No Tax on Overtime 2026 Guide: How IRC §225's $12,500 Overtime Deduction Really Works (and Why FICA Still Applies)

June 2026 Snapshot: Why This Is the First Real Year of "No Tax on Overtime"

On July 4, 2025, President Trump signed H.R. 1, the One Big Beautiful Bill Act (Public Law 119-21). Buried in its tax title is a brand-new Internal Revenue Code §225, "Qualified overtime compensation", which lets eligible workers deduct part of their overtime pay from federal income tax for tax years 2025 through 2028. As the IRS confirms, this is the long-promised "No Tax on Overtime" policy — but the headline is misleading, and understanding exactly how the deduction works is worth real money.[1, 2, 12, 3]

Two things make 2026 the pivotal year. First, this is the first full filing cycle in which employers must separately report qualified overtime on your W-2 — the IRS General Instructions for Forms W-2 and W-3 add a new Box 12 code "TT" for "the total amount of qualified overtime compensation." For tax year 2025, employers were not required to break it out; IRS Notice 2025-69 let workers self-determine the amount using any reasonable method. Second, with the deduction set to sunset after December 31, 2028, 2026–2028 is a narrow planning window.[18, 13]

This guide walks through exactly what counts (only the FLSA "half" premium, not your whole overtime check), the $12,500 / $25,000 caps, the MAGI phaseout, who is excluded, and the single most misunderstood point: the deduction is claimed on the new Schedule 1-A and reduces your taxable income — not your AGI — while still stacking on top of the standard deduction. Before you read on, it helps to see your real take-home math; our salary tool models gross-to-net pay so you can frame the overtime numbers below against your own paycheck.[16]

What Actually Counts: Only the FLSA "Half" Premium

The most expensive misconception is that your entire overtime paycheck is tax-free. It is not. IRC §225 defines "qualified overtime compensation" as the overtime required under section 7 of the Fair Labor Standards Act "that is in excess of the regular rate" at which you are employed. In plain English: only the premium portion — the extra "half" of time-and-a-half — is deductible, not the base hour you would have been paid anyway.[3, 6]

A worked example: suppose your regular rate is $30/hour. Under 29 U.S.C. §207(a)(1), hours over 40 in a workweek must be paid at 1.5×, or $45/hour. The deductible "qualified overtime compensation" is the $15 premium above your regular rate — not the full $45. If you work 10 overtime hours a week for 50 weeks, that is 500 overtime hours × $15 = $7,500 of deductible premium, comfortably inside the cap. The IRS gives the same example in its official overtime Q&A (FS-2026-01).[6, 10]

How the "regular rate" is computed matters, because bonuses and shift differentials can change it. The Department of Labor's regulations at 29 CFR Part 778 explain that the regular rate generally includes most forms of compensation (nondiscretionary bonuses, commissions), so your true premium may differ from a naive 0.5 × base-wage estimate. For most hourly W-2 workers, though, the simple "half of time-and-a-half" rule of thumb is accurate.[9]

The Caps: $12,500 Single, $25,000 Married Filing Jointly

IRC §225 states the deduction "shall not exceed $12,500 ($25,000 in the case of a joint return)." The IRS's Schedule 1-A guidance confirms the same figures. Note the asymmetry versus the tips deduction: qualified tips are capped at $25,000 even for single filers, but qualified overtime is capped at $12,500 for singles, doubling to $25,000 only on a joint return.[3, 16]

The $25,000 joint cap is a combined household limit, not $25,000 per spouse. If both spouses work overtime, their qualified overtime is added together and the total deduction is still capped at $25,000. Because married workers must file jointly to claim §225 at all (more on that below), there is no "married filing separately, $12,500 each" path.[3]

The MAGI Phaseout: $100 Lost Per $1,000 Over the Threshold

High earners get a reduced deduction. The statutory formula in §225 reduces the deduction by $100 for every $1,000 by which your modified adjusted gross income (MAGI) exceeds $150,000 (single) or $300,000 (joint). MAGI here is your AGI with certain foreign-income exclusions added back — for most domestic workers, MAGI simply equals AGI.[3]

