRS allowed for 2025 do not carry forward. A substitute Form W-2 on Form 4852 does not satisfy the requirement either.

If the reported amount is too high, you may only use the amount actually paid. If it is missing or too low, you have to ask your employer for a corrected Form W-2c. An employer who discovers a code TT error is obligated to file the correction with the Social Security Administration and furnish it to you. If the employer will not issue one, you lose the difference permanently, even though the wages were paid and the overtime was worked.

That makes your pay stub worth reading in December rather than in April. If your overtime is not tracked separately, raise it with payroll before the year closes.

Your paycheck does not change

Your employer may not reduce your withholding to account for this deduction unless you give them an updated Form W-4. The 2026 Form W-4 was revised so employees can account for the deduction in step 4(b).

Adjusting your W-4 carries its own risk. If you project 200 hours of overtime and work 120, you will owe at filing, and the IRS charges underpayment penalties above certain thresholds. Waiting until the fourth quarter to adjust means projecting from hours you have already worked rather than hours you hope to work.

Social Security and Medicare tax do not change

Social Security tax at 6.2 percent and Medicare tax at 1.45 percent apply to every overtime dollar, deduction or not. Note the asymmetry: the deduction covers only the premium half, while payroll tax applies to the entire overtime payment. Your employer matches the same amount. For high earners the Additional Medicare Tax of 0.9 percent applies above $200,000 for a single filer.

California daily overtime usually does not qualify

California requires overtime after 8 hours in a day and double time after 12. The FLSA requires it after 40 hours in a workweek. The deduction follows the federal rule, so daily overtime that does not also push the week past 40 is not qualified overtime.

A California worker who puts in 10 hours on Monday and 6 hours on each of four other days has worked 34 hours. California law treats the two extra Monday hours as overtime and pays them at time and a half. Federal law sees a 34 hour week with no overtime at all, so none of it is qualified and none of it appears in box 12 under code TT.

California income tax, State Disability Insurance and the employer's unemployment and training tax obligations apply to overtime exactly as they always have. The federal deduction changes nothing about California payroll.

State taxes are decided state by state

The federal deduction does not reduce your state taxable income unless your state provides for it. Alabama enacted its own overtime deduction under Act 2026-604 for tax years 2026 through 2028, capped at the lesser of the actual overtime premium or $1,000 per taxpayer, keyed to the same box 12 code TT amount. Alabama also exempted overtime wages from state income tax through June 30, 2025 under an earlier act, and that exemption expired, so Alabama overtime paid in the second half of 2025 is fully taxable by the state.

We do not publish a conformity list for all fifty states. Check your own state revenue department.

Four mistakes that cost workers the deduction

Deducting the full overtime payment instead of the premium. This is the most expensive error available, because it overstates the deduction by roughly three times on time and a half. The accuracy related penalty is 20 percent of the underpaid tax.

Assuming all extra pay counts. Holiday pay, shift differentials, and weekend premiums are not overtime unless the hours push you past 40 in the workweek. A worker paid time and a half on a holiday who works 32 hours that week earned premium pay, not FLSA overtime.

Claiming exempt on a Form W-4 because of the overtime law. The deduction is not a withholding exemption, and claiming exempt when you owe tax carries its own penalties.

Ignoring the regular rate. Nondiscretionary bonuses, shift differentials, and commissions belong in the regular rate before the overtime premium is computed. An employer using base pay alone underpays the overtime and reports a code TT figure that is too low. See how overtime premium adjustments affect the rate your premium is built on.

What to check before you file

Find your overtime pay on your final pay stub or your W-2. For a 2025 return, divide time and a half overtime by three to estimate the premium. For 2026 and later, use the box 12 code TT figure and nothing else.

Apply your federal bracket to the qualified amount, not to the overtime pay. A worker in the 12 percent bracket with $3,000 of qualified overtime saves about $360. In the 22 percent bracket the same amount saves about $660.

Confirm your overtime is tracked separately. Once a W-2 is issued with hours bundled together, separating them afterward means asking for a correction you may not get.

Run your figures through the no tax on overtime calculator, which shows the deduction and the payroll tax that still applies to the same wages. For federal overtime rules and calculations, visit the overtime hub. Employers checking their own reporting should confirm their payroll provider supports code TT before year end.

This is not legal or financial advice. Consult a qualified professional for your specific situation.