The 2025 tax reform introduces sweeping changes to how overtime compensation is taxed and reported for both employees and employers. Aimed at simplifying payroll compliance and enhancing transparency, this legislation bundles several workplace and tax-related updates into one streamlined measure. For tax years 2025 through 2028, businesses and workers will see major updates in how qualified overtime is calculated, deducted, and reported to the IRS.
Key Points
- The 2025 tax reform includes a new deduction for qualified overtime pay exceeding the Fair Labor Standards Act (FLSA) regular rate.
- The annual deduction is capped at $12,500 for individuals and $25,000 for joint filers, phasing out at $150,000/$300,000 modified adjusted gross income.
- Only the premium portion of overtime pay (the “half” in time-and-a-half) qualifies for the deduction.
- Employers must upgrade payroll tracking systems and align reporting with revised IRS requirements.
- Revised Form W-2 reporting codes will roll out for the 2026 filing year; transition relief applies in 2025.
- Businesses may benefit from smoother payroll operations and reduced year-end adjustments.
Q: What is the 2025 tax reform?
A: The 2025 tax reform, also known as the "One, Big, Beautiful Bill Act", is a comprehensive legislative package that rolls multiple workplace and tax updates into one measure, streamlining compliance and modernizing how overtime pay and deductions are handled. Among its changes is a new overtime deduction provision designed to simplify reporting and improve transparency.
Q: What is the new provision on overtime pay?
A: Effective for 2025-2028, individuals who receive qualified overtime compensation may deduct the pay that exceeds their regular rate of pay that is required by the Fair Labor Standards Act (FLSA) and reported on the Form W-2, Form 1099, or other specified statement provided to the individual.
- Maximum annual deduction is $12,500 ($25,000 for joint filers).
- Deduction phases out for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers).
Q: What is “qualified overtime”?
A: For employees who are covered under the Fair Labor Standards Act (FLSA), overtime is required for time worked over 40 hours in a workweek. This overtime is broken into two pieces of income: regular pay for time worked plus a premium overtime amount. Premium overtime is the half-time in “time and a half”. Only the premium portion of the overtime pay is considered exempt under the new legislation. Any overtime received that is not required by the FLSA is still taxable. This includes but is not limited to: State Laws (daily overtime), Union Agreements, Company Policies, etc.
Q: How does this affect my business payroll?
A: Payroll systems will need to be updated to track overtime pay more precisely by pay period. If you use a third-party processor, expect updates to their software and reporting templates. Internal payroll teams should review overtime policies and ensure pay codes and classifications match the new definitions.
Q: Are there any costs or tax benefits for employers?
A: Yes, potentially. The new deduction rules may improve cash flow timing and reduce administrative corrections. By aligning deductions with real-time pay data, businesses can also minimize year-end reconciliation work.
Q: What should employers do now?
A:
- Review payroll processes to ensure overtime tracking aligns with pay periods.
- Coordinate with your payroll provider or accountant about software updates and timing.
- Communicate with employees early if overtime calculation methods will appear differently on pay stubs.
- Stay tuned for IRS guidance; formal regulations and examples will clarify how to apply the new deduction across industries.
Q: What are the reporting requirements for the new overtime deduction?
A: Employers and other payors will be required to file information returns with the IRS (or SSA) and furnish statements to taxpayers showing the total amount of qualified overtime compensation paid during the year. Form W-2 will be revised for the 2026 filing year to include additional Box 12 reporting codes. For the 2025 tax year, the IRS will provide transition relief for taxpayers claiming the deduction and for employers and other payors that are subject to the new reporting requirements. Stay tuned for IRS guidance on formal regulations and examples on how to apply the new deduction across industries.
Q: Where can I go to learn more?
A: The IRS site (https://www.irs.gov/newsroom/one-big-beautiful-bill-act-tax-deductions-for-working-americans-and-seniors) explains the provisions on the new laws that went into effect during the current tax year, including “no tax on overtime”.
Our team will continue monitoring official guidance and provide updates as details are finalized. Reach out to discuss how these changes may impact your payroll strategy or compliance plans.
About the Authors
Kristen O'Connell, CPP
Kristen joined Trout CPA in 2018. With seventeen years of experience in payroll and accounting, Kristen brings extensive experience in managing payroll operations, compliance, and reporting. As the Payroll Supervisor at Trout CPA, she ensures accuracy, efficiency, and client satisfaction across all payroll functions, while supporting the firm’s broader payroll and accounting services.
As a member of the firm’s Outsourced Accounting team, Kristen leads the payroll department with deep expertise in payroll tax compliance, payroll conversions and implementation, vendor relationship management and payroll tax notice resolution. She is dedicated to delivering reliable, compliant, and client-focused payroll solutions that support both employee and business objectives.
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