The One Big Beautiful Bill Act (OBBBA) created a temporary federal income tax deduction tied to overtime pay. This has a resulted in a lot of confusion, but the deduction is actually fairly straightforward. And, importantly, employers are not obligated to make changes to their policies or their payroll practices.
The law allows your employees to make a deduction on their income taxes. It doesn’t change how they were paid, and it does not obligate you as an employer to assist them in calculating their tax deduction.
This FAQ explains what the “No Tax on Overtime” provision actually means for employers.
No.
The law created a federal income tax deduction for certain overtime compensation. It did not eliminate all taxes on overtime.
Overtime pay remains subject to standard payroll deductions for the following:
Employers are not obligated to eliminate other taxes from applying to employee paychecks. Instead, it is the employee’s option to submit a deduction on their income taxes. Employees can also plan ahead for that deduction by adjusting their withholdings by filling out an updated W-4 form.
No.
Employees can make a tax deduction for:
The “premium portion” is the additional half-time premium paid for hours worked over 40 in a workweek.
Example:
If an employee earns $20 per hour, their total overtime rate is $30 per hour.
The first $20 of the overtime rate reflects their standard hourly rate of pay, and is subject to all regular taxes.
The $10 in additional half-time pay is the “premium portion” that is eligible for the tax deduction.
For the premium portion of overtime pay to be eligible for a tax deduction, its payment must have been required by the FLSA. This means that the employee is non-exempt and worked over 40 hours in a workweek.
If an overtime rate was paid for any other reason, it isn’t eligible for the deduction. Examples of ineligible overtime include:
Only the premium portion is deductible. So the straight time rate is taxed as normal, only the half time premium is eligible for deduction
When employees file their income taxes, there is a cap on the amount of overtime that can be deducted. For tax years 2025 through 2028, the maximum amounts are:
The deduction begins phasing out at higher income levels.
This is per tax return, not per employer.
Not automatically.
Unless an employee adjusts their Form W-4, no changes should be made to how payroll is run or tax deductions are made.
Form W-4 was updated for 2026 to allow employees to reduce withholdings during the year rather than waiting to request the deduction on their tax return. These estimated withholding amounts would still need to be reconciled on tax returns based on actual overtime amounts paid. Therefore making a W-4 withholding change is not recommended for most employees, who do not regularly work large amounts of predictable overtime.
Yes, beginning in 2026 – though the IRS has not provided instructions for employers to follow.
For the 2025 tax year, separate payroll tracking or W-2 reporting of overtime was not required. Employees wishing to make a deduction on their 2025 taxes can refer to IRS guidance that was published on this topic.
At the end of 2026, employers are expected to be able to separately list qualified overtime premiums on employee W-2s. At this time, the IRS has not provided any guidance to employers or payroll companies as to how to accomplish this.
In general, however, this will be accomplished through your payroll system. The payroll system will need to:
Most major payroll providers are expected to implement these changes automatically, but employers should confirm with their individual provider.
CEDR Payroll and Timekeeping both have already implemented reporting capabilities that pull the total qualified overtime hours incurred per FLSA standards, and differentiate this from overtime incurred that is not subject to FLSA (like California daily overtime). If you’re using CEDR’s suite of services, you do not have to take any action to meet the new requirements.
No.
The law does not change:
All existing compliance under the Fair Labor Standards Act remains in place.
No.
Independent contractors are not subject to the FLSA’s overtime requirements, therefore cannot claim this deduction.
This provision is primarily a tax return issue for employees, not a payroll structure change for employers.
Your compliance obligations under federal wage and hour law remain the same. Your withholding obligations remain the same unless and until formal IRS instructions change.
The only operational impact is future reporting and system configuration.
For even more information, you can also see the IRS’ Questions and answers about the new deduction for qualified overtime compensation
Need help staying compliant with changing payroll laws? CEDR’s Payroll and HR Experts ensure your systems stay accurate—without extra work on your end.
Friendly Disclaimer: This information is general in nature and is not intended to provide legal advice or replace individual guidance about a specific issue with an attorney or HR expert. The information on this page is general human resources guidance based on applicable local, state, and/or federal U.S. employment law that is believed to be current as of the date of publication. Note that CEDR is not a law firm, and as the law is always changing, you should consult with a qualified attorney or HR expert who is familiar with all of the facts of your situation before making a decision about any human resources or employment law matter.
A Blog Written by CEDR, written by HR Experts to help you run your practice.
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