The federal provision for no tax on overtime begins January 1, 2025. Applies To: Non-exempt hourly employees earning under $150,000
A major shift in tax policy has been confirmed, sparking widespread buzz online and in the media: when does no tax on overtime start? The federal government has officially passed legislation that exempts qualifying overtime pay from federal income tax, delivering a major financial boost to millions of American workers.
The policy goes into effect on January 1, 2025, and will primarily benefit middle- and lower-income hourly employees who regularly work overtime.
If you’re wondering how this change will impact your paycheck, who qualifies, or what employers should prepare for, this guide has you covered.
Legislative Background
The “No Tax on Overtime” measure was enacted as part of the One Big Beautiful Bill Act (OBBBA), a sweeping piece of legislation designed to provide tax relief to working Americans. The Act was signed into law by the President on July 4, 2025, symbolically chosen to highlight its focus on economic freedom and worker empowerment.
The bill represents one of the most significant tax overhauls in recent years, targeting areas where working households often feel the most financial strain. Among its various provisions, the law introduced a new deduction specifically for qualified overtime pay. This was aimed at encouraging hard work, rewarding employees who put in extra hours, and ensuring that additional earnings do not result in an outsized tax burden.
Beyond overtime relief, the legislation bundled together several reforms meant to simplify the tax code and broaden benefits to middle- and lower-income earners. It also included incentives for seniors, updates to standard deductions, and adjustments to modernize payroll reporting requirements. By combining these measures into a single bill, lawmakers created a unified framework for easing tax pressures while also seeking to boost consumer spending power.
The inclusion of the overtime deduction was especially significant, as it marked the first time federal tax law directly addressed the treatment of time-and-a-half wages in this way. Policymakers argued that by allowing employees to keep more of their overtime earnings, the law would not only provide immediate financial relief but also help stimulate the broader economy through increased take-home pay and spending.
Key Point Summary
- Policy Launch Date: January 1, 2025
- Applies To: Non-exempt hourly employees earning under $150,000
- Benefit: No federal income tax on overtime wages
- Coverage Period: Tax years 2025 through 2028
- Payroll Change: Overtime must be tracked separately starting 2025; new W-2 format begins 2026
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When Does No Tax on Overtime Start?
The federal provision for no tax on overtime officially begins on January 1, 2025. It applies to non-exempt hourly employees earning less than $150,000 per year.
Under this law, qualifying workers will be able to deduct a portion of their overtime premium pay from their federal taxable income. The deduction is capped at $12,500 for individuals and $25,000 for joint filers. This effectively eliminates federal income tax on eligible overtime earnings.
The deduction phases out for individuals with incomes above $150,000 and joint filers above $300,000. The policy will remain in effect through 2028, unless extended by Congress.
So if you’re an hourly worker earning under the threshold and regularly working overtime, this new policy will directly increase your take-home pay starting in 2025.
Who Qualifies for the Overtime Tax Exemption?
Not all workers are eligible for the new overtime tax exemption. The policy is designed to support lower- and middle-income employees who regularly work extra hours to make ends meet. To qualify for this exemption, several specific conditions must be met. Here’s a breakdown:
✅ 1. Non-Exempt Status Under the Fair Labor Standards Act (FLSA)
To benefit from the overtime tax exemption, you must be classified as a non-exempt employee under the Fair Labor Standards Act (FLSA).
- Non-exempt employees are generally hourly workers who are entitled to overtime pay when they work more than 40 hours in a week.
- This includes positions such as retail workers, administrative staff, technicians, and many others in industries like hospitality, healthcare, and logistics.
- If you’re classified as exempt (such as many salaried managers or professionals), you do not qualify.
✅ 2. Income Threshold: Under $150,000 Per Year
Your total annual income must be below $150,000 to be eligible for the exemption.
- This threshold ensures that the benefit targets workers who are not in the top income brackets.
- The figure is based on your gross income, including wages, bonuses, commissions, and other taxable earnings.
- If your income fluctuates due to seasonal work or variable hours, eligibility may be assessed based on your average annual earnings.
✅ 3. Overtime Compensation Must Meet Federal Standards
To receive the tax exemption:
- Your overtime hours must be compensated at the federally mandated rate—1.5 times your regular hourly wage for any hours worked beyond 40 in a single workweek.
- This means your employer must be in compliance with the FLSA rules regarding overtime pay. If you’re being paid straight time or less than time-and-a-half for extra hours, you likely won’t qualify for the exemption.
- Documentation and proper payroll reporting are essential. You’ll likely need to show pay stubs or W-2 forms that indicate properly compensated overtime.
Additional Considerations
State laws may offer additional protections or stricter rules, but this exemption specifically applies at the federal tax level.
