Overtime Pay Deduction 2026: OBBBA Tax Break for Hourly Workers

What Is the OBBBA Overtime Deduction?

The One, Big, Beautiful Bill Act is the tax law enacted on 4 July 2025. Among other things it created four new deductions for tax years 2025 through 2028 — qualified tips, qualified overtime, car loan interest, and a $6,000 senior deduction — all claimed on a new form, Schedule 1-A, and all available to filers who take the standard deduction as well as to those who itemize. This article covers the overtime one.

How it works:

• Your regular straight-time pay and your overtime are both reported on your W-2 as wages (Box 1).
• Your employer separately reports the qualified overtime compensation — the premium portion — so you can claim it.
• You deduct that premium on Schedule 1-A, which flows to line 13b of Form 1040.

Example:

• You earn $20/hour regular rate, $30/hour for overtime (1.5× multiplier).
• You worked 48 hours one week: 40 regular + 8 overtime.
• Regular pay: 40 × $20 = $800.
• Overtime pay: 8 × $30 = $240.
• Overtime premium deduction available: $80 (the 8 hours × $10 premium over regular rate).

Note what this is not. "No tax on overtime" was the phrase most people heard, and it is not what the law does. The $240 of overtime pay is still fully taxable wages; $80 of it — one third — becomes deductible. It also remains fully subject to Social Security and Medicare tax, which the deduction does not touch at all.

2026 Caps, Phase-Out and Eligibility

How Much Can You Deduct?

This is a phase-out, not a cliff. A single filer with $170,000 of MAGI and $12,500 of qualified overtime loses $100 × 20 = $2,000 and still deducts $10,500. The widely repeated claim that one dollar over a threshold wipes out the whole deduction is wrong.

Who Qualifies?

• Employees who receive overtime required by section 7 of the Fair Labor Standards Act — that is, non-exempt workers paid at least time-and-a-half for hours over 40 in a workweek.
• Your filing status must not be married filing separately, and if you are married you must file jointly.
• You (and your spouse, if filing jointly) must include a Social Security number valid for employment on the return.
• The years are limited: 2025 through 2028, unless Congress extends them.

Who Does NOT Qualify?

• Exempt employees. The test is not salaried versus hourly — it is exempt versus non-exempt. A salaried non-exempt employee who is legally owed and paid FLSA overtime does qualify. A genuinely exempt executive, administrative or professional employee has no FLSA-required overtime to deduct, whatever their employer chooses to pay them.
• Overtime that only state law or a contract requires. This is the trap that catches the most people. California requires time-and-a-half after 8 hours in a day; the FLSA does not. Daily overtime, seventh-day premiums, weekend and holiday differentials, and union-contract overtime beyond the FLSA minimum are all real money — and none of it is qualified overtime unless the FLSA itself required it.
• The straight-time portion. Only the premium half counts, so of time-and-a-half only one third of the overtime payment is deductible.
• High earners above the top of the phase-out range.
• Married filers who file separately.

Calculating Your Overtime Premium Deduction

Step 1: Identify Qualifying Overtime Hours

Track all hours exceeding 40 in a workweek — a fixed, recurring 168-hour period your employer defines, not a pay period and not a calendar week of your choosing. Under the Fair Labor Standards Act, hours 41+ in that workweek are overtime hours. Two 50-hour weeks in a fortnight produce 20 qualifying hours; hours cannot be averaged across the two weeks to make 80 and produce none.

Step 2: Determine Your Overtime Premium Rate

Most overtime is paid at 1.5× your regular rate (time-and-a-half). Some roles offer 2× pay (double-time) after 12 hours or on certain days/holidays.

Example 1:

• Regular hourly rate: $18/hour.
• Overtime rate: $27/hour (1.5×).
• Overtime premium per hour: $27 − $18 = $9/hour.

Example 2:

• Regular rate: $22/hour.
• Double-time rate: $44/hour.
• Overtime premium per hour: $44 − $22 = $22/hour.

A caution on example 2. The FLSA requires one and a half times the regular rate. Where double-time is paid, only the part the FLSA compelled is qualified overtime — the premium half of time-and-a-half, or $11/hour here — and the extra $11 your employer paid voluntarily or under a contract is not. If your employer's reported figure treats all of it as qualified, ask them which rule produced the number.

Step 3: Sum Annual Overtime Premium

Multiply your annual overtime premium per hour by total overtime hours worked.

Full-year example:

• Regular rate: $20/hour.
• Overtime rate: $30/hour (1.5×).
• Overtime premium per hour: $10.
• Total overtime hours worked in 2026: 320 hours (roughly 6 hours/week).
• Annual overtime premium deduction: 320 × $10 = $3,200.

This $3,200 goes on Schedule 1-A and flows to line 13b of Form 1040. Your gross pay for the year is unchanged; what changes is taxable income.

