3 Things Business Owners Should Know About the New Overtime Tax Deduction

If your business pays employees for overtime, a recent change in federal tax law is coming that you’ll want to incorporate into your planning. Starting with the 2025 tax year and running through 2028, a new deduction opportunity becomes available for qualifying overtime pay, potentially altering how employees perceive extra hours and how employers plan for compliance.

According to Michelle Kohls, a human resources systems and payroll director at CLA (CliftonLarsonAllen LLP), this new rule may offer real value, but it brings a few nuances. To help business leaders make sense of it, Kohls shares three things every entrepreneur should know, and how CLA is already helping clients prepare.

1. The new rule doesn’t change how you process overtime

Employers don’t need to change their payroll systems or rewrite their overtime policies. “The good news is there’s no change as far as the new overtime tax deduction and how it affects overtime being processed through payroll systems,” Kohls says.

Overtime is still calculated under existing state and federal rules and remains subject to income tax, Social Security, and Medicare. The deduction itself happens later. “It will be something that the employee claims on their personal 1040 tax return,” Kohls explains.

At CLA, Kohls and her team are helping employers review how overtime is coded and displayed in their systems so everything aligns when new IRS forms roll out.

2. Clear tracking helps everyone

Even though overtime calculations don’t change, it’s good to double check how that pay is tracked. Kohls recommends confirming that overtime has its own pay code and appears clearly on employee pay stubs.

“Employers should already be tracking overtime pay according to the Fair Labor Standards Act,” she says. “What they need to make sure they are doing is tracking overtime in their payroll system with proper pay codes, so it then shows on employees’ pay stubs.”

For now, the IRS isn’t adjusting 2025 W-2 forms or payroll tax returns. “There will be no changes in 2025 to tax form W-2 or payroll tax returns,” Kohls notes. “There will be changes in 2026 through 2028, but for 2025, they will be filed as usual.”

If your current setup doesn’t clearly show overtime pay, Kohls suggests keeping a record for employees. “If it isn’t properly broken out, employers should give employees some type of tracking of what overtime wages for 2025 were,” she says.

CLA has been guiding clients through system checks and payroll assessments to make sure those details are in place before filings begin.

3. Understand the limits and prepare for questions

Employees can reduce their taxable income by up to $12,500 if filing individually, or $25,000 if filing married jointly. And not all overtime pay qualifies for the deduction. “Only the additional half-pay portion of overtime qualifies for the new tax deduction,” Kohls explains.

Some companies are reviewing their employee classifications “to see if reclassifying certain roles could make workers eligible for overtime and, in turn, the new deduction,” Kohls says. She notes that this approach can balance payroll costs while giving employees a potential tax benefit.

CLA teams are also working directly with management groups to help them prepare talking points and communication plans.

A good time to review payroll systems

The new deduction gives business owners a reason to take a closer look at payroll readiness. CLA is helping clients assess whether their systems can properly track and report overtime pay, and they are guiding them through what to expect once new reporting standards arrive.

“If they’re not using a system capable of correctly reporting overtime pay or are unsure how to set that up, we can help guide a payroll platform,” Kohls says. “We’re also meeting with management teams to share what’s involved with this ruling and what companies need to know as employees start asking questions.”

Taking time now to verify systems, pay codes, and communication processes can make next year’s transition much smoother.

Click here to learn more about CLA and how they can help your business with tax planning and more.

^{The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, investment, or tax advice or opinion provided by CliftonLarsonAllen LLP (CLA) to the reader. For more information, visit CLAconnect.com.}

^{CLA exists to create opportunities for our clients, our people, and our communities through our industry-focused wealth advisory, digital, audit, tax, consulting, and outsourcing services. CLA (CliftonLarsonAllen LLP) is an independent network member of CLA Global. See CLAglobal.com/disclaimer. Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered investment advisor.}