Federal law created a deduction for qualified overtime compensation, while New Jersey does not conform to it. The phrase "no tax on overtime" refers to a federal deduction for the qualifying premium portion, subject to its cap, phaseout, and other requirements. New Jersey continues to apply its own income-tax rules to overtime wages.
Occupation and employer labels do not decide eligibility. Apply the federal FLSA-premium, reporting, filing-status, MAGI, and cap rules, then separately apply New Jersey's nonconforming return treatment.
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. The pending-legislation discussion is current as of August 6, 2026; recheck the official bill record before relying on it.
In This Article
- What IRC Section 225 Actually Provides
- The FLSA Premium: What "Overtime" Means for This Deduction
- The 2025 Transition Reconstruction
- 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 A3151: A Current-Session Proposal That Has Not Passed
- The Tax Gap: 2025 Transition Examples for NJ Workers
- FICA and Self-Employment Tax: Still Applies
- Filing Status Rules: Joint Filing Required (MFS NOT Eligible)
- Frequently Asked Questions
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 a below-the-line deduction for qualified overtime compensation. Like the tip income deduction (Section 224) and the car loan interest deduction (IRC §163(h)(4)), it is claimed on Schedule 1-A; its total flows to Form 1040 Line 13b and reduces your taxable income, but it does not reduce AGI.
Key parameters:
- Maximum deduction: $12,500 (single or head of household) / $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) / $300,000 (MFJ)
- MFS is NOT eligible. Per IRS OBBBA worker-deductions guidance, taxpayers must file jointly if married to claim the §225 overtime deduction. MFS filers cannot claim this deduction (this matches the §224 tips deduction and §151(d)(5) senior deduction MFS rules).
- Below-the-line deduction (reduces taxable income, not AGI): you do not need to itemize
The deduction does not cover all overtime pay. It covers the qualifying premium - the extra half in the ordinary time-and-a-half example, not the full time-and-a-half amount.
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
Illustration: if $15,000 is total FLSA overtime compensation paid at 1.5x, the 0.5x premium component is $5,000 before applying the cap, phaseout, and other requirements.
The math nobody explains: Your W-2 shows $60/hour overtime pay. Only $20 of that (the premium above your $40 regular rate) qualifies for the deduction. The other $40 is still fully taxable.
Who qualifies:
- W-2 employees receiving qualifying FLSA overtime
- Workers paid on a 1099 can also qualify, but the compensation form is not the gating factor and neither is a label: what matters is whether FLSA Section 7 legally required the overtime premium, which turns on employment status. In substance the worker must be an FLSA-covered nonexempt employee entitled to Section 7 overtime, even if paid on a 1099 for tax purposes; a voluntary contractual premium paid to a genuine independent contractor does not qualify.
Who or what does NOT qualify:
- Salaried exempt employees who do not receive FLSA-mandated overtime
- 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)
- Pure self-employed individuals with no qualifying overtime compensation (there is no 'overtime' concept for ordinary Schedule C net income). A worker paid on a 1099 qualifies only if, in substance, they are an FLSA-covered nonexempt employee whose employment status entitles them to Section 7 overtime - not merely because a contract labels some pay 'overtime'.
- Married taxpayers filing separately (MFS) - joint filing required
The 2025 Transition Reconstruction
Calculating the exact FLSA premium requires knowing the regular rate and tracking the applicable overtime hours. Variable schedules, shift differentials, commission-based pay, and alternative FLSA overtime structures can change the required inputs and computation.
For tax year 2025, the IRS permits a reasonable reconstruction method (Notice 2025-69) when the qualified amount was not separately reported: if the figure you have is total compensation paid at the 1.5x rate, the qualified 0.5x premium is one-third (1/3) of it (0.5x divided by the 1.5x total rate); if the figure is total compensation paid at 2x, the qualified premium is one-fourth (1/4). This is a 2025 transition method, not a timeless rule. Starting with 2026, the ordinary path uses the separately reported qualified amount (for example, W-2 Box 12 code TT), so routine reconstruction should not be needed.
