By: Philip Giorlando and Fred Preis
The “no tax on overtime” provisions enacted as part of the One Big Beautiful Bill, effective for tax years 2025 through 2028, are widely understood as a benefit for hourly workers. What has received far less attention is the unintended compliance consequence for employers: the new law creates a direct channel through which previously undetected overtime violations may come to light.
How the Deduction Works
The new deduction allows non-exempt employees under the FLSA to deduct the overtime premium — the additional “half” in time-and-a-half pay — from their federal adjusted gross income, up to $12,500 per year ($25,000 for joint filers). Only overtime mandated by the FLSA qualifies; contractual overtime paid above and beyond the FLSA minimum does not.
All Eyes Are on Overtime
For 2025, employees must calculate the deductible amount themselves — typically by dividing total overtime pay by three — and document their FLSA eligibility in case of audit. Employees will therefore be paying closer attention to their pay records than the past. Employee disagreements about their overtime can lead to claims or lawsuits.
Additionally, the IRS can discover overtime issues while auditing employee tax returns. That inquiry will surface payroll records, classification determinations, and overtime calculation methodology — exactly the same records that a DOL Wage and Hour investigation would examine.
The IRS and DOL share information. An IRS audit that uncovers apparent FLSA violations can result in referrals to the DOL’s Wage and Hour Division.
Specific Areas of Risk
Employers should pay particular attention to the following vulnerabilities:
- Employee misclassification. Employers should confirm that their employees are properly classified as exempt under Federal Wage and Hour law. If an employee claims the deduction but has been classified as exempt from FLSA overtime requirements, the resulting audit may expose that the exemption was improperly applied.
- Incorrect overtime calculations. Employers should have their overtime methods reviewed to confirm they are properly paying overtime to their employees. Typically, overtime should be one and one-half times the regular rate of pay for every hour over 40 in a workweek. Exceptions could apply depending on the industry and job position, such as police officers, firefighters, and the healthcare industry.
- Discrepancies between employer and employee records. If an employee calculates their overtime premium using pay stubs that tell a different story than the employer’s internal payroll records, that inconsistency alone is a red flag. Employers should ensure that their records are accurate, complete, and internally consistent.
Recommended Employer Actions
Employers should have their employees classifications and pay practices audited to address any problems early and reduce the risk of a claim, charge, or lawsuit.
The new overtime tax deduction was designed to put money in workers’ pockets. As a practical side effect, it has given millions of non-exempt employees a financial incentive to document and assert their Federal Wage and Hour rights — and created a paper trail that flows directly to federal tax authorities. The appropriate response by employers is a proactive audit, undertaken now, before the 2025 filing season is underway.
BSW Labor and Employment Law Blog 