The federal government created a new deduction for overtime pay. New Jersey refused to follow it. That is the story, and it is the story that matters most to every NJ worker earning overtime. The headlines say "no tax on overtime" but what they mean is no federal tax on the premium portion of overtime pay, up to a cap, subject to income phaseouts. Your NJ-1040 still taxes every dollar of overtime at your full marginal rate.
I work with clients across New Jersey — nurses at Hackensack University Medical Center, police officers in Essex County, electricians on job sites in Bergen County, warehouse workers in the Meadowlands. They all heard the same thing: overtime is tax-free now. It is not. Not in New Jersey. And even federally, it is more limited than most people realize.
This guide explains exactly what the federal deduction covers, why NJ does not follow, what the real dollar impact is at different income levels, and what (if anything) NJ might do in the future. Every number is current as of March 2026.
In this guide:
- What IRC Section 225 Actually Provides
- The FLSA Premium: What "Overtime" Means for This Deduction
- The Safe Harbor Calculation
- Income Phaseouts
- W-2 Reporting: The 2025 Problem and the 2026 Solution
- Tips vs. Overtime: Different Rules
- NJ Does Not Conform: The Core Issue
- NJ Assembly Bill A2621: The Proposed Fix That Has Not Passed
- The Tax Gap: Worked Examples for NJ Workers
- FICA and Self-Employment Tax: Still Applies
- Filing Status Rules: MFS Is Allowed
- FAQ
What IRC Section 225 Actually Provides
Section 225 of the Internal Revenue Code was added by the One Big Beautiful Bill Act (OBBBA, Public Law 119-21), signed July 4, 2025. It creates an above-the-line deduction for qualified overtime compensation. Like the tip income deduction (Section 224) and the car loan interest deduction (Section 226), it is claimed on Schedule 1-A and reduces your adjusted gross income.
Key parameters:
- Maximum deduction: $12,500 (single, head of household, or married filing separately) / $25,000 (married filing jointly)
- Applies to tax years 2025 through 2028 only
- Covers only the FLSA premium portion of overtime pay — not total overtime pay
- Subject to income-based phaseouts starting at $150,000 (single/HoH/MFS) / $300,000 (MFJ)
- MFS is allowed — this is unique among Schedule 1-A deductions
- Above-the-line deduction: you do not need to itemize
The most important detail that people miss: this deduction does not cover all overtime pay. It covers the premium — the extra half, not the full time-and-a-half.
The FLSA Premium: What "Overtime" Means for This Deduction
Under the Fair Labor Standards Act (FLSA), qualifying overtime is paid at 1.5 times your regular rate for hours worked beyond 40 in a workweek. The "premium" is the 0.5x portion — the extra half above your regular rate.
Example: Your regular hourly rate is $30. You work 50 hours in a week.
- Regular pay (40 hours): $1,200
- Overtime pay (10 hours at 1.5x): $450
- The premium (the "half"): 10 hours x $15 (0.5 x $30) = $150
- Only the $150 premium is the deductible amount, not the full $450 of overtime pay
This distinction reduces the value of the deduction by two-thirds compared to what most people expect. If you earn $15,000 in total overtime pay at 1.5x, only $5,000 is the FLSA premium. That is the deductible portion.
Who does NOT qualify:
- Salaried exempt employees who do not receive FLSA overtime
- Independent contractors (1099 workers) — the deduction is for W-2 employees only
- Workers earning overtime at rates other than 1.5x FLSA (some union contracts pay 2x for holidays — only the FLSA-mandated 0.5x premium portion qualifies)
- Self-employed individuals — there is no "overtime" concept for Schedule C filers
The Safe Harbor Calculation
Calculating the exact FLSA premium requires knowing your regular rate and tracking hours worked beyond 40 each week. For many workers, especially those with variable schedules, shift differentials, or commission-based pay, this calculation is complex.
The IRS provides a safe harbor: you may deduct one-third (1/3) of your total overtime pay at the 1.5x rate as the premium amount. This is mathematically equivalent to the 0.5x premium divided by the 1.5x total rate.
Safe harbor example:
- Total overtime pay reported on your W-2: $18,000 (all at 1.5x FLSA rate)
- Safe harbor deduction: $18,000 x 1/3 = $6,000
- This is your deductible amount (subject to the $12,500/$25,000 cap and phaseouts)
The safe harbor is optional. If your actual premium calculation produces a higher number (which it generally will not for standard 1.5x overtime), you can use the actual calculation instead. For most workers, the safe harbor is the simplest and most practical method.
Double-time and higher rates: If your employer pays double-time (2x) for certain hours, the FLSA premium on those hours is 1.0x (not 0.5x). The safe harbor of 1/3 only applies to standard 1.5x overtime. For double-time hours, the premium is half of total overtime pay, not one-third. If you earn overtime at mixed rates, you will need to calculate each tier separately.
