2026 Overtime Pay Guidance for Employers
- Reviewed by Paylocity's Compliance & Government Relations Team
Understanding overtime pay is as crucial – and difficult – as it's ever been.
Even minor misclassifications or errors can lead to penalties, payroll disputes, or compliance issues. A challenge further compounded by recent federal updates affecting income tax.
Whether managing payroll, tracking labor costs, or navigating new compliance requirements, understanding how overtime is defined, calculated, and reported should be a top priority for all organizations, regardless of size or industry.
Key Takeaways
- Overtime pay is the extra compensation eligible employees can earn for working extended hours, which accrues at an accelerated rate.
- OT payment calculations begin by identifying the employee’s regular rate of pay and applying the correct overtime multiplier (1.5 under federal law), which may vary when multiple pay rates, bonuses, or special state rules apply.
- The 2025 No Tax on Overtime update allows eligible employees to deduct a portion of their overtime wages from their federal income taxes, though other payroll taxes (e.g., Social Security or Medicare) and applicable state income tax rules still apply.
What is Overtime Pay?
Overtime pay refers to the extra compensation employees earn when their total work hours exceed established working limits, typically more than 40 hours in a workweek. Because these additional hours place greater demands on employees, the corresponding wages they earn accrue at an elevated rate, ranging from 1.5 to double their regular pay rate.
Employers, therefore, must carefully monitor overtime hours, both to comply with state and federal overtime laws and to control labor costs, which can rise quickly when overtime payments become frequent or unavoidable.
Moreover, clear and consistent overtime pay rules support workforce stability by preventing overwork and maintaining fair compensation practices. As such, many employers rely on automated systems to simplify calculations, reduce errors, and create a more predictable payroll experience for both managers and employees.
What is the Federal Law About Overtime Pay?
Federal overtime requirements are governed by the 1938 Fair Labor Standards Act (FLSA), the statute that establishes nationwide standards for minimum wage, youth employment, and overtime obligations.
For all covered non-exempt employees, the FLSA’s overtime law mandates premium pay of no less than 1.5 times the employee’s regular rate for all hours worked over 40 in a fixed, seven-day workweek (i.e., a recurring block of 168 hours).
Additionally, the act outlines specific FLSA overtime exemptions, including certain administrative, executive, and professional roles, which are excluded from overtime eligibility when they meet specific criteria. The law also doesn’t, for example, require overtime pay for weekend, evening, or holiday work unless those hours push the employee beyond the 40-hour per week threshold.
What are Exempt vs. Non-Exempt Employees?
HR and payroll professionals must understand the difference and clearly distinguish between non-exempt and exempt employees to comply with FLSA and overtime requirements.
Three fundamental tests are used to determine whether a worker qualifies as exempt.
- Salary Basis: Is the employee hourly or salaried (i.e., paid a fixed amount each week regardless of hours worked)?
- Salary Level: Does the employee earn at least $684 per week (or $35,568 annually)?
- Job Duties: Does the employee’s primary work align with one of the officially recognized exempt roles?
A worker who meets all three criteria (paid on a salary basis, earning at least $684 per week, and performing primarily exempt duties) is classified as an “exempt employee” who can’t receive overtime pay. Conversely, a worker whose job is hourly, earning less than $684 a week, and doesn’t primarily involve an exempt role is classified as a “non-exempt employee,” meaning they’re eligible for overtime pay.
Misclassifying workers is not only a serious compliance violation, but it’s also one of the most common payroll errors an employer can make. Such violations can result in substantial financial penalties, employee lawsuits, and long-term reputational damage.
How Much is Overtime Pay?
Determining the amount of overtime pay an employee earns begins with understanding the formulas and legal standards that govern these calculations. Moreover, while federal overtime laws establish a nationwide baseline, employers must also account for state-specific rules that impose a different or unique overtime rate.
For these reasons, many employers opt to either invest in an overtime calculator or rely on publicly available resources for overtime calculation (e.g., Overtime Calculator Advisor, Coefficient Table, FLSA Digital Reference Guide, etc.).
Many others, however, streamline their overtime and general payroll efforts by partnering with a service provider that offers integrated payroll and time collection features, automating the entire payroll process for maximum efficiency.
How to Calculate Overtime Pay
Every overtime calculation begins with identifying the employee’s regular rate of pay, which serves as the foundation for the formula under federal overtime pay laws.
For most non-exempt employees, employers multiply the regular pay rate by 1.5 and apply the result to all overtime hours worked. For example, an employee earning $20 per hour who works an extra five overtime hours will receive $800 for their regular hourly rate ($20 × 40 hours) and an additional $150 in overtime premiums.
Overtime Pay = (Regular Rate of Pay × 1.5) × Number of Overtime Hours
Overtime Pay = ($20 × 1.5) × 5
$150 = $30 × 5
However, such calculations can become complicated for employees who work multiple jobs or roles for different pay rates (e.g., a server who also bartends for the restaurant), receive piecemeal compensation (i.e., wages per item or product produced), or earn commissions.
Things become even more complex when calculating overtime pay for salaried employees whose annual income doesn’t meet the FLSA overtime rule listed above ($35,568).