2025 transition reconstruction 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)
For tax year 2025, use a permitted Notice 2025-69 reconstruction only when its conditions are met, and retain the supporting pay records. Starting with 2026, use the qualified amount reported with W-2 Box 12 code TT; if it is wrong or missing, request a corrected Form W-2 rather than extending the 2025 reconstruction relief.
Double-time and higher rates: Only the federally required 0.5x premium qualifies. If your employer pays double-time (2x) for certain hours, the amount above straight time is 1.0x, but the FLSA-required premium remains 0.5x - the additional 0.5x from 1.5x to 2.0x is a voluntary premium and generally does not qualify. So the qualifying portion is one-fourth (1/4) of total double-time (2x) compensation, or, equivalently, one-half of the separately stated 1.0x excess over straight time - not half of total double-time pay. If you earn overtime at mixed rates, 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 | $275,000 |
| Head of Household | $150,000 | $275,000 |
| Married Filing Jointly | $300,000 | $550,000 |
| Married Filing Separately | Not eligible - joint filing required | n/a |
The deduction is reduced by $100 for each $1,000 (or fraction thereof) of MAGI above the applicable threshold. The table's full-phaseout points show when the maximum $12,500 or $25,000 cap would be eliminated; a taxpayer's smaller preliminary deduction can reach zero sooner.
Practical impact: Apply the filing-status threshold and phaseout to the taxpayer's actual MAGI and qualified-overtime amount. An occupation label does not establish FLSA eligibility, income, or whether the phaseout applies.
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 the qualifying overtime premium in W-2 Box 12 using code "TT". Per the 2026 General Instructions for Forms W-2 and W-3 (Box 12, code TT), Code TT reports the 0.5x premium portion only (the "half-time" above straight-time rate that qualifies for §225) - NOT the full 1.5x FLSA overtime compensation; the Treasury/IRS qualified-overtime FAQs (IR-2026-10, January 23, 2026) describe the deductible amount the same way. The straight-time portion of overtime hours remains in Box 1 wages. Your preparer claims the Code TT amount directly as the §225 deduction.
The Box 12 code TT reporting requirement simplifies compliance significantly. Code TT is the starting reported amount of qualified overtime compensation - the allowed §225 deduction is that amount after applying the $12,500/$25,000 cap, the MAGI phase-out, the SSN requirement, and the joint-return rule for married filers. No separate 1/3 safe-harbor calculation is needed for 2026 W-2 amounts; the reconstruction methods were 2025 transition relief.
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 computes gross income under its own sixteen separately enumerated statutory categories (N.J.S.A. 54A:5-1(a)-(p)) and never starts from federal AGI or federal taxable income, so a federal Schedule 1-A deduction has nothing to flow through. The state legislature has not enacted legislation conforming to Section 225 or the other Schedule 1-A deductions - a pattern I document in my NJ OBBBA Conformity Guide. A3151 is a pending state proposal, discussed below, and does not change current return treatment.
New Jersey rate context:
Apply the taxpayer's actual New Jersey taxable-income facts to the 2026 marginal-rate schedule:
| 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%). NJ tax of approximately $382 on that same $6,000 continues to apply exactly as it did before OBBBA - the federal deduction neither increases nor decreases it. The incremental saving from Section 225 is therefore the full $1,320 of federal tax; the $382 is the continuing NJ burden to budget for, not a reduction of the federal benefit.
For a complete breakdown of which OBBBA deductions NJ follows and which it does not, see my NJ OBBBA Conformity Guide.
NJ Assembly Bill A3151: A Current-Session Proposal That Has Not Passed
New Jersey Assembly Bill A3151 (opens in a new tab), pre-filed for introduction in the 2026 session, proposes excluding qualifying overtime pay from New Jersey gross income and withholding. It is a separate state proposal, not an enacted extension of the federal Schedule 1-A deduction. Prior-session A2621 contained a materially similar proposal but expired without enactment at the end of the 2024-2025 legislative session.
