Understanding the IRS Overtime Deduction for 2025: What Taxpayers Need to Know

The new IRS overtime deduction under Section 225 is creating a lot of confusion among taxpayers and tax professionals, especially because reporting requirements for 2025 are limited.

The IRS has provided guidance in Notice 2025-69, but many complex situations remain unclear. As a result, employees and employers may not have all the information needed on a standard Form W-2 to correctly calculate the deduction.

At Kamish & Associates, we want to help taxpayers understand how the overtime deduction works, who qualifies, and what documentation may be needed when filing a 2025 tax return.

Why the 2025 Overtime Deduction Is So Confusing

One of the biggest challenges is that the IRS has waived certain reporting requirements for tax year 2025.

In Notice 2025-62, the IRS announced that employers will not face penalties for failing to report qualified overtime compensation in 2025. Employers are encouraged, but not required, to provide overtime deduction details separately or in Box 14 of Form W-2.

Because of this, taxpayers may need to rely on their own pay records to claim the deduction correctly.

Best practice for 2025: Employees should provide their final pay statement along with their Form W-2 when working with a tax professional.

What Overtime Pay Qualifies for the IRS Deduction?

Not all overtime pay is eligible.

To qualify, overtime compensation must be paid under Section 7 of the Fair Labor Standards Act (FLSA) (29 U.S.C. §207). This means:

• The employee must be covered under the FLSA

• The employee must be non-exempt

• The overtime must be legally required under federal rules

Only the Premium Portion Is Deductible

The deduction applies only to the “extra” overtime premium, not the full overtime paycheck amount.

This premium portion is called qualified overtime compensation.

Example: If an employee earns $20 per hour and receives $30 per hour for overtime, only the additional $10 per hour is deductible.

Common Issues That Can Disqualify Overtime Pay

Several types of overtime are not eligible for the Section 225 deduction, including:

• State-required overtime beyond federal FLSA rules (such as California daily overtime)

• Overtime paid under the Railway Labor Act or other industry-specific exemptions

• Voluntary overtime premiums above time-and-a-half, such as double time

These situations can make calculating the correct deduction more complicated.

Will Employers Report Qualified Overtime Compensation on Form W-2?

For tax year 2025, employers are not required to report the deduction amount.

However, starting in 2026, qualified overtime compensation is expected to be reported on Form W-2 Box 12 using code TT (based on current IRS draft guidance).

What If Box 14 on Form W-2 Is Blank?

A missing Box 14 entry does not mean you do not qualify for the overtime tax deduction.

Under Notice 2025-69, taxpayers can use their own records, including:

• Pay statements

• Year-end payroll summaries

• Employer wage detail reports

IRS Methods for Calculating the 2025 Overtime Deduction

The IRS provides simplified calculation methods when overtime pay is paid consistently:

If Overtime Is Paid at Time-and-a-Half (1.5x)

If the employee is paid 1.5 times their regular rate for overtime hours beyond 40 per week:

• The deductible amount is 1/3 of total overtime pay

If Overtime Is Paid at Double Time (2x)

If the employee is paid twice their regular rate for overtime hours beyond 40 per week:

• The deductible amount is 1/4 of total overtime pay

Mixed Overtime Situations

If overtime includes both eligible and ineligible amounts and payroll records do not separate them, tax professionals may need to use a reasonable estimate to allocate qualified overtime compensation.

Income Limits and Deduction Maximums

The overtime deduction has both dollar limits and income phaseouts.

Maximum Deduction Amount

• $12,500 maximum (single filers)

• $25,000 maximum (married filing jointly)

Taxpayers filing married filing separately are generally not eligible.

Income Phaseout Rules

The deduction begins phasing out when modified adjusted gross income (MAGI) exceeds:

• $150,000 (single)

• $300,000 (married filing jointly)

For every $1,000 above the threshold, the deduction is reduced by $100.

Once income is high enough, the deduction phases out completely.

Final Takeaway: Documentation Matters for 2025 Tax Returns

Because overtime deduction reporting is not required for 2025, taxpayers should be prepared to provide pay records if they want to claim this deduction.

If your income is above the phaseout limits, the deduction may not apply, and additional calculation work may not be necessary.

Need Help Claiming the Overtime Tax Deduction?

The IRS overtime deduction rules are new, and many taxpayers may not realize they qualify or may calculate the deduction incorrectly.

Kamish & Associates can help you:

• Determine if your overtime pay qualifies

• Calculate your Section 225 deduction accurately

• Ensure proper documentation for your tax return

• Avoid IRS filing issues or missed deductions

📞 Contact our office today to schedule a tax planning or filing consultation.