In such cases, employers must combine all of a non-exempt employee’s compensation before identifying the correct overtime rate to ensure the overtime calculation accurately reflects the worker’s total earnings.
2026 State Overtime Laws
Many states supplement FLSA overtime rules with their own overtime rules, resulting in stricter requirements or different thresholds for when overtime begins. Some states, such as California, Colorado, and Nevada, implement daily overtime triggers, while others use higher salary thresholds for exemption or even double-time pay in certain situations.
Remote work further complicates compliance because employers must apply the overtime rules of the state where the employee physically performs the work, rather than the state where the organization is based.
Ultimately, employers should review official guidance regularly and contact their state’s labor office with any questions before trying to calculate overtime pay.
Is Overtime Pay Taxable?
Traditionally, overtime wages were fully taxable under federal payroll and income tax laws, meaning employers treated every dollar of overtime earnings the same as regular wages for withholding and reporting purposes. As a result, any additional income earned through an OT payment (including the modified time-and-a-half portion) was added to the worker’s total annual wages and taxed as ordinary income.
Ironically, due to the U.S. tax system’s graduated structure (with rates ranging from 10% to 37% based on an individual’s income), substantial overtime earnings could push an employee’s total earnings into a higher income bracket, sometimes creating the false perception that overtime itself was taxed at a higher rate.
In reality, there has never been a federal law dedicated to applying unique overtime tax rates. Instead, overtime pay was only subject to standard income and payroll taxes, including Social Security and Medicare. Regardless, this long-standing system changed with the passage of the “No Tax on Overtime” provision of the 2025 One Big Beautiful Bill Act (a.k.a. OBBBA or OB3).
2025 No Tax on Overtime Update
On July 4, 2025, the OBBBA became Public Law 119-21, introducing a new provision that effectively shields qualified overtime earnings from federal income tax.
The new law does not, however, change how federal payroll taxes, such as Medicare and Social Security, are applied. Furthermore, state and local overtime rules that exceed FLSA overtime requirements are not considered eligible overtime wages for this new federal deduction.
Instead, the update significantly reduces federal income tax obligations tied to overtime earnings by allowing employees to deduct part of their overtime earnings (the “half” of the FLSA’s “time- and-a-half” requirement) from their overall taxable income. The exact value of this, though, varies based on the provision’s income-based phaseouts and overall limits.
As such, employers must separately track and clearly report qualified overtime amounts on each employee’s Form W-2 to ensure workers can accurately claim the deduction when filing their annual Form 1040.
When does the “No Tax on Overtime” Provision Start?
Although the no tax on overtime update passed in July 2025, the start date was retroactively set to January 1, 2025.
Therefore, to help accommodate adjustments to the new law, tax year 2025 has been designated as a transition year, during which no penalties will be imposed if an employer fails to separately report an employee’s total qualified overtime compensation.
Nevertheless, employers are encouraged to provide workers with a separate accounting of overtime compensation, either via online portal, additional written statements, other secure methods, or via Form W-2 Box 14. Similarly, employees are encouraged to maintain detailed personal records (e.g., pay stubs, overtime summaries, etc.) to verify the accuracy of reported overtime taxes.
How Does No Tax on Overtime Work?
Under these new rules, eligible employees can claim a tax deduction for part of their earned overtime pay, specifically the modified “half” portion of the FLSA “time-and-a-half” requirement. This deduction is then applied to the worker’s overall taxable income, reducing their federal income tax liability by up to $12,500 for individual filers or $25,000 for joint filers.
To that end, the IRS offers several methods and examples taxpayers can reference when calculating their eligible overtime pay. If an employee, for instance, earns $15 per hour and works an extra 10 overtime hours every month, they’ll earn an additional $75 in overtime pay each time ($15 × 0.5 = $7.50; $7.50 × 10 = $75), totaling $900 at the end of the year ($75 × 12). Thus, when filing their annual tax returns, they’d be eligible for a $900 overtime tax deduction.
It’s important to note, though, that these deductions phase out as the worker’s adjusted taxable income exceeds certain wage thresholds ($150,000 for individual filers; $300,000 for joint filers).
Overtime Pay FAQs
How Does FLSA Overtime Work?
Under the Fair Labor Standards Act (FLSA), non-exempt employees must receive at least 1.5 times their regular rate of pay for all hours worked beyond 40 in a fixed, seven-day workweek. Certain roles may qualify for exemptions if they meet strict salary and duties tests.
How is Overtime Calculated?
Overtime is generally calculated by multiplying an employee’s regular rate of pay by 1.5 and applying that modified rate to all overtime hours worked. More complex scenarios (e.g., multiple pay rates, bonuses, commissions, or salaried non-exempt roles) require combining all compensation before determining the correct overtime rate.
Does Each State Have a Law Regarding Overtime?
No, not all states have their own overtime laws. Many follow federal FLSA standards, though some impose additional rules, such as daily overtime, higher thresholds, or double-time requirements.
When Does No Tax on Overtime Start?
Despite being enacted in July, the federal “No Tax on Overtime” provision retroactively took effect on January 1, 2025. Under it, employees may claim a new federal income tax deduction based on qualifying overtime pay (i.e., the 0.5 of the FLSA’s 1.5 requirement), up to a set annual limit.
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