Understanding the new "no-tax on overtime" deduction under Code §225

Understanding the new “no-tax on overtime” deduction under Code §225 

Under the One Big Beautiful Bill Act (OBBBA), new Code §225 creates a temporary “no-tax on overtime” deduction for tax years 2025–2028. Essentially, individuals may deduct the “premium” portion of overtime pay — the “half” in time-and-a-half required by the Fair Labor Standards Act (FLSA) — provided that overtime was required by the FLSA and reported on Form W-2, Form 1099, or other relevant payee statement. The deduction is capped at $12,500 per year (or $25,000 if married filing jointly), with a phase-out beginning at $150,000 modified adjusted gross income ($300,000 MFJ). Eligible taxpayers — whether itemizing or not — must provide a valid Social Security Number and must file jointly if married.  

In its transition-year guidance, the IRS recognized that many employers and payors lack systems to separately report “qualified overtime compensation” for 2025. Accordingly, under Notice 2025-62, the IRS provides penalty relief — no penalties under Code §§ 6721 or 6722 will be imposed for failing to separately report qualified overtime (or cash tips) on 2025 Forms W-2 or 1099s, as long as the rest of the return or statement is complete and correct.  

At the same time, under Notice 2025-69, the IRS offers instructions to individuals on how to compute their 2025 deduction without relying on separate reporting: taxpayers may use their own payroll records, pay stubs, or other documentation to determine the “qualified overtime” amount. The IRS also confirms that starting in 2026, updated Forms W-2 and 1099 will be required to separately report qualified overtime (and qualified tips), thereby simplifying future calculations.

Finally, the IRS reiterates that the deduction applies only to the overtime premium required by FLSA. Any additional amounts — for example, overtime paid under more generous state laws, collective bargaining agreements, voluntary premiums, standby pay, or on-call pay — remain ineligible for the “no-tax” deduction.  

Under the FLSA, overtime is owed for all hours worked over 40 in a workweek by nonexempt employees. The overtime rate must be