What's Happening?
Congressional Republicans have enacted a measure fulfilling President Trump's campaign promise of 'no tax on overtime' through the One Big, Beautiful Bill, signed into law in July. However, the law does not exempt all overtime pay from federal income taxes. Only the earnings above the standard hourly wage are tax-free, meaning for those earning time-and-a-half, only the 'half' is exempt. This provision is effective from 2025 to 2028, allowing single workers to deduct up to $12,500 of eligible overtime compensation, while married workers can deduct double that amount. The benefit phases out for single filers earning above $150,000 and is unavailable for those earning over $275,000. According to Howard Gleckman from the Urban-Brookings Tax Policy Center, only about 9% of taxpayers will qualify, primarily middle- or upper-middle-income earners.
Why It's Important?
The tax exemption on overtime pay is significant as it provides financial relief to middle-income workers, particularly those in manufacturing. While the measure aims to benefit workers, it is limited in scope, with only a small percentage of taxpayers qualifying. The provision is designed to support relatively well-paid manufacturing workers, who stand to gain the most. However, the complexity of the law and the requirement for workers to receive overtime to qualify may lead to confusion. Additionally, workers will still owe payroll taxes for Social Security and Medicare on their overtime compensation, and state and local taxes may apply depending on their location.
What's Next?
The IRS is tasked with writing regulations to clarify eligibility, qualifying overtime compensation, and reporting requirements. Employers must inform workers of their overtime earnings, which are not currently reported on W2 forms. The IRS has announced no changes to the W2 form for the current tax year, leaving employers to provide information separately or in a general box. The tax filing season begins in January, and the IRS's resource constraints may delay regulation writing, potentially causing confusion among employers, workers, and tax professionals.
Beyond the Headlines
The implementation of this tax exemption raises questions about the broader impact on tax policy and worker compensation. The measure may encourage discussions on how tax laws can better support workers across different income levels. Additionally, the requirement for overtime pay to qualify for the exemption may influence employer practices and worker compensation structures, potentially affecting labor market dynamics.
