Your Overtime Deduction Questions Answered
The "no tax on overtime" provision will cause problems for practitioners this season
In tax professional social media groups, the §225 overtime deduction is causing significant confusion. And rightly so — the IRS waiver of any required information reporting for tax year 2025 has made this deduction difficult to deduce correctly.
In Notice 2025-69, the IRS gave guidance on how employees can determine their overtime deduction for tax year 2025; however, it was silent on complex issues.
For tax year 2025, it is best practice for employees to provide their last pay statement with their Form W-2 to facilitate the determination of any potential overtime deduction.
What overtime pay is eligible for the deduction?
Overtime compensation is eligible for the deduction only if it is paid under §7 of the Fair Labor Standards Act (FLSA), which is 29 U.S.C. §207. The employee must be covered and non-exempt under the FLSA to be eligible for the overtime deduction.
In addition, the deduction amount is only the premium portion, which is the amount exceeding the regular rate of pay (i.e., the “half” in “time-and-a-half). The deductible amount is called qualified overtime compensation. For example, if an employee earns $20 per hour and the FLSA-required overtime rate is $30 per hour, the deduction is $10 per hour for hours worked in excess of 40 in a week.
Key problem points with this definition:
California and other states require overtime beyond the FLSA amounts; those overtime amounts are not eligible for the deduction.
The Railway Labor Act and other federal laws exempt specific industries or employees from the FLSA, and overtime is paid based on negotiated contracts or other provisions. Overtime paid under these rules is not eligible for the deduction.
Voluntary overtime paid in excess of the FLSA-required time-and-a-half, such as double time, is not eligible for the deduction.
Are employers required to report deduction amounts for tax year 2025?
There is no required reporting for tax year 2025. In Notice 2025-62, the IRS waived penalties for failing to report the qualified overtime compensation amount on Form W-2; however, employers were “encouraged” by the IRS to provide the information to employees in a separate statement or in box 14 of Form W-2.
Starting in 2026, qualified overtime compensation will be reported on Form W-2, box 12, using code TT (according to the current draft).
What if box 14 on Form W-2 does not state the deduction amount?
Under Notice 2025-69, the taxpayer can use their own records, such as their pay statements, to determine the qualified overtime compensation amount. Not having a box 14 entry on a Form W-2 does not mean the employee does not qualify for the overtime deduction.
These two methods come from Notice 2025-69:
If the FLSA-eligible worker is paid 1.5 times their regular rate only for hours worked in excess of 40 per week, the deduction amount is 1/3 of the total overtime pay for the year, as detailed on the year-end final pay statement.
If the FLSA-eligible worker is paid twice their regular rate only for hours worked in excess of 40 per week, the deduction is 1/4 of the total overtime pay for the year, as detailed on the year-end final pay statement.
If a taxpayer has a mix of eligible and ineligible overtime amounts, and the final pay statement does not separate those amounts, the tax professional may need to use a reasonable estimate to allocate the overtime. For example, if the taxpayer states that most of their overtime is from working more than 40 hours per week, but some is from working more than 8 hours per day, an 80% allocation of the total overtime amount may be reasonable. In this case, the deductible qualified overtime compensation is 80% of the total overtime pay multiplied by 1/3, assuming all overtime pay was paid at 1.5 times the regular rate.
If the box 14 amount is inconsistent with the total overtime amount (e.g., the box 14 amount is 100% of the total overtime reported on the last pay statement), due diligence requires practitioners to investigate inconsistent documents and ask questions to determine the correct qualified overtime compensation amount.
Materiality is important to consider as well. Does it make sense to spend significant time investigating a discrepancy or issue for a $100 change in total tax?
What are the limitations on the deduction?
The maximum deduction is $12,500 (or $25,000 married filing jointly). A taxpayer filing married filing separately is ineligible unless they are considered unmarried under §7703(b). There is no limit on the amount one spouse can contribute to the deduction. The overall limitation is applied before the income limitation below.
The deduction phases out starting at $150,000 (or $300,000 married filing jointly) of modified adjusted gross income (MAGI). MAGI is AGI plus the §911, §931, and §933 exclusion amounts.
For every $1,000 the taxpayer exceeds the threshold, their deduction is reduced by $100; fractional amounts do not reduce the deduction.
For example:
If a single taxpayer has $12,500 of qualified overtime compensation, their deduction fully phases out at $275,000 of MAGI.
If a married filing joint taxpayer has $25,000 of qualified overtime compensation, their deduction fully phases out at $550,000 of MAGI.
If the taxpayer’s deduction amount is $0 due to their income, there is no reason to spend any time determining their qualified overtime compensation amount.
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Hi Tom.
In your email you wrote: 'There is no limit on the amount one spouse can contribute to the deduction.'
This means that a MFJ couple who are under the MAGI phase out of $300k can take a full $25k deduction when one spouse has $25k qualified OT and the other spouse has -0-, correct?
TIA.
Hi Tom. I need clarification on "No Tax on Overtime" regarding firefighters. In regards to firefighters, my client is paid on a 56 hour pay period (bi-weekly) at 112 hours "regular pay." With his W2 the city included a supplemental statement calculating his deductible overtime as 12 hours total for the year.
I'm questioning this amount, while reviewing the Fact Sheet #8 on FSLA it indicates that Fire Protection and Law Enforcement employees have different overtime requirements, and employers may use a 28 day period to calculate overtime. It goes on to say that if their hours exceed 106 hours for a 14 day period they are entitled to overtime. If this is the case, my client who has a standard 112 regular hours per pay period, his overtime on his regular time alone would be 156 hours (6x26). He also had 269 hours of overtime (at double-pay) for the year. Could you help me clarify the appropriate deduction in this situation?