You may be hearing that an honest day’s work for an honest day’s pay just got sweeter for those who go above and beyond and put in overtime. This headline has been getting a lot of buzz lately, but as is the case with tax law, the devil is in the details, and you will be in for a surprise if you only take this news at face value.
There are several nuances to be aware of when it comes to new provisions in the One Big Beautiful Bill Act (OBBBA) relating to no tax on overtime, especially for union employees who are part of a collective bargaining agreement.
Tax-Free Overtime Highlights
The key highlights garnering the most attention:
What Are the Amounts?
- $12,500 of tax-free overtime for single filers; $25,000 for married filing jointly.
- Phase-out limits for higher earners - $150,000 for single filers; $300,000 for married filing jointly (phase outs begin $100 for every $1,000 over those limits)
How to Claim the Deduction
- Employees are entitled to an above-the-line deduction on their personal tax return for qualified overtime. This means that you can reduce your taxable income regardless of whether you itemize your deductions or take the standard deduction.
Withholdings will still be taken from employee paychecks and the deduction will be claimed when you file your individual income tax return, not as you earn the overtime during the year.
Defining Qualified Overtime Compensation
The nuances to be aware of are how the new tax bill defines “qualified overtime compensation” and other limitations.
Qualified overtime compensation is defined as an amount paid to an individual as required under section 7 of the Fair Labor Standards Act of 1938 (“FLSA”) that is in excess of the regular rate at which such individual is employed.Therefore, only the half-time required to be paid for overtime, not the entire time-and-a-half rate, qualifies for the deduction. For example, for an employee whose regular rate is $20/hour and overtime rate is $30/hour (1.5x), only the $10/hour is tax-free/deductible. 33% of that overtime pay would be tax-free while 67% remains taxable.
For employees who are covered by collective bargaining agreements that have more favorable overtime pay, and those covered by employers who voluntarily provide more favorable overtime pay, only the overtime pay required by FLSA will qualify for the deduction. Overtime in excess of time-and-a-half, and additional pay for weekends, holidays, etc, also would not qualify. For example, for an employee whose regular rate is $20/hour and overtime rate is $40/hour (2x), only the $10/hour (0.5x their regular rate) is tax-free/deductible. In that scenario, 25% of overtime pay would be tax-free while 75% remains taxable.
Additional Nuances
Other nuances to be aware of:
- An individual must have a valid Social Security number in order to claim the deduction.
- Married taxpayers filing separately do not qualify for the deduction.
- The deduction is temporary, for tax years 2025 through 2028.
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Overtime Reporting Rules
What employers must know about the overtime reporting requirements:
- Starting in 2025, employers will be required to report an employee’s qualified overtime.Employers must ensure that only qualified overtime is reported and not all overtime.
- The new bill allows for a transition period for 2025 in which employers may reasonably approximate qualified overtime wages.This will allow employers an adjustment period in which they can update the data in their payroll system to more accurately track the qualified overtime wages for each employee.
- Qualified overtime wages are subject to FICA/FUTA.
- Continue to use the IRS’ withholding tables; there is no requirement to reduce withholdings on qualified overtime pay.
- Brush up on exempt versus non-exempt employee classification and anticipate that employees may request a change from salaried to hourly in order to take advantage of the new tax savings.
This new legislation is nuanced and requires diligence, both on the part of employers and employees – specifically, those who are part of a collective bargaining agreement. As always, reading the fine print is key to avoiding problems down the line.
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For more information on this topic, please contact a member of Withum’s Construction Services Team.
