No Tax on Overtime: Public Entity Considerations Following the “One Big Beautiful Bill”

By: Jessica Park, Law Clerk

On July 4, 2025, President Trump signed H.R. 1, the “One Big Beautiful Bill Act,” into law. Among its numerous tax provisions, the newly enacted overtime tax exemption warrants attention from governmental entities. To prepare for the next tax season, entities should consider the implications of this provision for their personnel.

Overview of No Tax on Overtime

Beginning 2025 through 2028, qualified taxpayers may deduct eligible overtime pay from their taxable income. To qualify, the overtime pay must be required under Section 7 of the Fair Labor Standards Act of 1938 (FLSA). Overtime pay mandated solely by contractual agreements or state law does not qualify unless it also satisfies the FLSA definition of overtime. Notably, the deduction applies only to federal income taxes—not federal payroll taxes.

The maximum annual deduction is $12,500 per individual, or $25,000 for married couples filing jointly. The deduction phases out for taxpayers with modified adjusted gross income exceeding $150,000 ($300,000 for joint filers). To claim the deduction, taxpayers must:

1. Include their Social Security Number on the return; and
2. File jointly, if married.

Employers must file information returns with the IRS (or SSA) and provide annual statements to employees reflecting the total amount of qualified overtime compensation paid. For tax year 2025, the IRS will offer transition relief for both employees claiming the deduction and employers subject to the new reporting requirements.

Importantly, the deduction applies only to FLSA non-exempt workers or employees earning less than $35,568 annually (based on 2019 regulations, unadjusted for inflation).

Determining Exemption Status for Overtime Purpose

The “No Tax on Overtime” deduction is available only to non-exempt employees—those covered by the FLSA’s minimum wage and overtime protections. These workers are typically paid hourly and perform duties involving routine, manual, or repetitive tasks.

In contrast, exempt employees are not entitled to overtime under the FLSA. To qualify as exempt, an employee must meet all three of the following tests:

1. Salary Basis Test – The employee is paid a fixed salary not subject to variation based on hours worked or performance.
2. Job Duties test – The employee performs executive, administrative, professional, or sales duties as their primary role.
3. Salary Level Test – The employee earns more than $35,568 per year (threshold unchanged since 2019).

Section 13(a)(1) of the FLSA also exempts school employees who are “employed in the capacity of academic administrative personnel or teacher in elementary or secondary schools.” This includes superintendents, assistant superintendents, principals, vice principals, and academic counselors—all of whom are engaged in academic administrative functions and are classified as exempt.

Conversely, employees such as secretaries, custodians, cafeteria workers, and support staff involved in building maintenance, student health services, or non-instructional roles (e.g., social workers, psychologists, lunchroom managers, and dietitians) generally do not perform academic administrative functions. While some may qualify for exemption under 29 C.F.R. § 541.200, most are considered non-exempt.

29 C.F.R. § 541.303(b) further clarifies that teachers—including substitute teachers—are exempt if their primary duty is teaching, tutoring, instructing, or lecturing in an educational establishment. Coaching, drama, debate, and other recognized extracurricular activities also qualify as “teaching” for FLSA purposes. In contrast, preschool personnel whose primary role is to take care for children’s physical needs may not qualify. Possession of a teaching certificate typically indicates eligibility for exemption, regardless of the state-specific nomenclature.

Public entities should carefully assess the FLSA exemption status of each employee to determine eligibility for the overtime tax deduction.

Calculating Overtime Entitlement

Under the FLSA, non-exempt employees are entitled to overtime pay for all hours worked in excess of 40 hours per workweek. The 40-hour threshold includes only hours actually worked—sick leave, personal days, holidays, and meal breaks (if 30 minutes or longer and duty-free) are excluded. However, short rest breaks (20 minutes or less), travel between work sites, and restrictive on-call time are considered compensable.

In some cases, hours worked across multiple roles within the same school district may be aggregated for overtime purposes. For example, a custodiam working 30 hours per week and also serving as a 20-hour-per-week security guard for the same district would be entitled to overtime for 10 hours.

Calculating the Overtime Rate

FLSA requires overtime to be paid at 1.5 times an employee’s regular hourly rate, which must meet or exceed the federal minimum wage. For salaried employees, this requires converting annual salary into an hourly rate. Additionally, nondiscretionary bonuses—such as longevity payments required by contract—must be factored into the regular rate used for overtime calculations.

Public entities must maintain accurate records of all compensable time worked, including informal or unscheduled additional hours worked with the administration’s knowledge. For example, a custodian who voluntarily stays late or is assigned weekend or on-call duties may be entitled to overtime if their total hours exceed 40 in a given week, even if there was no formal approval of the administration so long as the administration has the knowledge of those additional hours.

To avoid unexpected FLSA liability, administrators must consider overtime implications before assigning work outside standard schedules.

Practical Considerations for Public Entities

To comply with the “No Tax on Overtime” reporting requirements, employers must include the total amount of qualified overtime compensation as a separate line item on Form W-2. This will require careful payroll tracking to isolate:

• Overtime payments mandated under the FLSA; and
• Wages paid in excess of the regular rate.

For tax year 2025, employers may use a “reasonable method”—to be defined by the Treasury Secretary—to approximate qualified overtime compensation. Public entities should proactively consult with payroll vendors or software providers to determine whether system updates or new reporting fields are required to capture qualified overtime wages in accordance with the law.