How Overtime Pay Is Taxed: Federal Rules & the 2026 Deduction

The federal Fair Labor Standards Act (FLSA) requires employers to pay non-exempt employees at least 1.5 times their regular rate for hours worked over 40 in a workweek. Exempt employees, typically salaried executives, administrators and professionals earning at least $684 a week who meet the duties tests, are not entitled to overtime. Job titles do not decide exemption; actual duties and pay do. Details are on the Department of Labor overtime page.

The "regular rate" includes most non-discretionary bonuses, shift differentials and commissions, not just your base hourly wage. If you earn a $100 production bonus for a 45-hour week, that bonus raises your regular rate for that week and therefore your overtime pay.

When state and federal rules differ, the employee gets whichever is more generous.

Payroll software estimates your annual income by multiplying each paycheck by the number of pay periods. A biweekly worker who normally earns $2,000 but makes $3,000 one period is treated, for that check only, as if they earned $78,000 a year rather than $52,000. Part of the check is therefore withheld at 22% instead of 12%. When you file your return, your tax is computed on your actual annual income, and any excess comes back as a refund. Overtime is not taxed at a higher rate; it is temporarily withheld at one.

The 2025 tax law created a temporary deduction for qualified overtime compensation for tax years 2025 through 2028:

• Only the premium portion counts: the extra half in 'time-and-a-half', not the full overtime wage.
• Maximum deduction: $12,500 per year ($25,000 for married couples filing jointly).
• Phase-out: reduced by $100 for every $1,000 of modified AGI above $150,000 ($300,000 joint).
• Available whether or not you itemize, but you must have a valid SSN and file jointly if married.
• It reduces federal income tax only; Social Security, Medicare and most state taxes still apply.
• Employers report the qualified amount separately on the W-2 (or a statement during the transition years).

Luis earns $25 an hour and works 50 hours a week for 40 weeks. His overtime rate is $37.50. Each week he earns $1,000 regular pay plus $375 overtime.

• Annual overtime pay: 400 hours × $37.50 = $15,000.
• Premium portion: 400 hours × $12.50 = $5,000, which is deductible.
• In the 12% bracket, the deduction saves about $600 of federal income tax.
• FICA of 7.65% still applies to the full $15,000 ($1,148).

Model your own weeks in the overtime pay calculator.

Because the new deduction is claimed on the return, your paychecks may still be withheld as before. If you expect a large deduction, you can lower withholding by adding the expected deduction in Step 4(b) of Form W-4. Our W-4 guide shows how.