A friend who works 12-hour shifts recently said, "No tax on overtime has come into effect, so won't overtime pay be tax-free?" To cut to the chase, the answer is no.

I initially thought the same way. So, I dug into the IRS guidelines and Indiana Department of Revenue materials, and there are more details than I expected.

First of all, this is not a tax exemption but a deduction. It reduces your taxable income when calculating federal income tax, so withholding from your paycheck remains unchanged.

The limit is $12,500 per year, or $25,000 for married couples filing jointly. The good news is that even those who take the standard deduction without itemizing can benefit from this.

There are also income limits. If your Modified Adjusted Gross Income (MAGI) exceeds $150,000 for individuals or $300,000 for couples, the deduction decreases by $100 for every $1,000 over the limit.

Here's where the biggest misunderstanding occurs. The deduction applies not to the entire overtime pay but only to the "half" portion of time-and-a-half pay.

If someone earns $24 an hour and works one hour of overtime, they receive $36. Of this, only the premium of $12 is deductible, while the remaining $24 is taxed as usual.

Additionally, it must be overtime as defined by the Fair Labor Standards Act (FLSA). Even if a company offers more generous double-time pay, only the legally mandated 0.5 times portion is deductible.

So, what's different for shift workers? The key is the calculation method for the workweek. The IRS considers overtime based on a fixed 168-hour week and does not allow averaging over two weeks.

For example, in a common 2-2-3 schedule at a factory or distribution center, working 12 hours results in 36 hours one week and 48 hours the next.

Combining the two weeks gives 84 hours, which might suggest "two instances of 4 hours overtime," but that's not how it works. The 36-hour week has no overtime, and only the 48-hour week counts for 8 hours.

For those receiving night shift differentials, there's good news. According to Department of Labor regulations, night pay must be included in the regular rate.

This means if your base pay is $22 and you receive a $2 night differential, your regular rate is considered $24, increasing the premium accordingly. If your paycheck calculates overtime based solely on the base pay, it's worth checking.

Now, let's run some actual numbers. If you earn $24 an hour and work a 2-2-3 schedule for 26 cycles in a year, you'll have 208 hours of overtime.

208 hours multiplied by the premium of $12 equals $2,496. This is the amount you can deduct over the year.

If you fall into the 12% federal tax bracket, your tax savings would amount to $299.52. Honestly, when I first calculated this, I was surprised that this was all there was.

But that's not the end of it. Indiana has decided to apply the federal overtime deduction to state income tax for the year 2026.

According to Indiana Department of Revenue Information Bulletin 128, the state deduction starts from the amount received on federal Schedule 1-A and is reflected in county income tax calculations.

With the Indiana state income tax rate at 2.95% in 2026, using the example above, you would save an additional $73.63 on state tax. There's also a bit more added based on your county tax rate.

However, this state deduction currently only applies to the year 2026. The federal deduction continues until 2028, but Indiana will decide on its extension in the next budget discussions.

It's also important to note that Social Security and Medicare taxes, totaling 7.65%, will still apply to the entire overtime pay.

So when will you get your refund? For the 2026 amounts, you'll calculate it on Schedule 1-A during next spring's tax filing, and most will feel it in the form of a refund.

Starting in 2026, companies must report the qualified overtime amount separately in Box 12 of the W-2 with code TT. Employees can only calculate deductions based on this TT amount.

So when you receive your W-2, check Box 12 first. If the TT number is empty or seems off, you should request a correction with a W-2c from HR, as the IRS states that Form 4852 cannot be used as an alternative.

Some may not want to wait for the refund. The 2026 W-4 will include an overtime section in Step 4(b) of the deduction worksheet, allowing you to input an estimated amount to reduce withholding from each paycheck.

However, if your overtime hours vary significantly, be cautious about being too aggressive. If you work less than expected, you might end up owing money next year.

In summary, this policy isn't as groundbreaking as some in politics claim, but it's not insignificant either. A few hundred dollars a year can cover several months of car insurance.

If I were you, I'd start by pulling my overtime hours by workweek from my pay stub and matching it with the TT number on my year-end W-2. If you have unique calculations due to union contracts or hospital work, definitely check with a tax professional.