What does “Tax-Free Overtime” really mean?
The One Big Beautiful Bill Act (OBBBA) created a tax credit with a limit of up to $12,500 for an individual and $25,000 for a married couple filing jointly for “qualified overtime pay.”
Who is eligible for the OBBBA Tax-Credit?
Only those employees who are both covered under the Fair Labor Standards Act (FLSA) and are not exempt (Non-Exempt Employee) from the FLSA’s overtime requirements are eligible to file for the tax-credit on their annual income tax returns for tax years 2025-2028. An additional requirement is that the taxpayer receiving the qualified overtime pay must have a social security number that is valid for employment. They must include that social security number on the tax return for which they are claiming the tax credit.
What is “Qualified Overtime”?
Under the OBBBA, only the “half” of the 1 ½ x regular rate for overtime (OT) qualifies for the tax credit. For example, if an employee earns a regular rate of $20/hour and works 4 hours of overtime at $30/hour, only the overtime premium of $10/hour x 4 OT hours = $40 qualifies for the tax credit.
Moreover, only overtime hours covered by the federal Fair Labor Standards Act (FLSA) qualify. Under the FLSA, overtime is defined as hours worked over 40 in a given work week (7-day workweek measurement period). Overtime accrued under a state specific overtime law (i.e., California’s daily overtime), is excluded and does not qualify for the tax credit. See list below and consult a CPA, Tax Advisor or Tax attorney for further instructions.
Which States have their own overtime rules in addition to FLSA?
The following states have their own overtime rules, in addition to FLSA:
- California
- Colorado
- Florida (Manual Laborers)
- Hawaii (Agricultural Workers)
- Kansas
- Kentucky
- Maryland (Agricultural Workers)
- Minnesota
- Nevada
- New York
- Oregon (Manufacturing; Canneries; Packing Plants; Agricultural Workers)
- Rhode Island
What are Auto Dealers Responsible for?
All employers, including auto dealers, must provide all non-exempt employees earning overtime pay with W-2s for tax years 2026 through 2028 that accurately separate and report OBBBA qualified overtime hours premium totals. Employer responsibilities for reporting for the 2025 tax year are waived. Employees are responsible for their own reporting for 2025.
Steps Employers Must Take
Take a close look at these key action items for employers in regard to tax-free overtime:
- For tax years 2026-2028 forms W-2, 1099-NEC, and 1099-MISC will be provided to allow separate reporting for an employee’s qualified overtime.
- Create a separate pay code that only records premium totals for OBBBA qualified over time hours for the tax year
- Work with your payroll provide to create the separate pay code
- Monitor that time records are accurate and that OBBBA qualified overtime hours are easily tracked
- Tracking per payroll period should begin starting January 1, 2026
- Delaying tracking until the end of the tax year will create unnecessary administrative burden and increase likelihood of errors.
Strengthen Your Dealership’s Overtime Compliance
For 40 years, KPA has helped dealerships reduce regulatory risk with software, training, and expert guidance. Our solutions are designed to support compliant advertising, transparent pricing, and consistent dealership processes. Chat with our team to see if your dealership is falling short in advertising compliance.