Income Phaseouts
The deduction phases out at higher income levels. The thresholds are based on modified adjusted gross income (MAGI).
Phaseout schedule:
| Filing Status | Phaseout Begins | Full Phaseout |
|---|---|---|
| Single | $150,000 | Gradual reduction |
| Head of Household | $150,000 | Gradual reduction |
| Married Filing Jointly | $300,000 | Gradual reduction |
| Married Filing Separately | $150,000 | Gradual reduction |
The phaseout operates similarly to other OBBBA deductions — for each $1,000 of MAGI above the threshold, the maximum deduction is reduced. The reduction rate ensures the deduction is fully eliminated at income levels well above the thresholds.
Practical impact: Most workers earning significant overtime — nurses, police officers, skilled tradespeople, manufacturing workers — earn well below the $150,000 single threshold. The phaseout primarily affects high-earning professionals who also qualify for FLSA overtime (certain roles in finance, technology, or healthcare that fall below the salary threshold for exemption).
W-2 Reporting: The 2025 Problem and the 2026 Solution
Tax Year 2025 (Returns Filed in 2026)
For 2025, there is no dedicated W-2 box for overtime pay. The IRS did not have time to update Form W-2 after the OBBBA was signed in July 2025. Workers claiming the deduction for 2025 must calculate their qualifying overtime from pay stubs, employer records, or timekeeping systems. Keep your final 2025 pay stub — it is your primary documentation.
This is a real compliance headache. Not every employer tracks FLSA overtime separately from total overtime. Some payroll systems report overtime hours but not the premium dollar amount. If your employer cannot provide a year-end overtime summary, reconstruct it from weekly pay stubs.
Tax Year 2026 (Returns Filed in 2027)
Starting in 2026, employers are required to report qualifying overtime compensation in W-2 Box 12 using code "TT". This is the total FLSA overtime pay (the full 1.5x amount, not just the premium). You or your preparer then apply the safe harbor (1/3) or actual calculation to determine the deductible amount.
The Box 12 code TT reporting requirement simplifies compliance significantly. If your W-2 shows code TT with an amount, you know you have qualifying overtime. Apply the 1/3 safe harbor and you have your deduction.
Tips vs. Overtime: Different Rules
The OBBBA created separate deductions for tips (Section 224) and overtime (Section 225). They are reported on different parts of Schedule 1-A and have different rules:
- Tips (Section 224): Deductible up to $25,000. Must be in a tipped occupation. Tips remain subject to FICA (Social Security and Medicare taxes). The deduction only affects income tax, not payroll tax.
- Overtime (Section 225): Deductible up to $12,500/$25,000. Must be FLSA overtime. Overtime also remains subject to FICA. The deduction only affects income tax, not payroll tax.
Critical point: Neither the tip deduction nor the overtime deduction reduces your FICA obligation. Your Social Security and Medicare taxes are calculated on gross wages including tips and overtime. The deductions are income tax deductions only. This is different from an exclusion, which would reduce wages for all purposes.
If you earn both tips and overtime (a server working overtime shifts, for example), you can claim both deductions separately, up to their respective caps.
NJ Does Not Conform: The Core Issue
New Jersey does not recognize the IRC Section 225 overtime deduction. Your overtime pay is fully taxable on your NJ-1040 at your regular NJ marginal rate, regardless of what you deduct federally.
This is not an oversight. New Jersey starts with federal gross income and makes its own adjustments. The state legislature has not passed any legislation conforming to Section 225 or any other Schedule 1-A deduction. As of March 2026, there is no pending legislation with enough support to change this.
Why this hurts NJ workers more than workers in most states:
New Jersey has among the highest state income tax rates in the country. The marginal rates for 2026 are:
| NJ Taxable Income (Single) | Marginal Rate |
|---|---|
| $0 - $20,000 | 1.4% |
| $20,001 - $35,000 | 1.75% |
| $35,001 - $40,000 | 3.5% |
| $40,001 - $75,000 | 5.525% |
| $75,001 - $500,000 | 6.37% |
| $500,001 - $1,000,000 | 8.97% |
| Over $1,000,000 | 10.75% |
A NJ worker in the 6.37% bracket who deducts $6,000 in overtime premium federally saves approximately $1,320 in federal tax (at 22%) but pays approximately $382 in NJ tax on that same $6,000. The NJ tax is unavoidable. The combined net savings is $938 instead of the $1,320 the worker expected.
For a complete breakdown of which OBBBA deductions NJ follows and which it does not, see my NJ OBBBA Conformity Guide.
NJ Assembly Bill A2621: The Proposed Fix That Has Not Passed
New Jersey Assembly Bill A2621, introduced in the 2025-2026 session, proposed conforming NJ to the federal overtime deduction. The bill would have allowed NJ taxpayers to deduct the same FLSA premium amount on their NJ-1040 that they deduct on their federal return.
