You've probably heard the rumors or seen the headlines by now. People are talking about "tax-free overtime" like it’s some kind of mythical financial unicorn. But honestly, if you're waiting for a day when the IRS just stops looking at your extra hours entirely, you might be waiting a long time.
That said, things changed in a huge way recently.
On July 4, 2025, the "One Big Beautiful Bill" (officially the Working Families Tax Cut or Public Law 119-21) was signed into law. It didn't make the taxes "go away" in the sense of a total deletion from the tax code, but it did create a massive new deduction. Basically, if you’re a non-exempt worker, a huge chunk of your overtime pay is now shielded from federal income tax.
But there's a catch. Actually, there are several.
The question isn't just when is the overtime tax going away, but rather, how do you actually get that money back? Since the law is retroactive to January 1, 2025, the "going away" part starts the moment you file your 2025 tax return in early 2026.
When Does the Overtime Tax Break Actually Start?
The short answer: It already has.
Because the law was signed midway through 2025 but made retroactive, the tax benefits apply to every hour of qualified overtime you worked since New Year’s Day of 2025. If you’re looking at your paycheck right now and still seeing federal withholdings, don't panic. Employers weren't required to stop withholding immediately because the IRS needed time to update their systems.
You’ll see the "disappearing" tax when you file your taxes this year.
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The IRS has introduced a new form—Schedule 1-A—specifically for this. You’ll list your "qualified overtime compensation" there. For the 2025 tax year, the government is allowing employers to use "any reasonable method" to estimate how much you earned in OT, since many companies weren't tracking the "premium" portion of the pay separately yet.
By the 2026 tax year, the process gets much more formal.
Starting in January 2026, the IRS is requiring employers to use Box 12 on your W-2 with a specific code—likely "TT"—to report exactly how much of your pay was qualified overtime. This makes it a lot easier for the tax software to just "poof" that income out of your taxable total.
The $12,500 Limit and the "Half-Time" Rule
Let’s get into the weeds for a second because this is where most people get confused. The law doesn't say all your overtime pay is tax-free. It specifically targets what’s called "qualified overtime compensation."
Under the Fair Labor Standards Act (FLSA), overtime is usually "time and a half." If you make $20 an hour, your overtime rate is $30.
- The first $20 is your "regular rate."
- The extra $10 is the "overtime premium."
The new law allows you to deduct that extra $10—the "half" in time-and-a-half.
Breaking Down the Math
If you earned $5,000 in total overtime pay this year, only about $1,666 of that (the premium portion) is typically deductible.
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The law caps this deduction at $12,500 for individuals and $25,000 for married couples filing jointly. For the average worker, that’s a massive ceiling. You’d have to work a staggering amount of overtime to hit that cap.
However, if you're a high earner, the benefit starts to vanish. The phase-out begins if your Modified Adjusted Gross Income (MAGI) hits $150,000 (or $300,000 for joint filers). Once you cross those thresholds, the deduction is reduced by $100 for every $1,000 you earn over the limit. If you’re making $275,000 as a single filer, the benefit is gone entirely.
Does This Mean No Taxes at All?
Kinda, but mostly no.
This is the biggest misconception floating around job sites and breakrooms. The "One Big Beautiful Bill" only applies to federal income tax. It does not—I repeat, does not—touch payroll taxes.
You and your employer still have to pay:
- Social Security (6.2%)
- Medicare (1.45%)
Also, unless you live in a state like Wisconsin, which recently moved to align its state tax laws with the federal changes, you might still owe state and local income taxes on every penny of that overtime.
It’s a bit of a bummer, honestly. You’ll see the deduction on your federal 1040, but your FICA withholdings will look exactly the same as they always have.
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Why the Overtime Tax Break Might "Go Away" Again
There is a ticking clock on this.
The current legislation is not permanent. Like many provisions in the Working Families Tax Cut, the "no tax on overtime" rules are scheduled to expire on December 31, 2028.
Unless a future Congress votes to extend it or make it permanent, we’ll be right back to the old system in 2029.
Why the expiration date? It’s mostly about budget rules in Washington. By making it temporary, it "costs" less on the official government balance sheets. It gives lawmakers a chance to see if it actually encourages people to work more or if it just creates a giant hole in the Treasury.
What Most People Get Wrong About Qualification
Not every "extra hour" counts as tax-free overtime.
The law is very specific: it must be overtime required under Section 7 of the FLSA.
- W-2 Employees only: If you're a 1099 independent contractor or a gig worker, you're out of luck. The FLSA doesn't cover you, so you don't get the deduction.
- Non-Exempt Status: If you're a "salaried exempt" manager who stays late but doesn't get paid extra for it, there’s nothing to deduct.
- No "State Only" Overtime: Some states, like California, require overtime pay if you work more than 8 hours in a single day. However, the federal FLSA only requires it after 40 hours in a week. If your overtime is triggered by state law but you haven't hit 40 hours for the week yet, that pay might not qualify for the federal deduction.
It's a nuanced mess. This is why the IRS is pushing for better reporting on W-2s—they need to be able to tell which hours were "FLSA-mandated" and which were just "company policy" or "state-mandated."
Real-World Action Steps for 2026
Since we are now in the 2026 filing season (looking back at 2025), here is what you should actually do to make sure you're getting the money you're owed:
- Audit Your Paystubs: Look for a line item that specifically breaks out "Overtime Premium." If your paystub just shows one lump sum for OT, you’re going to have to do some math to figure out the "half" portion of your time-and-a-half.
- Talk to Payroll: Ask if they are using the "reasonable method" estimation for the 2025 tax year. Some employers are providing a separate letter or statement to employees to help them file Schedule 1-A.
- Check Your W-4: If you're working a lot of overtime, you might be over-withholding now that this deduction exists. You might want to adjust your W-4 to put more money in your pocket throughout the year rather than waiting for a big refund.
- Don't Forget State Taxes: When you use tax software, pay close attention to the state section. It might "import" your lower federal income, but some states will make you "add back" that overtime deduction if they don't recognize the new federal law.
The overtime tax isn't "going away" in a single day; it's being phased into your tax returns through 2028. Make sure you’re actually claiming the deduction, or you’re basically just giving the government a tip they didn't even ask for.