Doing the math on the limits: a single filer's $12,500 cap is fully phased out at $275,000 MAGI ($12,500 ÷ $100 × $1,000 = $125,000 above the $150,000 start). A joint filer's $25,000 cap is gone at $550,000. Worked example: a single nurse with $200,000 MAGI loses ($200,000 − $150,000) ÷ $1,000 × $100 = $5,000, leaving a maximum deduction of $7,500 (and she can only deduct that much if she actually earned at least $7,500 of overtime premium).[3, 22]

Who Qualifies — and the Big Exclusions Most People Miss

The deduction is built around FLSA section 7, so eligibility tracks federal overtime law, not your sense of "working extra." The Department of Labor's overtime page explains the core rule: covered, non-exempt employees must receive 1.5× pay for hours over 40 in a workweek. Only that federally-required overtime premium feeds the §225 deduction.[7, 6]

That definition quietly excludes a lot of people. The DOL's Fact Sheet #23 notes the FLSA standard is weekly — there is no federal requirement for daily overtime. So: (1) exempt salaried professionals, executives, and administrators (the "white-collar" exemptions) earn no FLSA overtime and get nothing; (2) independent contractors paid on a 1099 are not "employees" under the FLSA; (3) California-style daily overtime (over 8 hours/day) and other state-only overtime that exceeds the federal weekly requirement is not §225-qualified; and (4) "overtime" your employer pays voluntarily but the FLSA does not require also fails the test.[8]

Two personal requirements round it out, straight from §225: you must include a valid Social Security number on the return, and if you are married you must file jointly — married filing separately disqualifies you entirely. There is no age or occupation list for overtime (unlike tips, which require a Treasury-listed tipped occupation).[3]

How You Claim It: Schedule 1-A Reduces Taxable Income — Not AGI

This is the most misreported fact about all four OBBBA deductions, so read carefully. You claim the overtime deduction on a new form, Schedule 1-A (Form 1040), "Additional Deductions", with the total flowing to Form 1040, line 13b. The IRS's own Schedule 1-A page states the deductions "reduce taxable income" and are available "whether they itemize deductions or claim the standard deduction."[16, 17]

Why does "taxable income, not AGI" matter? Because §225 is not listed among the above-the-line adjustments in 26 U.S.C. §62, it does not lower your AGI; under §63 it instead comes off after AGI to reach taxable income. Many headlines and even some tax write-ups loosely call this an "above-the-line" deduction. It is not. The practical consequence: the overtime deduction will not lower AGI-based thresholds such as Medicare IRMAA surcharges, ACA premium-credit eligibility, the taxable-Social-Security calculation, or most state income taxes that start from federal AGI.[4, 5]

The upside of being a Schedule 1-A deduction is real, though: you can take the overtime deduction and the full standard deduction. A 2026 single filer could stack the standard deduction on top of up to $12,500 of overtime deduction, with both reducing taxable income. You do not have to itemize, and you do not lose anything by taking the standard deduction.[15]

It's a Deduction, Not an Exemption: FICA and State Tax Still Apply

Despite the "no tax" branding, your overtime is not exempt from all taxes. §225 creates only a federal income-tax deduction. Payroll taxes are untouched: per IRS Tax Topic 751, the employee still pays 6.2% Social Security (up to the wage base) and 1.45% Medicare (no limit), plus the 0.9% Additional Medicare Tax on wages over $200,000. Those FICA taxes are withheld from every overtime dollar — premium included — exactly as before.[19]

State income tax is a separate question. Because §225 reduces federal taxable income rather than federal AGI, and most states begin their calculation from federal AGI, the overtime deduction often does not automatically flow through to your state return — even in conformity states. Some states have legislated their own overtime treatment; many simply continue taxing overtime in full. No-income-tax states (Texas, Florida, Nevada, and others) sidestep the issue entirely. Check your state's 2026 conformity rules before assuming a state benefit.[5]

2026 Reporting: The New W-2 Box 12 Code "TT"

For tax year 2026, the IRS General Instructions for Forms W-2 and W-3 introduce Box 12, code "TT" to report "the total amount of qualified overtime compensation" (with code "TP" doing the same for qualified tips). When you get your 2026 W-2 in early 2027, that "TT" figure is the number you carry to Schedule 1-A — no guesswork required.[18]