Independent contractors and gig workers are generally not covered by this policy, as they are not classified as employees under FLSA rules.
Union workers may be subject to different agreements but must still meet federal standards to qualify.
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How Does the Policy Affect Take-Home Pay?
Workers who regularly put in overtime are set to experience a noticeable improvement in their overall financial picture once the new policy takes effect for the 2025 tax year. Although the change won’t immediately show up in every paycheck during the year, it will have a meaningful impact when employees file their taxes and see a larger refund or a smaller tax bill.
Increased Net Pay:
Under the new rules, qualifying overtime pay will be eligible for a significant deduction from taxable income—up to $12,500 for single filers and $25,000 for married couples filing jointly. This means that a portion of the extra earnings from working beyond regular hours will no longer be counted toward federal taxable income. In practice, workers will still see the same federal withholding on overtime in their paychecks during 2025 because the IRS has not yet adjusted withholding tables. However, the benefit will be realized when employees submit their tax returns in early 2026. At that point, the deduction will reduce their taxable income, which in turn lowers the amount of federal income tax they owe, effectively putting more money back in their pockets.
Annual Tax Savings:
The savings from this policy could be substantial. Many employees who work frequent overtime may see an increase in their annual take-home pay of around $1,400 to $1,750 once the deduction is applied. For example, an employee earning $8,000 in overtime pay during the year could potentially keep $1,000 or more of that income that would have otherwise been paid in federal taxes. The exact benefit will vary depending on a worker’s income level, tax bracket, and the amount of qualifying overtime hours they work, but in most cases, the result will be hundreds—if not thousands—of extra dollars each year.
Motivation for Extra Hours:
By reducing the tax burden on overtime, the policy creates a strong financial incentive for workers to take on more hours when they are available. For many employees, the thought of keeping more of their hard-earned overtime pay could make the decision to volunteer for extra shifts much easier. This is particularly relevant in sectors such as healthcare, manufacturing, retail, and logistics, where overtime is often an essential part of meeting demand. In these industries, employees who are already accustomed to putting in extra time may be more inclined to accept additional work knowing the net reward will be greater.
Employer Perspective:
Employers also stand to gain from the policy. While they are still required to withhold taxes from overtime pay in the same way as before, they can use the policy as a recruiting and retention tool. Overtime becomes a more attractive option for filling scheduling gaps, covering peak periods, and responding to sudden increases in demand. This is especially valuable in industries struggling with labor shortages, as offering tax-advantaged overtime could help employers encourage current staff to step up rather than relying solely on temporary hires. The key for employers will be to ensure accurate record-keeping of qualifying overtime hours so that employees can claim the maximum allowable deduction at tax time.
In short, while workers won’t immediately see larger paychecks from this change in 2025, the impact will be clearly felt when they file their taxes. Over time—especially if IRS withholding rules are updated in later years—the benefits could become more visible in regular pay, turning overtime into an even more powerful source of extra income.
PPayroll and W-2 Changes Employers Should Know
Starting in January 2025, employers will need to adapt payroll and reporting processes to comply with the new No Tax on Overtime rules. The law requires that only the half-time premium portion of overtime pay, as defined under the Fair Labor Standards Act (FLSA), qualifies for the tax deduction. This means payroll systems must now distinguish between:
- Regular wages – the base hourly rate times regular hours worked.
- Overtime base pay – the regular rate for hours worked beyond 40.
- Overtime premium – the additional 50% “time-and-a-half” portion, which is the amount eligible for the deduction.
Employers must configure payroll software to flag and total this qualifying overtime premium separately for each employee. While this tracking begins in 2025, W-2 forms will not display the new overtime field until January 2026 when reporting 2025 wages. The IRS is introducing a dedicated box on the W-2 to show the total qualified overtime amount, allowing employees to claim the deduction without manual calculations.
It’s also important to note that employees will not see changes to their federal income tax withholding in 2025. The deduction will be applied when they file their 2025 return in early 2026. Therefore, accurate year-long tracking is critical to ensure employees receive the full benefit.
Employers are strongly encouraged to coordinate with payroll vendors or in-house accounting teams early, update employee classification records to confirm FLSA coverage, and conduct trial runs before year-end. This proactive approach reduces the risk of compliance issues, IRS reporting errors, or disputes over overtime totals during tax season.
Example: W-2 Before and After the New Rule
Before 2025 – Standard W-2 Layout
- Box 1 (Wages, tips, other compensation): $58,000
- No separate overtime field — all pay (regular + overtime) combined in total wages.
- Employees would have to manually calculate how much of that total was overtime.