Status as of August 6, 2026: A3151's current official text is labeled "Introduced Pending Technical Review by Legislative Counsel." It has not been enacted. A proposal does not change an NJ return unless the Legislature passes it and the governor signs it.
Unless and until A3151 or another bill is enacted with an applicable effective date, workers should prepare on the basis that overtime remains fully taxable by New Jersey.
The Tax Gap: 2025 Transition Examples for NJ Workers
These examples use the Notice 2025-69 reconstruction for tax year 2025 and show the federal savings and, separately, the continuing NJ tax on the same premium. For 2026 and later, substitute the actual W-2 Box 12 code TT amount; do not reuse the one-third reconstruction. The NJ figure is context - NJ taxed this overtime before OBBBA and taxes it the same way after, so the incremental saving from Section 225 is the federal amount; the NJ line shows what still has to be budgeted at the state level.
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
- Incremental saving from §225: the full $1,613 federal reduction. Continuing NJ tax on the same $7,333 (unchanged by the deduction): $467
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 6.37% (MFJ household income $160,000 is in the 6.37% bracket - the 5.525% bracket for MFJ ends at $150,000): $637
- Incremental saving from §225: the full $2,200 federal reduction. Continuing NJ tax on the same $10,000 (unchanged by the deduction): $637
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
- Incremental saving from §225: the full $3,000 federal reduction. Continuing NJ tax on the same $12,500 (unchanged by the deduction): $796
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
- Incremental saving from §225: the full $480 federal reduction. Continuing NJ tax on the same $4,000 (unchanged by the deduction): $221
- Because NJ never conformed, the worker's NJ bill is the same as it would have been without OBBBA; the federal $480 is the entire incremental benefit
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 6.37% (MFJ household MAGI $168,000 is in the 6.37% bracket starting at $150,000 MFJ): $701
- Incremental saving from §225: the full $2,420 federal reduction. Continuing NJ tax on the same $11,000 (unchanged by the deduction): $701
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. Form 8959 separately applies the 0.9% Additional Medicare Tax when combined Medicare wages and self-employment income exceed $200,000 for single/head-of-household/qualifying-surviving-spouse filers, $250,000 MFJ, or $125,000 MFS; wages reduce the threshold applied to self-employment income but not below zero, and RRTA compensation is tested separately.
For a worker earning $30,000 in overtime, the ordinary 7.65% employee-FICA arithmetic is $2,295 only when all $30,000 remains within the worker's available Social Security wage base and no Additional Medicare Tax applies. Actual payroll tax depends on total Social Security wages, combined Medicare wages and self-employment income, filing status, and the Form 8959 thresholds. Section 225 reduces neither the FICA wage base nor those payroll-tax computations.
Filing Status Rules: Joint Filing Required (MFS NOT Eligible)
Per IRS OBBBA worker-deductions guidance, married taxpayers must file jointly to claim the §225 overtime deduction. MFS filers are NOT eligible. This matches the MFS treatment for the §224 tips deduction and the §151(d)(5) senior deduction - all three OBBBA Schedule 1-A worker deductions require joint filing for married taxpayers.
Planning implication for couples on income-driven student loan plans: Couples who file MFS for reasons unrelated to tax optimization (income-driven student loan repayment plans, liability isolation, or estranged spouse situations) cannot claim the overtime deduction while filing MFS. Run the numbers carefully: the federal income-tax savings from §225 may not outweigh the loss of student-loan benefits from filing jointly, but you cannot get both simultaneously. This is a real trade-off, not a workaround.
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 no qualified overtime compensation was paid. Exempt status, duties, salary, and the current FLSA rules determine whether overtime was required; a salaried job title alone does not decide eligibility.
My employer pays double-time for holidays. Does that qualify?
Partially. The FLSA-mandated premium is 0.5x for standard overtime, and only that federally required 0.5x premium qualifies. For double-time hours, the amount above straight time is 1.0x, but the FLSA-required portion is still only 0.5x - the additional 0.5x above the FLSA mandate (the portion from 1.5x to 2.0x) is a voluntary premium and generally does not qualify. The 2025 one-third reconstruction applies to 1.5x overtime; for 2x pay the qualifying share is one-fourth of the total (or half of the separately stated 1.0x excess). Calculate double-time premiums separately.