Status as of March 2026: The bill was referred to the Assembly Taxation Committee. It has not been scheduled for a vote. No companion bill has been introduced in the NJ Senate. Based on the current legislative calendar and committee priorities, passage before the end of the session is unlikely.
Even if A2621 or a similar bill eventually passes, it may not be retroactive to 2025. NJ tax conformity changes typically apply prospectively. Workers should plan assuming NJ non-conformity for the foreseeable future.
The Tax Gap: Worked Examples for NJ Workers
These examples show the federal savings and the NJ "tax gap" — the state tax you still owe on overtime that is federally deductible.
Example 1: Police Officer, $85,000 Base + $22,000 Overtime
- Filing status: Single
- Total overtime (1.5x): $22,000
- Safe harbor premium (1/3): $7,333
- Below $12,500 cap, below $150,000 phaseout
- Federal deduction: $7,333
- Federal tax savings at 22%: $1,613
- NJ tax on same $7,333 at 6.37%: $467
- Net savings after NJ tax gap: $1,146
Example 2: Registered Nurse, $78,000 Base + $30,000 Overtime
- Filing status: Married filing jointly (household MAGI: $160,000)
- Total overtime (1.5x): $30,000
- Safe harbor premium (1/3): $10,000
- Below $25,000 cap, below $300,000 phaseout
- Federal deduction: $10,000
- Federal tax savings at 22%: $2,200
- NJ tax on same $10,000 at 5.525%: $553
- Net savings after NJ tax gap: $1,648
Example 3: Electrician (IBEW), $95,000 Base + $40,000 Overtime
- Filing status: Single
- Total overtime (1.5x): $40,000
- Safe harbor premium (1/3): $13,333
- Cap applies: deduction limited to $12,500
- Below $150,000 phaseout (MAGI: $135,000)
- Federal deduction: $12,500
- Federal tax savings at 24%: $3,000
- NJ tax on same $12,500 at 6.37%: $796
- Net savings after NJ tax gap: $2,204
Example 4: Warehouse Worker, $52,000 Base + $12,000 Overtime
- Filing status: Single
- Total overtime (1.5x): $12,000
- Safe harbor premium (1/3): $4,000
- Below $12,500 cap, well below $150,000 phaseout
- Federal deduction: $4,000
- Federal tax savings at 12%: $480
- NJ tax on same $4,000 at 5.525%: $221
- Net savings after NJ tax gap: $259
- This worker keeps only 54% of the theoretical benefit because of NJ non-conformity
Example 5: Married Couple, Both Earning Overtime
- Spouse 1: $70,000 base + $15,000 OT (premium: $5,000)
- Spouse 2: $65,000 base + $18,000 OT (premium: $6,000)
- Filing MFJ, household MAGI: $168,000
- Combined premium: $11,000
- Below $25,000 cap, below $300,000 phaseout
- Federal deduction: $11,000
- Federal tax savings at 22%: $2,420
- NJ tax on same $11,000 at 5.525%: $608
- Net savings after NJ tax gap: $1,812
FICA and Self-Employment Tax: Still Applies
I cannot emphasize this enough: the overtime deduction does not reduce FICA taxes. Your employer still withholds 6.2% Social Security tax (up to the $184,500 wage base for 2026) and 1.45% Medicare tax on all overtime pay. The employer match is unaffected. The 0.9% Additional Medicare Tax above $200,000/$250,000 is also unaffected.
For a worker earning $30,000 in overtime, the FICA taxes are approximately $2,295 (employee share) regardless of the Section 225 deduction. The deduction only reduces income tax. This is a significant distinction that affects the true value of the deduction.
Filing Status Rules: MFS Is Allowed
Unlike the car loan interest deduction (Section 226) and the senior citizen deduction, the overtime deduction under Section 225 allows married filing separately status. This is unusual among OBBBA Schedule 1-A deductions and is a deliberate legislative choice.
Why this matters: Some married couples file separately for reasons unrelated to tax optimization — income-driven student loan repayment plans, liability isolation, or estranged spouse situations. Those filers can still claim the overtime deduction. The cap for MFS is $12,500 (same as single), and the phaseout threshold is $150,000.
Frequently Asked Questions
Is all overtime tax-free now?
No. The deduction covers only the FLSA premium (the 0.5x "extra half" of time-and-a-half). It only reduces federal income tax, not FICA. And NJ does not conform, so overtime remains fully taxable at the state level in New Jersey.
I am a salaried employee and do not receive overtime. Does this deduction help me?
No. If you are classified as exempt under the FLSA and do not receive overtime pay, Section 225 provides no benefit. This includes most salaried managers, professionals, and executives above the FLSA salary threshold ($58,656 for 2026).
