No Tax On Overtime

 

Let’s look at the overtime tax changes.

This is one of the provisions from the One Big Beautiful Bill (OBBB) that the president signed on July 4, 2025. It is retroactive to January 1, 2025, and we will be seeing the overtime deductions on individual tax returns filed in 2026 for tax year 2025.

Note that I said “deduction.” As we have discussed before, tax credits are generally worth more than a deduction. The tax impact of a credit is dollar-for-dollar. The tax impact from a deduction depends on your tax rate (if you are at a 22% rate, then your deduction is worth 22 cents on the dollar).  That said, we will take the break.

The key thing here is that the break applies to overtime, so you must be in a job that pays overtime. Multiple parties might address overtime requirements: the federal government, a state government, a union, a voluntary arrangement by your employer, but only the federal definition will work here.

The Code looks at the Fair Labor Standards Act (FLSA), which introduces us to the terms: “exempt” and “nonexempt” employee. Generally speaking, nonexempt employees are required to be paid overtime, whereas exempt employees are not. The overtime pay is defined as 1.5 times the regular pay rate for all hours over 40 and that itself over a 7-day period.

COMMENT: The definition of exempt looks to a duties test (executive, administrative, or professional). A CPA will be considered a professional and therefore exempt for purposes of the FLSA.

Let’s say you are nonexempt under FLSA. You next question should be: how is your overtime computed? The FLSA requires 1.5 times the regular pay rate. Let’s say that your employer pays double time (I wish). How much is your overtime and how much qualifies for the deduction?

EXAMPLE: You make $35/hour and your employer pays double rate for overtime. You have 150 hours of overtime for the year.

150 hours times $35 times 200% = $10,500

That is what you were paid for those overtime hours, but that is not the deduction.

We have previously discussed how the Code likes to take a common term and restrict it by placing “qualified” in front. Your qualified overtime deduction caps out as follows:

150 hours times $35 times 50% = $2,625

Note that the deduction does not apply to the base pay ($35) for your overtime hours. It applies only to the additional pay, and the additional only up to 50% ($35 times 50%). Chances are good that is not the way you think of overtime, but we are talking tax.

COMMENT: Not quite “No Tax On Overtime.”

The FLSA refers to a 7-day period. There are occupations (firefighters come to mind) that are paid on a different cycle. The Code allows for this variation, and we will not discuss it further.

There is a significant reporting issue for 2025 returns to be filed in 2026: the 2025 Form W-2 does not have a box to report “qualified” overtime. In fact, it does not have a specific box to report overtime at all, although an employer may use an available box (probably box 14) to report. The tax bill (OBBA) was signed by the president on July 4, 2025, a bit late into the year to reasonably demand retroactive changes in W-2 reporting. The new 2026 W-2 forms (for returns to be filed in 2027) will be changed to include the amount of qualified overtime.

But what are we to do for the 2025 returns filed in 2026?

First, it is a concern only if you are paid overtime. That knocks out quite a few of us.

Second, I suspect that tax preparers will routinely request a copy of your last 2025 paystub, if you are paid overtime. The stub should have information showing the calculation. Granted, the numbers may have to be reworked, but it is a logical place to start.

Third, your employer might voluntarily provide this information for 2025, in which case you likely have an attachment to your Form W-2. I suppose an employer could alternatively send you to a website for this information. There is a one-time reporting safe harbor for employers: if they tracked your overtime for the second half of 2025 (remember, OBBA was signed July 4, 2025), they can extrapolate to the full 2025 year. This safe harbor goes away for 2026, as employers will be required to track and report actual detail.

COMMENT: There is a somewhat similar W-2 reporting issue for qualified tips. The difference between the overtime deduction and the tips deduction is there is (some) existing tip reporting on the W-2. The tax preparer has a place to start. The preparer has no similar starting place for overtime.

Like the tips deduction, this is not an itemized deduction. You can get this deduction whether you itemize or not.

There is an overall limit on the deduction. If you are single, the limit is $12,500. If you are married, the limit is $25,000.

And this overall limit is reduced if you have too much income. Too much starts at $150,000 for singles and $300,000 for marrieds. Beyond that point, you will phase-out at a dime on the dollar.

If you are married, you will need to file a joint return.

You will need to provide your social security number to claim the deduction. Leave it out and the IRS will automatically revise your tax return and send you a bill.

A bonus will not qualify for this deduction. It must be overtime, even if the bonus is in lieu of overtime. Stand-by or on-call pay will not qualify either.

