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.

The Gig Economy

Say that I retire. Perhaps my wife wins the lottery or marries well.

I get bored. Perhaps I would like a little running-around money. Maybe I flat-out need extra money.

I find a website that connects experienced tax practitioners to people needing tax services. There might be specializations available: as a practitioner I might accept corporate or passthrough work, for example, but not individual tax returns. I could work as much or as little as I want. I might work Friday and Saturday afternoons, for example, but not accept work on weekdays. I could turn down or fire clients. I could take time off without fear of dismissal.

There would have to be rules, of course. Life is a collection of rules. I might have to provide my state license to substantiate my credentials. I might have to post an E&O policy. It seems reasonable to expect the website to impose standards, such as for professional conduct, client communications, timeliness of service and so on

How would I get paid?

I am thinking that I would bill through the website. An advantage is that the website can devote more resources than I care to provide, making the arrangement a win-win-win for all parties involved. The website would collect from the client and then electronically deposit to my bank account.

Here is my question: is the website my employer?

Don’t scoff. We are talking the gig economy.

The issue has gained notoriety as states – New Jersey and California come to mind – have gone after companies like Uber and Lyft. From these states’ perspective, the issue is simple: if there is more than a de minimis interdependence between the service recipient and provider, then there must be an employment relationship between the two. Employment of course means FICA withholding, income tax withholding, unemployment insurance, disability insurance (in some cases), workers compensation and so on.

Let us be honest: employment status is Christmas day for some states. They would deem your garden statue an employee if they could wring a dollar out of you by doing so.

New Jersey recently hit Uber with a tax bill for $650 million, for example.

The employee-independent contractor issue is a BIG deal.

What in the world is the difference between an employee and an independent contractor?

People have been working on this question for a long time. The IRS has posited that employment means control – of the employer over the employee – and also that control travels on a spectrum. As one moves to the one end of the spectrum, it becomes increasingly likely that an employer-employee relationship exists.

The IRS looks at three broad categories:

(1)  Behavioral control

(2)  Financial control

(3)  Relationship of the parties

The IRS then looks at factors (sometimes called the 20 factors) through the lens of the above categories.

·        Can the service recipient tell you what, where, when and how to do something?

·        Is the service recipient the only recipient of the provider’s services?

·        Is the service relationship continuing?

Answer yes to those three factors and you sound a lot like an employee.

Problem is the easy issues exist only in a classroom or at seminar. In the real world, it is much more likely that you will find a mix of yes and no. In that event, how may “yes” answers will mean employee status? How many “no” answers will indicate contractor status?

Answer: no one knows.

Some states have taken a different approach, using what is called an “ABC” test. There was a significant case (Dynamex) in California. It interpreted the ABC test as follows:

(1)  The service provider is free from the direction and control of the service recipient in connection with the performance of the work.

(2)  The service provider performs work outside the usual course of the service recipient’s business.

(3)  The service provider is customarily engaged in the independent performance of the services provided.

I get the first one, but I point out that it is rarely all or nothing. If we here at CTG Command bring on a contractor CPA – say for the busy season or to collaborate on a tax area near the periphery of our experience – we would still have expectations. For example,

·        our office hours are XXX

·        reviewer turnaround times to tax preparers are XXX

·        responses to client calls are to occur with XXX hours or less

·        responses to me are to occur within X hours or less

·        drop-dead due dates are XXX

How many of these can we have before we fail the A in the ABC test?

Let’s look at B.

We are a CPA firm. Odds are we are interested in experienced CPAs. It is quite unlikely that we will have need of a master plumber or stonemason.

Have we automatically failed the B in the ABC test?

And what does C even mean?

I am a 30+ year tax CPA. I am a specialist and have been for many years. I would say that I am “customarily engaged” in tax practice. Do I have “independent performance,” however?

If I interpret this test to mean that I have more than one client, it somewhat makes sense, although there are still issues. For example, upon semi-retirement, I would like to be “of counsel” to a CPA firm. I have no intention of working every day, or of being there endless hours during the busy season. No, what I am thinking is that the firm would call me for specialized work – more complex tax issues, perhaps some tax representation. It would provide a mental challenge but not become a burden to me.

Would I do this for more than one firm?

Doubt it. I point to that “burden” thing.

Have I failed the C test?

I am still thinking through the issues involved in this area.

Including non-tax issues.

If I take an Uber and the driver gets into an accident – injuring me – do I have legal recourse to Uber? Seems to me that I should. Is this question affected by the employee-contractor issue? If it is, should it be?

This prompts me to think that the law is inadequate for a gig economy.

There is, for example, always some degree of control between the parties, if for no other reason than expectation is a variant of control. Not wanting to lose the gig is – at least to me – an incident of control to the service recipient. Talk to a CPA firm partner with an outsized client about expectation and control.

Why cannot CTG Command gig an experienced tax professional – say for a specific engagement or issue - without the presumption that we hired an employee? I can reasonably assure you that I will not be an employee when I go “of counsel.” You can forget my attending those Monday morning staff meetings.

Am I “independently performing” if I have but one client? What if it is a really good client? What if I don’t want a second client?

Problem is, we know there are toxic players out there who will abuse any wiggle room you give them. Still, that is no excuse for bad tax law. Not every person who works – let’s face it – is an employee. The gig economy has simply amplified that fact.