The BBB and the New “Limited” Exclusion for Qualified Overtime Pay

President Trump’s recently enacted policy bill, the Big Beautiful Bill (“BBB”) implemented many of his priorities, including a prominent campaign promise: no taxes on overtime. While great for American workers, employers may be wondering how these changes will be implemented and whether they will impact their withholding procedures.

First, the no taxes on overtime provision in the BBB is limited in nature.  Not all overtime payments are excluded from taxes.  The BBB provides a deduction up to $12,500 ($25,000 for married filing jointly) for qualified overtime compensation received during the year. The deduction phases out with Modified Adjusted Gross Income of $150,000 ($300,000 in the case of a joint return).

The exclusion from income applies only to a category of income defined narrowly in the BBB as “qualified overtime compensation.”  This means that the entirety of overtime pay is not excludable from income.  Rather, only the pay differential (the difference in pay rate between regular hours and overtime hours) is excluded.  For example, if an employee is normally paid $20 per hour, but earns $30 per hour during overtime, only the incremental $10 per hour qualifies for the new exclusion.

Please note that a higher overtime rate or more generous overtime eligibility under state law or pursuant to a collective bargaining agreement does not qualify for the deduction.  Likewise, shift differential payments or payments in excess of the federal overtime rate paid for working on a holiday also do not qualify.  For purposes of the BBB, overtime is defined as in conjunction with the FLSA.  This means that overtime is compensation for hours “worked” in excess of forty (40) in a work week, not for hours worked in excess of eight (8) in a day.

The BBB places on employers the obligation to record and keep track of the total amount of qualified overtime compensation received by employees on an annual basis.  Employers are required to report qualified overtime compensation on an employee’s W-2 at the end of each calendar year.  Because there currently is no place on the W-2 form to report this information, the IRS is expected to issue new W-2 forms at some point later this year.

Under a transition rule for 2025, employers “may approximate” on employees’ W-2s the amount of qualified overtime compensation under “any reasonable method specified” by the IRS. This is another aspect of the law where employers will need to keep track of what the IRS has to say when the IRS provides guidance.

The overtime exclusion is currently effective only for tax years 2025 through 2028.

We will continue to monitor any regulatory changes that affect employers and for updates on future guidance that will be provided by the IRS.  Please do not hesitate to contact the attorneys at Hoffman & Hlavac if you have any questions regarding the overtime exclusion or any other labor and employment law issue.

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