After 2025 – New Overtime Field on W-2 (Issued January 2026 for 2025 wages)
- Box 1 (Wages, tips, other compensation): $58,000 (includes regular pay + overtime base pay)
- NEW Box X (Qualified Overtime Premium): $3,200 (only the half-time premium portion eligible for the deduction)
- Social Security and Medicare wages remain unchanged, since the deduction is for federal income tax only.
- Employee uses the amount in Box X directly on their tax return to claim the no-tax-overtime deduction without extra math.
How It Works in Practice:
If an employee earned $58,000 in total pay for 2025, and $3,200 of that was the half-time overtime premium, they could deduct $3,200 from taxable income when filing their federal tax return in 2026. This could save them anywhere from a few hundred to over a thousand dollars in federal income tax, depending on their tax bracket.
When Will It End, and Could It Be Extended?
While the question “when does no tax on overtime start” is finally answered, many are now asking how long it will last. As it stands:
- The policy is active for four tax years: 2025 through 2028.
- It will expire automatically on December 31, 2028, unless Congress votes to extend or make it permanent.
The future of the policy may depend on its economic impact and political shifts over the next few years.
What You Should Do to Prepare
For Employees
- Confirm Overtime Tracking with HR or Payroll
Ask your employer exactly how your overtime will be recorded under the new rules. The tax deduction only applies to the half-time premium portion of overtime pay, so accurate tracking is essential. - Review Pay Stubs Starting January 2025
The no-tax-overtime benefit starts January 1, 2025. Even though you won’t see an immediate change in your take-home pay, your pay stubs should clearly show overtime hours and the extra pay for them. - Keep Overtime Documentation
Save copies of timesheets, pay slips, and work schedules showing your overtime hours. These will help you confirm the correct amount when filing your taxes. - Adjust Your W-4 if Needed
Since the deduction will be claimed on your 2025 tax return, you might want to review your tax withholding to avoid over- or under-payment during the year. - Know the Limits and Rules
There’s an annual cap on how much overtime pay can be deducted, and income limits apply. Make sure you know whether you qualify so you can plan ahead.
For Employers
- Upgrade Payroll Systems
Ensure your payroll software can separately track the half-time premium portion of overtime pay. This will make year-end reporting easier and reduce errors. - Train HR and Payroll Teams
Staff should understand which overtime qualifies, how to record it, and how to answer employee questions about the deduction. - Communicate the Changes to Staff
Let employees know that the benefit applies when they file taxes in 2026 for income earned in 2025, not in their regular paychecks. - Prepare for Year-End Reporting
Develop a clear process for providing overtime totals to employees so they can claim the deduction without confusion or missing data.
Caveats & Scope of Coverage
While the “No Tax on Overtime” provision was designed to provide relief to millions of workers, its practical impact is narrower than it might initially appear. Estimates suggest that only a relatively small share of taxpayers—roughly 8 to 9 percent of all filers—will actually qualify to claim the deduction. This is largely due to income thresholds, filing restrictions, and the requirement that overtime must meet very specific definitions under federal labor law.
One of the biggest limitations is that the benefit only applies to overtime pay that falls under the Fair Labor Standards Act (FLSA) definition—work performed beyond 40 hours in a standard workweek and compensated at time-and-a-half. Workers who are paid under different rules, such as those in the airline and railroad industries or employees covered by state-specific daily overtime systems (for example, overtime triggered after eight hours in a single day), are excluded from this federal deduction. As a result, many workers who do receive overtime pay in practice may not see any change in their tax liability under the new law.
Another important caveat is that the measure operates strictly at the federal level. State and local tax laws are not automatically aligned with the federal deduction, and many jurisdictions may continue to treat overtime pay as fully taxable. This means that workers could still see taxes withheld at the state or local level, even if they are able to deduct their overtime earnings for federal income tax purposes. The end result will vary depending on where an employee lives and works, leading to uneven benefits across the country.
These restrictions highlight the reality that while the law was promoted as a broad tax break for working Americans, the coverage is relatively narrow. The relief will be most meaningful for workers who:
- Consistently log more than 40 hours per week under FLSA rules,
- Fall within the income thresholds set by the legislation, and
- Live in states where the lack of alignment with federal tax law does not erase much of the benefit.
For many others, the change may feel limited or even negligible compared to the initial promise of “no tax on overtime.”
Conclusion
So, when does no tax on overtime start? The official answer is January 1, 2025, and it could become one of the most meaningful tax changes for working-class Americans in years. If you’re eligible, this law will reduce your tax burden and increase your take-home pay—without requiring complex deductions or itemized filings.
This isn’t just tax relief—it’s a step toward recognizing and rewarding hard work. Make sure you’re ready to take advantage when the clock strikes midnight on the new year.
Plan your finances today and get ready to keep more of what you earn in 2025.