Will NJ ever conform to the federal overtime deduction?
Unknown. Assembly Bill A3151 proposes a New Jersey overtime exclusion, but its official status is "Introduced Pending Technical Review by Legislative Counsel" and it has not been enacted. Do not claim a state exclusion unless enacted law applies to the return year.
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?
No. It is a below-the-line deduction on Schedule 1-A; its total flows to Form 1040 Line 13b, reducing taxable income but not AGI. This is an important distinction: AGI-dependent benefits (EITC, CTC phase-outs, Roth IRA limits, IRMAA surcharges) are not improved by the overtime deduction.
I am an independent contractor who works more than 40 hours per week. Do I qualify?
Working more than 40 hours does not by itself qualify. Ordinary Schedule C income has no overtime concept. The compensation form is not the gating factor: the amount must be overtime required under FLSA Section 7, which turns on the worker's actual employment status and pay facts. Apply the current information-reporting requirements to any qualifying amount; a contractual label alone is insufficient.
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) do not qualify. The IRS addressed this directly in its updated FAQs (FS-2026-13, August 6, 2026): only the FLSA-required premium portion is qualified overtime, and a premium required solely by state law - including a state daily-overtime mandate - or by a contract or collective bargaining agreement is not qualified.
What about compensatory time instead of overtime pay?
If your employer provides comp time instead of immediate cash overtime pay (permitted for certain public-sector employees under FLSA Section 207(o)), Section 225 applies to compensation received - so the deduction arises when wages are actually paid with respect to that comp time. Per Notice 2025-69 Example 6, wages paid when you USE accrued comp time can contain a qualified overtime component (one-third in the notice's 2025 example), and a later cash-out of unused comp time can also qualify to the extent it represents FLSA overtime premium. Timing follows when the wages are paid, not when the overtime hours were worked. Per the updated IRS FAQs (FS-2026-13, August 6, 2026, Q16-Q18), only the FLSA-required premium portion is qualified overtime, and premiums required solely by state law or by a contract or collective bargaining agreement are not qualified - so paid or cashed-out comp time qualifies only to the extent it carries the federally required 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). For tax year 2025, apply the Notice 2025-69 reconstruction (1/3 of 1.5x overtime pay) to each employer's overtime separately, then sum the results. For 2026 and later, use each W-2's Box 12 code TT amount instead - the reconstruction was 2025 transition relief. 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 can qualify. For 2025, apply only a Notice 2025-69 reconstruction whose conditions fit the records. For 2026 and later, use W-2 Box 12 code TT; if it is wrong or missing, request Form W-2c rather than substituting the 2025 reconstruction.
Does the deduction apply to overtime earned in a state with no income tax (like Florida)?
The federal deduction does not depend on state residence, but its cap, phaseout, filing-status, reporting, and FLSA requirements still apply. State treatment is separate: a no-income-tax state has no state income-tax conformity calculation, while New Jersey does not allow the federal Section 225 deduction on the NJ-1040.
What is the NJ vs. federal tax difference for someone with $25,000 in overtime?
Assume a 2026 single filer's W-2 Box 12 code TT correctly reports $8,333 of qualified overtime compensation and the filer is in the 22% federal and 6.37% NJ brackets. Before credits and other return effects, the federal deduction changes federal tax by approximately $1,833, while NJ tax on the same $8,333 remains approximately $531 because NJ does not conform. For an MFJ couple, use the combined qualified amounts actually reported and the couple's applicable federal and NJ brackets; do not reconstruct a 2026 amount from total overtime pay.
For a broader look at how NJ handles all federal deductions for small businesses, see my NJ vs. Federal Tax Rules guide.
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Related reading: Schedule 1-A Complete Guide | NJ OBBBA Conformity Guide | OBBBA Tax Changes for NJ Filers | No Tax on Tips in NJ | Car Loan Interest Deduction
