There is no tax on overtime in Arizona at the state level yet, and none is scheduled. Governor Katie Hobbs vetoed a 2024 bill that would have exempted overtime pay from Arizona income tax, and no replacement has been signed into law since. Every overtime dollar you earn in Arizona is still taxed at the state’s flat 2.5 percent rate. The one piece of real relief available to Arizona workers right now is federal: a new deduction under 26 USC § 225 that covers tax years 2025 through 2028 and, because Arizona starts from your federal AGI, trims your state tax bill too.
Where Arizona Stands Right Now
Arizona Republicans passed a 2024 tax package with an overtime exemption inside it. Hobbs vetoed the package, pointing to the hit the state’s general fund would take and the effect on education and public safety spending. The legislature never mustered the two-thirds override vote, so the proposal died.1Arizona Legislature. Arizona Legislative Bill Process
A second attempt is in motion. In early 2026, Republican legislators passed HB 2785, a tax conformity package that reportedly includes overtime and tip relief along with expanded child tax credits.2Arizona Legislature. House and Senate Republicans Pass Full Tax Conformity Whether it becomes law depends on the governor’s signature. As of mid-2026, nothing has been signed, and no overtime-related ballot initiative appears among the certified measures for Arizona’s November 2026 general election.
Until that changes, Arizona treats overtime the same as any other wages. Under ARS § 43-1001, Arizona gross income starts from your federal adjusted gross income, which already includes overtime pay.3Arizona Legislature. Arizona Code 43-1001 – Definitions The subtractions listed in ARS § 43-1022 cover items like government pensions, social security benefits, and military pay. Overtime is not on the list.4Arizona Legislature. Arizona Code 43-1022 – Subtractions From Arizona Gross Income
The flat 2.5 percent individual income tax rate then applies.5Arizona Department of Revenue. Individual Income Tax Highlights One quiet benefit of a flat rate: overtime cannot push you into a higher state bracket. But on $10,000 of overtime in a year, you still owe $250 in Arizona income tax that the vetoed bill would have erased.
The Federal Deduction That Does Work for Arizona Workers
Congress created an overtime deduction when Arizona’s didn’t pass. Section 225 of the Internal Revenue Code, enacted as part of the One Big, Beautiful Bill, lets eligible workers deduct qualified overtime compensation from federal taxable income for tax years 2025 through 2028.6Office of the Law Revision Counsel. 26 USC 225 – Qualified Overtime Compensation It’s a deduction, not a full exemption, and the mechanics matter.
Only the premium portion of overtime pay qualifies. If your regular rate is $20 per hour and time-and-a-half brings you to $30, only the $10 premium is deductible, not the full $30. The annual cap is $12,500 for single filers and $25,000 for married couples filing jointly.6Office of the Law Revision Counsel. 26 USC 225 – Qualified Overtime Compensation
The deduction phases out at higher incomes. It shrinks by $100 for every $1,000 of modified adjusted gross income above $150,000, or $300,000 on a joint return. A single filer earning more than $275,000 gets nothing, and joint filers lose it entirely above $550,000.6Office of the Law Revision Counsel. 26 USC 225 – Qualified Overtime Compensation
Eligibility runs through the Fair Labor Standards Act. You have to be a non-exempt worker whose employer is required by federal law to pay overtime after 40 hours. Salaried employees who are FLSA-exempt do not qualify, and married taxpayers have to file jointly to claim the deduction.7Internal Revenue Service. IRS Notice 2025-69 – Guidance for Qualified Tips and Overtime Compensation Only the FLSA-required premium counts, so if your employer voluntarily pays double-time where the law requires only time-and-a-half, only the half-time piece is deductible.
Here’s the piece that matters most for Arizona workers specifically. The federal deduction reduces your federal AGI, and Arizona taxable income starts from federal AGI.3Arizona Legislature. Arizona Code 43-1001 – Definitions Claim the overtime deduction on your federal return and your Arizona taxable income drops by the same amount automatically. A worker who deducts the full $12,500 at the federal level also saves $312.50 in Arizona tax, without Arizona passing any overtime law of its own.
How to Claim It on Your 2025 and 2026 Returns
For tax year 2025, the W-2 was not redesigned in time to separately report overtime compensation. The IRS issued Notice 2025-69, which lets workers satisfy the reporting requirement using existing W-2s combined with pay stubs, earnings statements, or similar records that show overtime hours and premium pay.7Internal Revenue Service. IRS Notice 2025-69 – Guidance for Qualified Tips and Overtime Compensation Keep anything that breaks out your regular rate, overtime hours, and premium pay. Starting with tax year 2026, employers must separately account for qualified overtime compensation on your W-2.8Internal Revenue Service. Treasury, IRS Issue FAQs to Address the New Deduction for Qualified Overtime Compensation
The deduction expires after 2028 unless Congress extends it. Plan accordingly.
A Worked Example
Say you’re a single Arizona worker earning $25 per hour and you average 10 overtime hours a week all year. Your overtime premium is $12.50 per hour. Over 52 weeks, that’s roughly $6,500 in deductible overtime compensation. At the 22 percent federal bracket, you save about $1,430 in federal tax. The same $6,500 reduction flows through to your Arizona AGI and saves another $162.50 in state tax.
Push that up to the $12,500 cap and the Arizona-side savings reach $312.50. The federal savings vary with your bracket, but the state-side math is always 2.5 percent of whatever you deduct federally.
Why Your Overtime Paycheck Still Looks Small
The deduction shows up at tax time, not on payday. The IRS classifies overtime as supplemental wages, which employers may withhold at a flat 22 percent federal rate regardless of your actual bracket.9Internal Revenue Service. Employer’s Tax Guide (Publication 15) If your real effective rate is lower, you get the difference back as a refund.
Arizona employers also withhold the 2.5 percent state tax on overtime at the same rate as regular wages. If you work substantially more overtime than your W-4 anticipated, you may owe at filing, with possible interest on the underpayment. Add FICA (6.2 percent for Social Security, 1.45 percent for Medicare) and overtime can shrink by roughly a third before hitting your account. The federal deduction helps on the annual return but will not change the paycheck itself.
What to Watch Next
HB 2785 is the one to track. If Hobbs signs it, Arizona would layer its own overtime exemption on top of the federal deduction. If she vetoes it, the status quo holds: 2.5 percent on every overtime dollar at the state level, with the federal § 225 deduction doing the only real work. Check whether your pay stubs clearly break out regular and overtime hours, and if you have not reviewed your W-4 since the federal law changed, now is the moment to adjust it.