How the Overtime Deduction Stacks With the Standard Deduction

You get both. That is the point of putting these deductions on Schedule 1-A rather than into the itemized schedule.

A W-2 Employee With No Qualified Overtime

• Wages: $62,000, none of it FLSA overtime.
• 2026 standard deduction (single): $16,100.
• Taxable income: $62,000 − $16,100 = $45,900.

The Same Worker With $3,200 of Qualified Overtime

• Wages: $62,000, of which $3,200 is qualified overtime premium.
• AGI: $62,000 — unchanged.
• Standard deduction: $16,100.
• Schedule 1-A overtime deduction: $3,200.
• Taxable income: $62,000 − $16,100 − $3,200 = $42,700.

Tax savings: the $3,200 comes out of the top of this filer's income, and at $45,900 of taxable income that top is the 12% band — which for 2026 runs from $12,400 to $50,400. The saving is $3,200 × 12% = $384. Most articles quote 22% and roughly double the benefit; check your own band first with the tax bracket explainer, because a deduction is only ever worth the rate on the last dollars it removes, and for a $62,000 earner that is 12%, not 22%.

The Key Difference — and the Thing Almost Everyone Gets Wrong

The overtime deduction is not an above-the-line deduction and does not reduce your adjusted gross income. It sits below AGI, alongside the standard deduction. That matters more than it sounds:

• It does not lower your MAGI for Medicare IRMAA, for education credits, for the Roth IRA income limits, for ACA premium credits, or for the 3.8% net investment income tax.
• It does not reduce Social Security or Medicare tax. FICA is withheld on the full overtime payment, premium included.
• It does reduce taxable income, and therefore federal income tax, whether you itemize or not.
• Confusingly, its own phase-out is measured on MAGI — so income you cannot reduce with this deduction is what decides how much of it you get.

If you have been told this deduction will get you under an income threshold, it will not. The levers that lower AGI are traditional 401(k) and HSA contributions, deductible IRA contributions, and the deductible half of self-employment tax.

Employer Reporting Requirements

Your employer is required to report qualified overtime compensation separately, and for 2026 that reporting is the figure you should use rather than your own reconstruction. Look for:

• Box 1 (wages): total W-2 wages, overtime included. This is unchanged.
• A separate qualified-overtime figure, either in Box 12 or on a supplemental statement your employer provides with the W-2.

For tax year 2025 — the first year of the deduction — the IRS gave employers transition relief and allowed a reasonable method of estimating the amount, so 2025 statements vary in quality and some are missing entirely. If yours was, reconstruct from:

• Your pay stubs (showing hourly rate and hours worked each week).
• Your time records.
• Your W-2.

Action: Contact your payroll department and ask one specific question — whether their reported qualified overtime figure includes only the FLSA-required premium, or all overtime-coded pay. Those produce very different numbers if you work in a state with daily overtime rules or under a union contract, and the number on your return is the one you have to defend.

State Tax Implications

The overtime deduction is federal only, and states diverge in a way that matters here more than usual.

• Most states start from federal AGI or federal taxable income. Because this deduction sits below AGI on Schedule 1-A, a state that starts from federal AGI will not pick it up automatically — the state simply never sees it.
• A handful of states have separately enacted their own overtime exclusions; several others have explicitly decoupled from the federal provision.
• Nine states levy no income tax on wages at all, which makes the question moot.

Action: Do not assume the federal deduction flows through to your state return, in either direction. Check your state's conformity rules for tax year 2026 on the state revenue department's own site, and be sceptical of national coverage that treats state treatment as a footnote.

FAQ

Q: Can I deduct overtime if my employer pays it as a flat bonus instead of calculated overtime? A: Generally no. The deduction covers the premium portion of overtime required by section 7 of the FLSA. A flat "overtime bonus" that is not computed as time-and-a-half on hours over 40 in a workweek is not FLSA-required overtime, however it is labelled on the pay stub. Ask payroll how the figure was derived before you claim it.

Q: I earn $170,000 single. Can I deduct any overtime? A: Yes — this is a phase-out, not a cliff. Above $150,000 of modified AGI the deduction drops by $100 for each $1,000, so at $170,000 you lose $2,000 and can still deduct up to $10,500 of the $12,500 cap. It reaches zero at $275,000 single ($550,000 joint).

Q: My W-2 shows total wages of $70,000 with no separate overtime figure. Can I deduct based on my pay stubs? A: For 2025 returns, yes — the IRS allowed employers a reasonable estimation method in the first year, and many did not report it separately. For 2026 the employer is expected to report it, so start by asking for a corrected statement. If you do reconstruct it yourself, keep pay stubs showing hours, rates and the workweek boundaries, and count only the premium half of hours over 40 in a week.

Q: If I claim the overtime deduction, do I lose the standard deduction? A: No. It is claimed on Schedule 1-A and is available to itemizers and non-itemizers alike. You take the standard deduction and the overtime deduction. What it is not is an above-the-line adjustment — it does not reduce your AGI, so it will not get you under an AGI-based threshold.

