Impact of No Tax on Overtime on Signatory Contractors

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Click here for a memo Signatory Contractors can use to communication these changes to their employees.

Click here to view the August 22 webinar on FCA’s YouTube page and click here for presentation slides.

The recently enacted One Big Beautiful Bill Act (OBBBA) changes how certain overtime pay is treated for federal tax purposes. Importantly, the new deduction is tied to the federal Fair Labor Standards Act (FLSA) definition of overtime, not union agreements or state laws. This means not all overtime covered under union contracts will qualify.

NOTE: This is a tax credit that applies to employees, not the business itself.

Contractors will need to adjust payroll systems, coordinate with unions, and communicate clearly with employees to ensure compliance and to help employees maximize the potential tax benefit for employees.

Why This Matters

• Employees may now deduct the half-time premium portion of FLSA-defined overtime from their federal income taxes.
• They cannot deduct the full overtime wage, only the premium amount.
• Under the law, there is no indication that overtime owed solely under union agreements, state law, or company policy that does not meet the FLSA definition qualifies for tax exemption.
• Federal payroll taxes (Social Security and Medicare) remain unaffected.

What Changed

• Effective Date: Retroactive to January 1, 2025; enacted July 4, 2025.
• Deduction: Above-the-line deduction for “qualified overtime compensation” (the FLSA half-time premium).
• Deduction Limits: Up to $12,500 per individual / $25,000 joint filers.
• Phase-Out: Begins at modified adjusted gross income of $150,000 (individual) or $300,000 (joint), reducing at 10%. Once the phase-out reduction equals or exceeds the maximum deduction ($12,500 or $25,000), the taxpayer loses the deduction entirely.
• Phase-Out Begins once modified adjusted gross income exceeds the threshold; the allowable deduction is reduced by 10% of the excess income over the threshold.

• • Calculation Example – Single Filer
    • Employee earns $160,000 MAGI.
    • Excess over $150,000 = $10,000
    • 10% of $10,000 = $1,000
    • Deduction reduced by $1,000.
    • If originally eligible for $12,500, new deduction = $11,500.

• • Calculation Example – Joint Filers
    • Couple earns $315,000 MAGI.
    • Excess over $300,000 = $15,000
    • 10% of $15,000 = $1,500
    • Deduction reduced by $1,500.
    • If originally eligible for $25,000, new deduction = $23,500.

• Who Qualifies: Non-exempt employees (hourly, non-professional, or earning less than $35,568 annually).
• Scope: Applies to federal income tax only; does not affect payroll taxes.

What It Means for Union Signatory Contractors

• Applies only to overtime covered by FLSA (hours worked over 40 per week at “time-and-a-half”).
• Union contracts may differ in how overtime is calculated (e.g., daily overtime, different multipliers, or thresholds). Those differences may result in some overtime not qualifying for the deduction.
• Employers must track and report “qualified overtime compensation” separately on employee W‑2s (or equivalent). A transition period in 2025 allows for estimates.

What Contractors Need to Do

• Update Payroll Systems: Ensure systems capture FLSA-qualified overtime separately.
• Train Payroll Staff: Clarify distinctions between contract overtime and FLSA overtime.
• Coordinate with Union Representatives: Ensure compliance while maintaining transparency with employees.
• Provide Documentation: Supply employees with accurate records of qualified overtime (via W‑2s, 1099s, or payroll statements).
• Inform Employees: Encourage workers to maintain their own overtime records for tax filing in 2026.
• Communicate Limitations:
  • Deduction does not apply to state/local income taxes.
  • No relief from Social Security or Medicare payroll taxes.
  • Deduction currently expires after tax year 2028, unless extended by Congress.

Key Takeaway

Employees may deduct the “half” portion of their time-and-a-half FLSA overtime pay on federal taxes. However, overtime earned under union contracts or state law beyond FLSA rules does not qualify. Contractors must act now to align payroll practices and employee communications with the new law.