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U.S. workers will be able to claim a new tax deduction for overtime hours, a measure included in the One Big Beautiful Bill Act (OBBBA).
The benefit, implemented by the Internal Revenue Service (IRS), allows taxpayers to deduct part of this pay from federally taxable income, as long as certain requirements are met.
Why will part of overtime pay be tax-free?
According to the IRS document on “updates to questions and answers on the new deduction for qualified overtime compensation”, the new tax deduction was added under the OBBBA, enacted in July 2025. The measure lets certain U.S. workers deduct part of the overtime pay they receive from federally taxable income.
The benefit is designed to reduce the tax burden on people who work beyond their regular schedule and receive extra pay for that time. But that does not mean overtime pay is completely tax-free. The deduction applies to the additional amount required under the Fair Labor Standards Act (FLSA).
The IRS set a limit of $12,500 a year for individual returns and $25,000 for joint returns. In addition, the benefit begins to phase out once modified adjusted gross income exceeds $150,000 a year, or $300,000 for joint filers.
What counts as overtime pay?
To claim the deduction, it is not enough to have received extra pay for working more hours. The compensation must be required under Section 7 of the FLSA, which generally says covered employees must be paid time and a half their regular rate when they work more than 40 hours in a workweek.
Extra pay that employers offer voluntarily or that is tied to other work conditions, such as working on a holiday, exceeding eight hours a day, or working special shifts, does not qualify when those payments are not required by federal law.
Who can claim this IRS tax deduction?
The benefit is aimed at workers who:
- Are covered by the FLSA.
- Are not exempt from its overtime rules.
- Receive additional pay required by that law.
Workers who may be excluded include certain executive, administrative, and professional employees, outside sales workers, some information technology employees, and workers in certain agricultural, railroad, and transportation jobs.
How do you claim the overtime deduction?
Workers must claim the benefit when filing their federal tax return, using Form 1040 and completing Schedule 1-A, where the amount they can deduct is calculated.
For payments for tax year 2026, employers must report qualified overtime compensation separately on the W-2 form, specifically in box 12 under code TT.
The worker must use that amount to complete Schedule 1-A, which takes into account the annual limits and the corresponding reductions based on income.