S1046, the "No Tax On Overtime Act of 2025" proposes one of the most significant tax policy changes affecting American workers in decades.  But would it provide much needed support to struggling Americans coping with rising prices and housing costs, or would it just help explode the deficit with no real impact on workers?  

Let's take a deep dive into the implications of the bill (and its companion in the House, HR405), look at where similar things have been tried before, and also look broadly across the country at what state legislatures are doing in this space.

Read the full IssueVoter analysis here. 

The single-paragraph bill would add Section 139J to the Internal Revenue Code, stating simply that "gross income shall not include overtime compensation required under section 7 of the Fair Labor Standards Act [FLSA] of 1938." This covers time-and-a-half pay for hours worked beyond 40 per week for non-exempt employees.

The timing aligns with President Trump's campaign promise to eliminate taxes on overtime pay, giving the proposal renewed political momentum. "Americans who choose to work overtime to support their family should be able to keep more of their hard-earned paycheck, not less," Rep. Russ Fulcher stated about the House bill, positioning the policy as relief for inflation-burdened families.

The House passed a broader reconciliation bill in May 2025 that includes a temporary overtime tax exemption through 2028, with a $160,000 income cap and Social Security number requirement. However, the Senate version excludes this provision, potentially leaving S1046's standalone approach as the primary vehicle for permanent change if the House provision doesn't make it into the agreed final version.

Massive fiscal impact with regressive distribution?

So what would be the impact? The Congressional Budget Office estimates $124 billion in lost federal revenue over ten years for the current limited proposal, while broader interpretations could cost up to $1.5 trillion including payroll taxes. The Tax Foundation's comprehensive analysis projects $680-866 billion in revenue loss from income tax exemptions alone, with costs potentially reaching $3.1 trillion under the broadest interpretation.

These estimates likely understate actual costs due to behavioral changes and gaming opportunities. Alabama's pioneering state-level overtime tax exemption provides a cautionary example.  HB 217 was projected to cost $34 million annually, it actually consumed $230 million in just nine months before expiring in 2025. State officials acknowledged the massive discrepancy resulted from inadequate data on overtime payment patterns.

The distributional impact contradicts populist messaging about helping working families. Only 12% of American employees work FLSA-qualified overtime regularly, with another 5% working overtime occasionally. This narrow beneficiary base creates significant demographic disparities in who gains from the policy. Institute on Taxation and Economic Policy analysis shows the bottom 60% of taxpayers would receive an average tax cut of only $80 annually, while the top 20% would benefit by $940. This occurs because higher-income workers are more likely to work overtime and face higher marginal tax rates, magnifying their tax savings.

State-level momentum builds despite fiscal concerns

Following Alabama's precedent, many states introduced similar overtime tax exemption legislation in 2025, seeking to capitalize on the national momentum for such a policy. What's striking is that none have so far made it out of committee, while many have already died. It seems the proposals are wilting under the scrutiny they face in committee. 

The map belows shows states which have introduced legislation in current sessions aiming to provide tax relief for overtime payments. Click a state to see the bills, and click 'Detail' for the full bill information. 

The bills reveal significant variations in scope and implementation approach, with some states learning from Alabama's costly experience while others pursue broader exemptions. 

Connecticut's HB 5024 proposes a straightforward personal income tax exemption for all overtime compensation beyond standard work schedules, representing the most common approach among states. North Carolina's H11 takes a more comprehensive strategy, bundling overtime exemptions with separate deductions for bonus pay and tips up to $2,500 annually, while allowing married couples filing jointly to claim overtime deductions separately. Alabama's HB 467 demonstrates the most sophisticated design, incorporating lessons from their previous overtime exemption that cost $200 million more than projected—the new bill includes mandatory economic impact studies, phased implementation starting October 2024, special provisions for railway workers under collective bargaining agreements, and required monthly reporting to revenue departments. 

Several Midwest states like Illinois and Michigan are pursuing similar broad exemptions, while states like Massachusetts and New York are taking more cautious approaches with bills still in early committee stages, suggesting growing awareness of the fiscal risks that derailed Alabama's initial experiment.

Economic arguments reveal fundamental tensions

Proponents argue overtime tax exemptions provide efficient work incentives by targeting marginal labor supply. The American Enterprise Institute suggests "overtime hours are a reasonable proxy for effort, exempting overtime pay from taxation could be a more efficient way to encourage work than a broader income tax cut." Supporters contend the policy addresses workforce shortages while providing relief to families sacrificing leisure time for additional income.

Critics highlight severe economic distortions and inequities. Former Congressional Budget Office Director Doug Holtz-Eakin condemns the proposal as "a zero tax rate on a completely unprincipled definition of income," emphasizing gaming opportunities for high earners. Tax policy experts warn of horizontal inequity issues where workers with identical incomes face different tax burdens based solely on work structure.

Historical precedent offers mixed lessons. France implemented overtime tax exemptions in 2007 and again in 2019, with research by economists Cahuc and Carcillo finding limited actual impact on work hours. The Fair Labor Standards Act's original 1938 design aimed to discourage overtime work and spread employment—directly opposing current exemption proposals.

The Economic Policy Institute provides the strongest critical perspective: "In the end, exempting overtime from taxes is not a real pro-worker policy. Instead, it is a giveaway to businesses that would create new inequities in the tax code while expanding employer power and draining public budgets."

Implementation challenges threaten policy effectiveness

Administrative complexity poses the greatest barrier to successful implementation. The IRS would need to modify W-2 forms, create new reporting requirements, and develop extensive regulatory guidance. Employers must separate overtime tracking and reporting, while maintaining coordination with state tax systems that wouldn't automatically follow federal exemptions.

Gaming opportunities create additional risks. High-earning executives could restructure compensation to access tax-free overtime, with one analysis showing how a "$10 million CEO could make $2.7 million in overtime tax-free" through strategic reclassification. Such gaming could dramatically increase revenue losses beyond current projections.

Unintended labor market consequences include potential employment reductions as overtime becomes more attractive than new hiring. Workers unable to work overtime due to caregiving responsibilities, health constraints, or family obligations would face relative disadvantages. The policy could exacerbate workplace inequities rather than addressing them.

Conclusion

HR405 represents a politically appealing but economically problematic approach to tax relief. While promising to help working families, the legislation would primarily benefit middle and upper-middle income workers while imposing massive fiscal costs during a period of budgetary constraints. The narrow beneficiary base—only 12% of workers—combined with regressive distributional effects undermines its populist messaging.

State-level experiences, particularly Alabama's 600% cost overrun, demonstrate how behavioral responses and insufficient data can explode fiscal projections. The administrative complexity required for implementation, combined with substantial gaming opportunities, suggests actual costs could far exceed current estimates.

Rather than exempting overtime from taxation, policymakers seeking to help working families might consider more targeted approaches: expanding overtime eligibility through higher salary thresholds, strengthening wage and hour enforcement, or providing broad-based tax relief that doesn't distort labor markets. HR405's fundamental design flaws—regressive benefits, massive costs, and administrative complexity—make it an inefficient vehicle for delivering meaningful relief to struggling American workers.

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