My employer pays double-time for holidays. Does that qualify?
Partially. The FLSA-mandated premium is 0.5x for standard overtime. For double-time hours, the FLSA premium is 1.0x (the amount above straight time). The additional 0.5x above the FLSA mandate (the portion from 1.5x to 2.0x) is not FLSA-required and may not qualify. The safe harbor of 1/3 only applies to standard 1.5x overtime. Calculate double-time premiums separately.
Will NJ ever conform to the federal overtime deduction?
Unknown. Assembly Bill A2621 has been introduced but has not advanced. New Jersey has historically been reluctant to adopt federal tax deductions that reduce state revenue. The cost of conforming to all OBBBA deductions would be hundreds of millions in lost NJ revenue annually. I would not plan on it.
Can I claim both the overtime deduction and the tip deduction?
Yes, if you qualify for both. They are separate deductions on separate parts of Schedule 1-A with separate caps ($12,500/$25,000 for overtime, $25,000 for tips). A restaurant worker earning both tips and FLSA overtime can claim both.
Does the overtime deduction reduce my AGI?
Yes. It is an above-the-line deduction on Schedule 1-A, which reduces AGI. A lower AGI can improve eligibility for other tax benefits that phase out based on AGI (education credits, IRA deductions, etc.).
I am an independent contractor who works more than 40 hours per week. Do I qualify?
No. The deduction is for FLSA overtime, which only applies to W-2 employees. Independent contractors are not covered by the FLSA and cannot claim Section 225. Self-employed individuals do not have "overtime" for tax purposes.
What records do I need to claim the deduction?
For 2025: pay stubs showing overtime hours and rates, or an employer-provided overtime summary. For 2026 and later: your W-2 with Box 12 code TT showing qualifying overtime compensation. In all years, keep records of hours worked and rates paid in case of audit.
Does the deduction apply to state overtime laws (like California's daily overtime)?
The statute references FLSA overtime specifically. California and a few other states require overtime for daily hours exceeding 8 (rather than weekly hours exceeding 40). To the extent those hours also qualify as FLSA overtime (weekly hours over 40), the premium qualifies. Hours that are overtime under state law but not under the FLSA (daily overtime in a week with 40 or fewer total hours) likely do not qualify, though the IRS has not issued specific guidance on this point.
What about compensatory time instead of overtime pay?
If your employer provides comp time instead of cash overtime pay (permitted for certain public-sector employees), there is no cash payment to deduct. Section 225 applies to compensation received. When you eventually cash out unused comp time, that cash payment may qualify if it represents FLSA overtime premium.
How do I calculate the deduction if I had multiple employers?
Add up the qualifying overtime from all employers. Each employer calculates FLSA overtime independently (hours worked at one employer do not combine with hours at another for FLSA purposes). Apply the safe harbor (1/3) to each employer's overtime separately, then sum the results. The total is subject to the single $12,500/$25,000 cap.
I am retired and receive a pension. My pension includes overtime I earned during my career. Does the deduction apply to pension income?
No. The deduction applies to overtime compensation received in the current tax year. Pension income, even if calculated using a formula that included overtime-eligible wages, is retirement income — not current overtime compensation.
My pay stub shows "overtime" but I am paid a day rate, not hourly. Do I qualify?
Day-rate workers are covered by the FLSA if they are non-exempt. The FLSA overtime premium for day-rate workers is calculated differently (the regular rate is the day rate divided by hours worked, and the premium is 0.5x that rate for hours over 40). If your employer pays FLSA-mandated overtime, the premium qualifies. The safe harbor may not produce accurate results for non-standard pay structures — consider using the actual calculation.
Does the deduction apply to overtime earned in a state with no income tax (like Florida)?
Yes. The deduction is federal. It applies regardless of your state of residence. If you live in a state with no income tax, you get the full federal benefit with no state tax gap. NJ residents are in the opposite position — they get the federal benefit but face NJ tax on the full overtime amount.
What is the NJ vs. federal tax difference for someone with $25,000 in overtime?
For a single filer in the NJ 6.37% bracket: safe harbor premium is $8,333. Federal savings at 22% is approximately $1,833. NJ tax on the same $8,333 is approximately $531. The gap means NJ residents keep approximately $1,302 — about 71% of the theoretical benefit. For an MFJ couple with combined $25,000 overtime: safe harbor is $8,333. Same federal savings. NJ tax gap depends on the applicable NJ bracket.
For a broader look at how NJ handles all federal deductions for small businesses, see my NJ vs. Federal Tax Rules guide.
Related reading: Schedule 1-A Complete Guide | NJ OBBBA Conformity Guide | NJ vs. Federal Tax Rules for Small Business
Circular 230 Disclosure: This post provides general tax information and is not a substitute for personalized tax advice. Consult a qualified tax professional for advice specific to your situation.
