Federal Tax Overtime Implication on 2025 W2s

HR Question

What do I need to do for the 2025 W2s for compliance with the new Federal Overtime Pay Deduction rule?

HR Answer

First, as a general overview, Section 70202 of the One Big Beautiful Bill Act (OBBBA) creates a new above‑the‑line tax deduction for qualified overtime compensation. Beginning in 2025, overtime pay required under Section 7 of the Fair Labor Standards Act (FLSA) is exempt from federal income tax. This means workers can deduct the federal overtime premium portion of their pay directly from their federal income taxes.

Individuals are subject to an annual deduction cap of $12,500 for single filers and up to $25,000 for married couples filing jointly. There is also an income phase-out that applies. For every $1,000 a taxpayer’s modified adjusted gross income exceeds $150,000 (single), or $300,000 (joint), the deduction is reduced by $100. High‑income earners may therefore lose the deduction entirely.

What Does This Mean for the 2025 W‑2?

For the 2025 tax year, the IRS is not penalizing employers for failing to provide a separate accounting of qualified overtime on returns. Employers are encouraged (but not required) to furnish statements that help employees claim the deduction.

• Box 1 (Wages, tips, other compensation) are reported as normal for 2025. Do not remove FLSA overtime from Box 1 this year. For 2025, the deduction is what is referred to as an “above‑the‑line deduction” on their own personal tax returns.
• Box 14 (Other) will be used to provide an informational amount for the federal overtime premium. This will provide the amount of allowable overtime for employees to deduct.

 Allowable Overtime Premium

The only allowed deduction for employees is that which is required under Section 7 of the Fair Labor Standards Act (FLSA). State-mandated, union‑contract negotiated, or company policy overtime does not qualify. Examples of overtime that does not qualify for the deduction includes such things as:

• Daily overtime in states where you pay overtime if you work over 8 hours in one day.
• Company policy that pays overtime (or even double time) for hours worked on the weekend, regardless of whether or not they worked 40 hours that workweek.
• Company policy that counts vacation, sick, paid time off benefits as “hours worked” when calculating overtime. FLSA only required overtime if you WORKED in excess of 40 hours in a work week.

Those extra overtime perks that you provide to your employees are wonderful benefits, but not allowable overtime under the exemption. They should not be included in Box 14.

Federal Income Tax Impact Only

The OBBBA deduction affects federal income tax only. Overtime pay remains subject to:

• Social Security and Medicare (Boxes 3, 5, and related taxes)
• State and local income taxes (Boxes 16–20). These boxes should be completed as usual.

Although optional for 2025, it may be helpful to include a year‑end statement to your employees regarding this rule. Remind them they can claim the FLSA-qualified overtime premium as an above-the-line deduction on their federal tax return and provide information on where to find that number.

Preparing for 2026 and Beyond

The OBBBA’s overtime deduction offers a valuable tax benefit to many workers. 2025 is a transitional year for this piece of legislation and employers should begin preparing today for 2026, scheduled to sunset in 2028.

Beginning in 2026 forward, employers will be required to furnish statements showing qualified overtime received throughout the year. So now is the time to consider reviewing your pay codes to clearly delineate FLSA required overtime (deductible). This will allow you to easily produce the data for the 2026 W2s.  Employers should begin preparing now by updating payroll processes, educating employees, and monitoring IRS guidance as further details emerge.

To learn more about the One Big Beautiful Bill Act’s impact on payroll and benefits, check out our guide that outlines benefits and payroll implications.