The “no tax on overtime” rule in Colorado is really a federal deduction, not a state one. For tax years 2025 through 2028, eligible workers can deduct up to $12,500 of qualified overtime pay ($25,000 for joint filers) from federal taxable income under the One Big Beautiful Bill Act. Colorado’s flat 4.40% tax normally piggybacks on federal taxable income, so the deduction flowed through to state returns for 2025. Starting with tax year 2026, HB 25-1296 requires the deducted overtime to be added back on the Colorado return. You keep the federal savings; the matching state savings go away.
What Counts as Qualified Overtime
The deduction covers only the premium portion of overtime pay, not the whole overtime paycheck. If your regular rate is $25 per hour and time-and-a-half brings your overtime rate to $37.50, only the extra $12.50 per overtime hour is deductible. The base $25 stays fully taxable, even during overtime hours.1Internal Revenue Service. One, Big, Beautiful Bill Act: Tax Deductions for Working Americans and Seniors
The overtime also has to be required by Section 7 of the Fair Labor Standards Act. That limits the deduction to workers who are both covered by the FLSA and non-exempt from its overtime rules, which in practice means hourly, non-exempt employees. Salaried exempt employees don’t qualify even if their employer voluntarily pays them extra for long hours. Overtime that a union contract or state law requires but the FLSA does not, including some pay owed under Colorado’s COMPS Order, also falls outside the deduction.2Internal Revenue Service. Questions and Answers About the New Deduction for Qualified Overtime Compensation If your classification isn’t obvious, confirm it with your employer or a tax professional before claiming the deduction.
Caps, Phase-Outs, and Filing Rules
The annual cap is $12,500 for single filers and $25,000 for joint filers. The deduction phases out once modified adjusted gross income exceeds $150,000 ($300,000 joint) and disappears entirely at $275,000 ($550,000 joint).1Internal Revenue Service. One, Big, Beautiful Bill Act: Tax Deductions for Working Americans and Seniors
You can claim the deduction whether or not you itemize, since it’s an above-the-line adjustment. Married taxpayers, however, must file jointly to claim it, and every taxpayer on the return needs a valid Social Security number. Married filing separately disqualifies you regardless of income or hours worked.
On the federal return, the calculation goes on Schedule 1-A (Form 1040), Part III, and the result carries to Form 1040, line 13b.3Internal Revenue Service. 2025 Schedule 1-A (Form 1040) No separate application or election is needed.
Why Colorado Workers See No State Savings in 2026
Colorado applies its 4.40% flat rate to federal taxable income with certain adjustments.4Department of Revenue – Taxation. Individual Income Tax Frequently Asked Questions Under that starting point, a federal deduction typically reduces Colorado tax automatically. For tax year 2025, that’s exactly what happened with the overtime deduction.
HB 25-1296 changes the picture beginning in tax year 2026. The bill requires any overtime compensation excluded from federal taxable income to be added back to Colorado taxable income.5Colorado General Assembly. Legislative Council Staff Memorandum – OBBBA Fiscal Impacts Colorado has effectively decoupled from the federal deduction for 2026, 2027, and 2028. You’ll still claim the deduction federally, but you’ll add the same amount back on your Colorado return.
The add-back will appear on the Colorado additions schedule that accompanies the DR 0104. Watch for updated forms and line instructions from the Colorado Department of Revenue when the 2026 filing season opens.
W-2 Reporting Starting in 2026
Employers must report qualified overtime compensation in Box 12 of the W-2 using Code TT beginning with tax year 2026. That box will show only the premium portion, not total overtime earnings.6Internal Revenue Service. 2026 General Instructions for Forms W-2 and W-3 Colorado state employees will see Code TT capture standard overtime premiums, callback overtime once weekly hours exceed 40, and compensatory time payouts.7Office of the State Controller. One Big Beautiful Bill Act Implementation
Hold onto your pay stubs anyway. Stubs show week-by-week hours, rates, and premiums in a way that a single W-2 code cannot, and that detail is what resolves any IRS question about how you calculated the deduction.
What the Deduction Is Actually Worth
Consider a Colorado construction worker earning $28 per hour who works 10 overtime hours per week for 50 weeks. The overtime premium is $14 per hour, totaling $7,000 per year. At a 22% federal bracket, deducting that $7,000 saves roughly $1,540 in federal tax.
For 2025, that same $7,000 also reduced Colorado taxable income, saving about $308 at the 4.40% rate. Starting in 2026, the HB 25-1296 add-back erases that $308. The federal $1,540 remains.
Workers with heavy overtime can hit the $12,500 annual cap, and high earners will run into the income phase-out before they get close to it.
Things “No Tax on Overtime” Does Not Mean
- Your overtime paycheck is not tax-free. Only the premium above your regular rate qualifies, and your base rate during overtime hours is still fully taxed.
- Payroll taxes still apply. Social Security (6.2%) and Medicare (1.45%) come out of all overtime earnings, premium included. The deduction affects income tax only.
- Colorado is not exempting overtime from state tax in 2026. The add-back cancels the flow-through benefit at the state level.
- FLSA-exempt salaried employees don’t qualify, even when employers pay them extra for long weeks.
- Overtime required only by Colorado’s COMPS Order or a union contract, but not by the FLSA, doesn’t count as qualified overtime compensation.
The federal overtime deduction is real, but its scope is narrower than the shorthand suggests, and Colorado has explicitly opted out of matching it from 2026 through 2028.