One Big Beautiful Bill (OBBB) Overtime Deduction – What Employers Need to Know for 2026

The One Big Beautiful Bill Act (OBBB or OBBBA) includes a no tax on overtime provision for tax years 2025 through 2028—essentially a deduction for qualified overtime compensation. Employers, especially those who work with labor unions and contractors, need to educate employees about how their deduction will be calculated, so they have reasonable expectations.

Who Qualifies for the Overtime Deduction?

Only W-2 employees are eligible. Individuals working as independent contractors or employees who work for rail carriers don’t qualify for the deduction.

What’s Covered by the Overtime Deduction?

The OBBB introduced a deduction for qualified overtime compensation on overtime required by the FLSA. The FLSA requires overtime after an employee works 40 hours a week. The overtime deduction only applies to the overtime premium portion of FLSA required overtime. The overtime premium portion is the overtime pay that exceeds the employee’s regular rate.

Collective Bargaining Agreement Impact on Overtime Deduction

Overtime that’s not required by the FLSA isn’t eligible to be deducted. Since the FLSA only requires overtime to be paid at time and a half, only the premium portion required under federal law may qualify for the deduction. This can include employers who offer more than the FLSA required overtime amount or workers who are covered by a collective bargaining agreement.  

Example:

A construction worker is part of a collective bargaining agreement. They earn $40 per hour as a regular wage and are eligible for double pay under their collective bargaining agreement. They work 10 hours of overtime for a total of 50 hours a week. Their straight pay (40 hours * $40) equals $1,600. Their overtime pay for the week (10 hours * $80) equals $800. Because the deduction only covers the premium portion, only $20 of the overtime pay qualifies. The worker would qualify for a $200 deduction (10 hours * $20).

Collective bargaining agreements may have different requirements for what is considered overtime. Some employers may pay overtime for shifts that go over 8 hours, but if the worker doesn’t reach 40 hours during the week, they don’t qualify for the overtime deduction.

Example:

A construction worker earns $40 an hour as their regular wage. Under the collective bargaining agreement, the employer is required to pay daily overtime. On Monday, the employee works 9 hours, but they only worked 38 hours total that week. No part of this CBA required overtime qualifies for the deduction.

If the employee works more than 40 hours in the week and qualifies for overtime under their collective bargaining agreement, the premium portion of the overtime pay does qualify for the deduction.

Example:

A construction worker is paid $40 an hour as their regular wages and time and a half for daily overtime for shifts over 8 hours. They work 9 hours every day for five days for a total of 45 hours worked that week. Their regular wages for the week (40 hours * $40) would equal $1,600. Their overtime for the week would be $60 per hour for a total of $300 (5 hours * $60). The worker’s premium portion is $20, bringing their qualified overtime deduction to $100 (5 hours * $20).

Not Qualified Overtime Compensation

The following items are not eligible for deduction:

  • Overtime required by state law
  • Overtime earned under a collective bargaining agreement, except for FLSA overtime that exceeds 40 hours a week
  • Weekend premiums, shift differentials or other differentials not covered by the FLSA

More limitations on overtime eligibility:

  • The deduction is limited to $12,500 for an individual, or $25,000 for married filing jointly.
  • There are phaseouts for higher-income individuals with modified adjusted gross income over $150,000, or $300,000 for joint filers.
  • The deduction is reduced by $100 for every $1,000 over the threshold.
  • Overtime pay may also be subject to state and/or local taxes based on where the employer is located.

Next Steps for Employers

The IRS released guidance in November to provide penalty relief to qualifying employers and other payors for tax year 2025. IR-2025-10 explained that employers and payors won’t face penalties if they fail to provide the total amount of qualified overtime compensation on Forms W-2 or 1099s for 2025.

This relief is only viable if a complete and correct return or statement is provided. Updated Forms W-2 and 1099 will be required starting in 2026 to separately report qualified overtime.

Remind employees that the deduction is claimed on their individual personal tax return and any applicable federal and state taxes will still be deducted from gross payroll.

The IRS also released guidance to help individual taxpayers who qualify for no tax on tips or overtime. Sharing these resources with employees can help answer questions and keep them informed.

Anders Tax advisors work closely with employers to ensure compliance with federal, state and local regulations.

Employers working in union environments may find additional clarification in our companion memorandum addressing overtime deductions under collective bargaining agreements.

Memo on OBBB No Tax on Overtime Provision

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