New tax break on overtime pay comes with limits

COLUMBIA, Mo. – A new federal tax provision allows some workers to deduct part of their overtime pay from their taxable income, but the change is narrower and more complicated than it may sound.

The provision, in effect for tax years 2025 through 2028, does not eliminate taxes on all overtime pay, according to Andrew Zumwalt, director of the University of Missouri’s Personal Financial Planning program.

Instead, it allows a deduction for the overtime “premium” — the extra pay workers receive beyond their regular hourly wage — subject to income limits and documentation requirements.

Under the law, eligible workers may deduct up to $12,500 of qualified overtime compensation, or up to $25,000 for married couples filing jointly. As with the new deduction for tips, the benefit phases out at higher income levels and requires the worker to have a valid Social Security number.

Only the premium portion counts

A key point often missed is that only the premium portion of overtime pay is deductible, Zumwalt says. Federal labor law generally requires employers to pay “time and a half” for overtime hours. In that case, only the extra “half,” not the full overtime paycheck, qualifies for the deduction.

For example, if an employee is paid $15,000 in total overtime compensation at time-and-a-half rates, only $5,000 counts as qualified overtime compensation for federal tax purposes. That amount is calculated by dividing the total overtime pay by three.

The same approach applies to higher overtime rates. For double time, the qualified portion is one-fourth of the total overtime pay; for triple time, it is one-sixth. Any amount paid above what is required under federal labor law generally does not qualify for the deduction.

Who qualifies as an overtime worker?

The deduction applies only to workers who are covered by, and not exempt from, the Fair Labor Standards Act (FLSA). Most salaried employees are exempt and therefore ineligible. The law also does not create a new definition of overtime; it relies on existing labor law rules.

Special rules apply in certain situations, such as law enforcement employees paid on a work-period basis or public employees who receive compensatory time instead of cash overtime pay. In those cases, the same principle applies: only the portion representing the FLSA-required overtime premium qualifies.

Missouri income tax impact

While the deduction reduces federal taxable income, it does not lower Missouri taxable income. Missouri’s income tax calculation begins with federal adjusted gross income and allows only specific state-authorized adjustments. Because the overtime deduction is taken “below the line” on the federal return, it does not flow through to Missouri taxable income.

As a result, workers who claim the overtime deduction on their federal return should expect to pay Missouri income tax on the full amount of their overtime pay, even if part of it is deductible for federal purposes.

Extra challenges for 2025 filers

W-2 forms do not yet include a dedicated box for reporting qualified overtime compensation. For 2025 returns, taxpayers will need to rely on pay stubs, earnings statements or other records to calculate the deductible amount. If pay statements clearly separate the overtime premium, that figure can be used. If not, taxpayers may need to apply IRS-approved “reasonable methods,” such as dividing total overtime pay by three or four, depending on the overtime rate. Some employers may report the required info in Box 14 to make filing easier for their employees. Beginning in 2026, employers are required to report the qualified amount in Box 12 using a new code.

Zumwalt encourages workers who expect to claim the deduction to keep detailed records and, if necessary, ask employers for clarification. “This is a potentially valuable federal tax break,” he said, “but it’s not automatic, it’s not simple, and it won’t reduce Missouri income taxes.”

Zumwalt discussed this and other changes to federal income tax law at a recent training for volunteers in the Volunteer Income Tax Assistance (VITA) program, in which IRS-certified volunteers discuss and prepare tax returns for free. For more information, visit the Missouri Taxpayer Education Initiative website.