Like tips, the overtime deduction is for federal income tax only. It will not reduce your FICA taxes, and your state will decide whether you have a state equivalent to the federal tax deduction. Some states will; other states will not.

In case you were wondering: you cannot claim the overtime deduction and the tips deduction on the same income. One or the other, folks.

The deduction has a shelf life of four years. It will go away (unless a future Congress extends it) after the 2028 returns to be filed in 2029.

BTW, you can now revise your 2026 federal Form W-4 (telling your employer how much to withhold) to allow for your expected qualified overtime deduction. You did not have this option (directly; one could get there indirectly) for 2025. Why the difference between 2025 and 2026? Just look to November.

And there you have the new overtime deduction.

Overcontributing To Your 401(k)

 

One of the accountants had a question for me:

A:               I added up the W-2s, but the wages per the software does not agree to my number.

CTG:          Is your number lower?

A:               Yes.

Let’s talk about 401(k)s. More specifically, let’s talk about 401(k)s when one changes jobs during the year. It can be an issue if one is making decent bank.

You are under age 50. How much can you defer in a 401(k)?

For 2021 you can defer $19,500. The limit increased to $20,500 for 2022.

You change jobs during 2021. Say you contributed $14,000 at your first job. The second job doesn’t know how much you contributed at first job. You contribute $12,000 at your second job.

Is there a tax problem?

First, congrats. You are making good money or are a serious saver. It could be both, I suppose.

But, yes, there is a tax problem.

The universe of retirement plans is divided into two broad categories:

·      Defined benefit

·      Defined contribution

Defined benefit are also known as pension plans. Realistically, these plans are becoming extinct outside of a union setting, with the government counting as union.

Defined contribution plans are more commonly represented by 401(k)s, 403(b)s, SIMPLES and so forth. Their common feature is that some – maybe most – of the dollars involved are the employee’s own dollars.

Being tax creatures, you know that both categories have limits. The defined benefit will have a benefit limit (the math can be crazy). The defined contribution will have a contribution limit.

And that contribution limit is $19,500 in 2021 for someone under age 50.

COMMENT: If you google “defined contribution 2021” and come back with $58,000, you may wonder about the difference between the two numbers. The $58,000 includes the employer contribution. Our $19,500 is just the employee contribution. This difference is one of the reasons that solo 401(k)s work as well as they do: they max-out the employer contribution – assuming that the income is there to power the thing, of course.  

Let’s go back to our example. You deferred $26,000 for 2021.

Are you over the limit?

Yep.

If you add your two W-2s together, is the sum your correct taxable wages for 2021?

Nope.

Why not?

Because a 401(k) contribution lowers your (income) taxable wages. You went $6,500 over the limit. Your taxable wages are $6,500 lower than they should be.

 What do you do?

There are two general courses of action:

(1)  Contact one of the employers (probably the second one) explain the issue and request that the W-2 be amended by the deadline date for filing your return – that is, April 15. Rest assured, you have just drawn the wrath of someone in the accounting or payroll department, but you have only so many options. 

BTW the earnings on the excess contributions are also taxable to you. Say that you earned 1% on the excess. That $65 will be taxable to you, but it will be taxable the following year. 

In summary,

§  Your 2021 W-2 income goes up by $6,500

§  You will report the $65 earnings on the excess contribution in 2022.

    It is a mess, but the second option is worse.

(2)  You do not contact one of the employers, or you contact them too late for them to react by April 15.

Your 2021 W-2s show excessive 401(k) deferral.

Your tax preparer will probably catch this and increase your taxable W-2 totals by $6,500. This is what created the accountant’s question at the beginning of this post.

Oh well, you say. You are back to the same place as option one. No harm, no foul – right?

Not quite. 

First, your employer may not be too happy if the issue is later discovered. This is an operational plan issue, and there can be penalties for operational plan issues. 

Second, once you go past the time allowed for correction, the money is stuck in the plan until you are allowed take a distribution (or until the employer learns of the issue and corrects the plan on its own power). 

Say you never tell them. Let’s not burn this bridge, right? 

Problem. Take a look at this bad boy: 

                 Section 402(g)(6)  Coordination with section 72 .

For purposes of applying section 72 , any amount includible in gross income for any taxable year under this subsection but which is not distributed from the plan during such taxable year shall not be treated as investment in the contract.

What does this assemblage of mostly unintelligible words mean?    

It means that you will be taxed again when the 401(k) finally distributes the excess contribution to you. 

Yep, you will be taxed twice on the same income. 

That $6,500 got expensive. 

Upon reflection, there really is no option 2. You have to tell your employer and have them correct the W-2.