Tax year 2025 was different. Because the law passed mid-year, IRS Notice 2025-69 granted transition relief: employers could approximate qualified overtime by "any reasonable method," and if your 2025 W-2 did not separate it out, you were allowed to determine the amount yourself from pay stubs or payroll records. If you worked overtime in 2025 and have not yet filed (or filed without claiming it), your year-end pay statement showing the overtime premium is your documentation.[13, 14]

If your 2026 W-2 is missing the Box 12 "TT" entry but you know you earned FLSA overtime, ask your employer or payroll provider to correct it before you file. The IRS's overtime FAQ is the authoritative starting point if you and your employer disagree on the qualified amount.[11]

How Much Will You Actually Save? Multiply by Your Marginal Rate

A deduction is not a credit. Your actual cash savings equal the deductible premium times your marginal federal tax rate — not the premium itself. Take our earlier example of $7,500 in deductible overtime premium. In the 12% bracket that is $900 saved; in the 22% bracket, $1,650; in the 24% bracket, $1,800. The same overtime, taxed at a higher marginal rate, produces a larger deduction benefit.[10]

Nationally, the benefit is meaningful but bounded. The nonpartisan Bipartisan Policy Center and the Peter G. Peterson Foundation note the Joint Committee on Taxation scores the overtime deduction at roughly $90 billion over its four-year life (about $32.8 billion in 2026 alone) — and that cost would more than double, to about $227 billion over a decade, if Congress made it permanent. For an individual worker, the realistic range is a few hundred to roughly $2,000–$3,000 a year, depending on overtime hours and bracket.[22, 23]

Withholding and Estimated Tax: Why the Benefit Lands at Refund Time

Your employer's payroll system generally withholds federal income tax on overtime as if it were fully taxable. That means the §225 benefit usually shows up as a larger refund (or smaller balance due) when you file — not as fatter paychecks during the year. The early data bears this out: tax-news outlets reported refunds running higher in the 2026 filing season as workers claimed the new overtime and tips deductions for the first time.[20]

If you would rather have the money during the year, you can adjust withholding using Form W-4 — declaring an estimated deduction at Step 4(b) reduces the income tax withheld each pay period. The IRS's Tax Withholding Estimator can model this, and Publication 505 covers withholding and estimated-tax mechanics in depth. Self-employed or gig workers who make quarterly estimated payments should factor the expected deduction into those calculations rather than overpaying all year.[21, 20]

Five Common Mistakes That Cost Overtime Workers Money

1. Deducting the whole overtime check. Only the premium above your regular rate qualifies — deducting the full 1.5× amount overstates the deduction and invites an IRS adjustment. 2. Assuming all extra hours count. Daily overtime, state-only overtime, and voluntary employer overtime that the FLSA does not require are excluded, as DOL Fact Sheet #23 makes clear.[8]

3. Filing married-separately. A married worker who files separately loses the deduction entirely under §225. 4. Expecting FICA or state relief. Social Security and Medicare keep coming out, and many states still tax overtime in full. 5. Forgetting the 2028 sunset. The deduction expires after tax year 2028 unless Congress extends it — do not build a permanent budget around a temporary tax break. Treat 2026–2028 as a limited window.[3]

Strategy: Turn a Four-Year Tax Break Into Lasting Wealth

Because the deduction sunsets after 2028, the smartest move is to treat the tax savings as found money and put it to work rather than absorbing it into everyday spending. If the overtime deduction saves you $1,650 a year in the 22% bracket, investing that amount annually for the four-year window — and letting it compound afterward — turns a temporary tax provision into a durable balance-sheet improvement.

This is where overtime hours can quietly build long-term wealth: the extra premium pay, lightly taxed for four years, becomes seed capital. Run your own numbers — plug your expected annual tax savings (or the after-tax overtime itself) into a compounding model to see what a disciplined 10- or 20-year investment of that windfall could become.

No Tax on Overtime: Frequently Asked Questions

The questions below address the most common points of confusion about IRC §225 — what portion is deductible, whether FICA is waived, the AGI-versus-taxable-income distinction, eligibility for salaried and gig workers, the 2025 retroactive year, stacking with the standard deduction, withholding, state conformity, and the high-income phaseout.