(This column originally appeared in the Inquirer)
One of the more touted provisions of President Donald Trump’s “Big Beautiful” tax and spending bill, which was signed into law this summer, was a new deduction that reduces taxes on overtime wages.
But nothing is as good as it seems, and both employers and employees should be aware of a few concerns.
Not all overtime wages are tax-free
For starters, the “no tax on overtime” promise doesn’t apply to all overtime wages. The calculation only takes into consideration the differential of overtime wages paid, not the entire amount of overtime pay.
For example, if an employee makes $20 per hour and after 40 hours is paid time-and-a-half ($30) it’s only the “half” part ($10) that’s eligible for the deduction.
Many financial experts are recommending that employers update their payroll systems to ensure they are tracking hourly vs. salaried workers, and that they are properly classified under the Fair Labor Standards Act (FLSA).
“Accurate tracking is critical,” said Alex Jones, a CPA and senior manager at Brinker Simpson & Company LLC in Media.
“Misinformation online has led some employers to mistakenly think they no longer need to track or run overtime through payroll, which is incorrect” Jones said. “Employers must continue to pay, record, and report overtime as usual and they must separate overtime pay from regular wages.”
In addition, it’s still unclear whether all overtime pay will be eligible for the deduction. The current guidance only discusses overtime pay on wages under the Fair Labor Standards Act. But some employers pay overtime subject to union agreements — or in accordance with industry practices, such as prevailing wages in construction — and may be required to adjust their calculation of these wages. These kinds of overtime wages have not yet been addressed under the new law.
“For example, employees may receive overtime under a different system such as a collective bargaining agreement, or the Railway Labor Act,” Scott Klein, a senior manager at the American Institute of Certified Public Accountants (AICPA), said in an email to CFO Dive. “We recommend that employers keep a careful account of the rates and systems that apply for the hours worked by each employee.”
Who takes the overtime deduction?
The overtime deduction is only taken by the employee on their individual tax return. This means employers must withhold all taxes as usual at the time the wages are earned and they must still pay in their employer’s contribution to Social Security and Medicare.
Also, the overtime wage deduction is on the federal level. Most states, including Pennsylvania and New Jersey, do not have this provision for individual state income taxes. Federal and state unemployment and workers’ compensation costs are also unaffected by this rule.
The deduction has an annual limit of $12,500 for individual filers and $25,000 for married couples filing jointly. And it phases out for individuals with an annual modified adjusted gross income over $150,000 ($300,000 for joint filers).
“The ‘no tax on overtime’ deduction is valuable for middle-income workers but offers little or no benefit to high earners due to phaseouts,” said Jones.
When does ‘no tax on overtime’ start and end?
Like the “no tax on tips” provision of the bill, the “no tax on overtime” provision will expire at the end of 2028.
However, despite the bill passing in the middle of this year, the deduction applies for all overtime wages earned and paid starting Jan. 1, 2025.
What employers should know
While the deduction could be beneficial for many workers, some headaches remain for employers.
For the first time ever, companies will now be required to report qualified overtime compensation paid during the year on each employee’s W-2 form. Unfortunately, guidance from the IRS has been limited and the current government shutdown isn’t helping. With only a little more than two months remaining until the end of the year, the clock is ticking.
This is why the AICPA last week called on the IRS to provide a safe harbor for employers and to protect employers from penalties if their reporting is incomplete or inaccurate.
“Employers and payors are unsure of how to satisfy information reporting required … for individuals to be eligible for these deductions,” said Klein. “Additionally, tax return preparers and individuals preparing their own tax returns are unsure which type of alternative documentation they can rely on to support the deductions for qualified overtime compensation.”
Although the rule may have some drawbacks, it also comes with potential unexpected benefits.
Reducing taxable income may help some taxpayers qualify for other credits, such as the Earned Income Tax Credit or child and dependent care tax credits, said Linda Scheer CPA, a Tax Manager at J. Cohen CPAs & Advisors in Philadelphia.
Scheer’s advice to both employees and employers is to plan ahead.
“Employees should review pay stubs throughout the year to confirm accuracy and prevent end-of-year mismatches,” she said. “For employers, payroll systems need to accurately track and report overtime pay. Employers that prepare early and maintain clear systems will avoid compliance issues.”
“For employees who qualify,” she added, ”this is a ‘win’ with meaningful savings.”