Q: Can I claim the overtime deduction and itemize instead? A: Yes. The overtime deduction is independent of the standard-versus-itemized choice, so make that choice on its own merits and claim the overtime deduction either way.

Q: My spouse and I both have overtime. Can we both claim it? A: Yes, but the cap is per return, not per person: $25,000 combined on a joint return, against the same $300,000 phase-out threshold. If you are married you must file jointly to claim it at all — married filing separately is ineligible.

Q: What documentation do I need? A: Keep:

• Your W-2(s).
• Pay stubs or payroll records showing hours worked and rates.
• A calculation summary of total overtime hours × premium per hour.
• Any supplemental statement from your employer on overtime premium.

Action Items for 2026

1. Confirm overtime tracking: Ask your payroll department whether they separately report qualified overtime, and whether their figure is FLSA-only or all overtime-coded pay.
2. Reconstruct from pay stubs: If not separately tracked, compile pay stubs showing overtime hours and rates. Calculate: (Overtime rate − Regular rate) × FLSA overtime hours worked in 2026 — hours over 40 in a workweek, not over 8 in a day.
3. Check where you land in the phase-out: Estimate your 2026 modified AGI. Below $150,000 single / $300,000 joint you get the full amount up to the cap; above it, subtract $100 for each $1,000 over.
4. Don't over-adjust your W-4: The deduction is worth your marginal rate on up to $12,500, which for most hourly workers is $1,500 or less. If you want it reflected in your paycheck rather than your refund, enter it in Step 4(b) of a new Form W-4 and check the result with the take-home pay calculator — and remember FICA is withheld on the overtime regardless.
5. Multistate workers: If you worked in multiple states, get advice on both the FLSA-qualification question and state conformity. California, New York and several other states have overtime rules that are more generous than the FLSA, and the extra pay they generate is not deductible federally.
6. Model the whole return: The overtime deduction interacts with the standard deduction, the Child Tax Credit and any other Schedule 1-A item you claim. The 2026 tax return estimator carries all of them through to one number rather than adding separate savings estimates together.

Real-World Scenarios

Scenario 1: Hospital Nurse (Non-Exempt, Hourly)

• Regular rate: $31/hour; total W-2 wages about $76,600.
• Overtime rate: 1.5× = $46.50/hour.
• Hours: 45/week × 52 weeks. FLSA overtime hours: (45 − 40) × 52 = 260.
• Overtime premium per hour: $46.50 − $31 = $15.50.
• Annual overtime deduction: 260 × $15.50 = $4,030 — under the $12,500 cap, and MAGI is far below $150,000, so no phase-out.
• Taxable income of $76,600 − $16,100 = $60,500 puts her in the 22% band, so the deduction is worth $887.
• Note the shift-differential trap: if part of that overtime was paid at a weekend or night rate the hospital sets by contract rather than by the FLSA, only the FLSA-required premium counts.

Scenario 2: Freelance Electrician (1099) — NOT Eligible

• Gross 1099 income: $85,000.
• The overtime deduction requires FLSA-required overtime paid to an employee. An independent contractor has none, because the FLSA does not cover them.
• This electrician uses Schedule C business deductions and the QBI deduction instead.

Scenario 3: Exempt Salaried Manager — NOT Eligible

• Salary: $175,000, exempt executive.
• Genuinely exempt employees are owed no FLSA overtime, so there is no qualified overtime to deduct — and at $175,000 of MAGI the phase-out would already have cut a full $12,500 deduction to $10,000 anyway.
• The distinction that matters is exempt versus non-exempt, not salaried versus hourly. A salaried non-exempt employee paid FLSA overtime does qualify.

Scenario 4: Married Couple, Both Overtime Workers

• Spouse A W-2 wages: $65,000, qualified overtime: $2,500.
• Spouse B W-2 wages: $60,000, qualified overtime: $2,200.
• Combined AGI: $125,000 — the deduction does not reduce AGI.
• Combined MAGI is far below the $300,000 joint phase-out, and $4,700 is far below the $25,000 joint cap, so the full $4,700 is deductible.
• Taxable income: $125,000 − $32,200 standard deduction − $4,700 = $88,100, which is in the 12% band for a joint return. The deduction is worth $564.

Summary Table

Bottom Line

This is a real deduction for non-exempt workers who put in FLSA overtime, and it is smaller than the headlines suggested. Three things decide what you actually get: only the premium half of time-and-a-half qualifies, the cap is $12,500 single and $25,000 joint, and the benefit is worth your marginal rate — 12% or 22% for most hourly workers, so $400 to $1,500 rather than the four-figure numbers people expect from "no tax on overtime". It runs for tax years 2025 through 2028 only. Document the hours, use your employer's reported figure where you have one, and do not count on it to lower your AGI — it sits below AGI and will not move a single income threshold.