No Tax on Overtime: how the deduction is actually calculated (with worked examples)
Last reviewed July 10, 2026 · sourced to IRS guidance (linked below)
"No tax on overtime" is the most misunderstood piece of the One, Big, Beautiful Bill Act (OBBBA). It does not make overtime paychecks tax-free. It's a federal income-tax deduction for tax years 2025–2028 that covers only the FLSA-required premium portion of overtime — the extra "half" in time-and-a-half — and for 2026 it only works if the employer reports that number separately on the W-2. Here's the arithmetic, with examples.
The one rule that drives everything: premium only, FLSA only
Per the IRS, "qualified overtime compensation" is overtime required by section 7 of the Fair Labor Standards Act that exceeds the employee's regular rate. Two consequences:
- Premium only. If an employee's regular rate is $20/hr, the FLSA overtime rate is $30/hr — but only the $10/hr premium is qualified overtime. The $20 base portion of each OT hour is ordinary taxable wages.
- FLSA only. Overtime the FLSA doesn't require doesn't qualify: overtime paid under a state-only rule (e.g., daily overtime for a week that never crosses 40 hours), contractual OT for FLSA-exempt salaried staff, and any generosity above the FLSA minimum. If you pay double time, only the 0.5× portion the FLSA actually requires is qualified — the other 0.5× of the premium is not.
Example 1 — the basic split
Maria earns $20/hr and works 10 overtime hours a week for 50 weeks in 2026 at time-and-a-half ($30/hr). Her total OT pay is $15,000 — but her qualified overtime is 500 hrs × $10 premium = $5,000. That's the number that belongs in W-2 Box 12 code TT, and the most she can deduct.
Example 2 — double time
Dev's regular rate is $20/hr and his employer pays double time ($40/hr) for hours over 40. For each OT hour, only the FLSA-required half — $10 — is qualified overtime. The extra $10/hr above the FLSA requirement is ordinary wages. 100 OT hours → $2,000 wages at base rate + $1,000 qualified premium + $1,000 non-qualified extra premium.
Example 3 — state daily OT that isn't FLSA OT
Priya works four 10-hour days (40 hours total) in a state with daily overtime after 8 hours. Her 8 hours of daily-OT premium are required by state law, not by FLSA §7 (she never exceeded 40 hours in the workweek) — so none of it is qualified overtime for the federal deduction.
Caps and the income phase-out
| Item | Rule |
|---|
| Maximum deduction | $12,500 per year ($25,000 married filing jointly) |
| Phase-out | Reduced once modified AGI exceeds $150,000 ($300,000 joint) — $100 of deduction lost per $1,000 of MAGI over the threshold |
| Who can claim it | Employees with FLSA-required OT reported on their W-2 (self-employed/1099 amounts use 1099-NEC box 1d / 1099-MISC box 14). Available whether or not you itemize; joint filing required if married |
| Years | 2025–2028 |
| Payroll taxes | Unchanged — Social Security/Medicare withholding and employer payroll taxes still apply to all OT pay |
Example 4 — phase-out
Sam (single) has $8,000 of qualified overtime premium and MAGI of $170,000. That's $20,000 over the $150,000 threshold → the deduction shrinks by 20 × $100 = $2,000. Sam deducts $6,000.
What the employer has to do for 2026
For tax year 2026 the reporting is mandatory: the final 2026 Form W-2 adds Box 12 code TT — total qualified overtime compensation (the premium-only number, not total OT pay). (Tips get code TP plus a Treasury occupation code in new Box 14b — covered in the employer guide.) The 2025 penalty grace period does not extend to 2026, so the practical to-do is simple but relentless: capture the premium split every pay period — regular rate, OT hours, premium-only dollars, per employee. Reconstructing a year of splits in January 2027 is the failure mode.
Common payroll trap: most timesheet and POS reports show total overtime pay. If your system can't output the premium-only figure, Box 12 TT becomes a manual calculation for every employee — and the regular rate itself moves whenever nondiscretionary bonuses or shift differentials are in play. Ask your payroll provider now which field feeds code TT.
TipLedger tracks per-period qualified-tip and OT-premium splits that reconcile to W-2-ready totals (Box 12 TP/TT). Free during the beta.
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Related reading
- Tip pools and tip-outs: whose share is a qualified tip — The parallel question on the tips side: which pooled dollars are actually deductible.
- The specified service trade or business exclusion — The SSTB rule reaches qualified tips, not qualified overtime — worth knowing which of your two deductions it touches.
- No Tax on Tips: how much will you actually save? (2026 worked examples) — marginal-rate math, the $25,000 cap, the MAGI phase-out, and what does not change (FICA, state tax).
- Does your state still tax tips and overtime? — Colorado adds the overtime deduction back for 2026 and later while leaving the tips deduction alone, and says overtime stays subject to Colorado withholding even if it is exempt from federal withholding.
- No Tax on Tips & Overtime: what small W-2 employers must report in 2026 — both deductions at a glance, the end of the 2025 grace period, and a 5-step readiness checklist.
- No Tax on Tips: the final IRS occupation list (2026) — the 8 occupation categories and the 4 tests a payment must pass to be a "qualified tip."
- Do you have to report overtime on 2025 W-2s? — for 2025 the premium-only figure goes in Box 14 (Other) under the Notice 2025-62 penalty relief, before the mandatory 2026 reporting kicks in.
- Box 12 code TT: the 2026 employer reporting rule — the employer side, written from IRS FS-2026-13 (August 6, 2026): the per-workweek formula, the double-time and regular-rate traps, and why an unreported amount is simply not deductible.
- The August 2026 mid-year payroll checkpoint — eight questions to run against your payroll system while 2026 is still open.
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