What Public Safety Employees Need to Know

TIMOTHY E. KELLY, ESQ., AND
KEVIN W. REGO, ESQ., LLM
Certified Taxation Law Specialists
Tim Kelly & Associates

President Donald Trump signed H.R. 1, the One Big Beautiful Bill Act, into law on July 4. One of the provisions of this massive bill, now codified at Internal Revenue Code (IRC) § 225, concerns the deduction of overtime from income. This was met with widespread approval from members of law enforcement and the firefighting services, who often earn more in overtime compensation than they do in base salary.

Unfortunately, the adage “If it seems too good to be true …” applies. Yes, overtime may be deducted from taxable income — but not all overtime. The overtime that can be deducted from gross income must be Fair Labor Standards Act (FLSA) overtime. There are many restrictions on the use of this deduction. In fact, even this simple summary of the new overtime deduction law can be very confusing because of the many limitations. The overtime eligible for the deduction is termed “qualified overtime.” Recognizing the potential for abuse in interpreting the scope of this term, the law specifically requires the Treasury Department (home of the IRS) to issue “regulations or other guidance” regarding the application of IRC § 225.

But in the meantime, there will be much speculation about the scope of the law. This is especially true regarding the potential confusion surrounding the application of Section 7k of the FLSA (codified in regulations at 29 CFR § 553.201[a]), which serves as an exception to standard overtime rules for law enforcement officers.

Section 70202 of the act allows employees to deduct up to $12,500 ($25,000 for joint filers) in overtime compensation. But as mentioned above, this does not include all forms of overtime. On the upside, however, when overtime compensation is “qualified” as a deduction, that deduction is made “above the line” and does not require the taxpayer to itemize their deductions.

What H.R. 1 Does Not Consider to Be Deductible Qualified Overtime

• Overtime compensation paid before January 1, 2025, or after December 31, 2028. As of now, this deduction is only valid for four years, retroactive to January 1 of this year (2025).
• Overtime compensation paid solely because of state law (e.g., California’s requirement for overtime paid for hours over a defined daily limit).
• Overtime compensation paid under the terms of an employer policy or collective bargaining agreement.
• Deduction of overtime exceeding $12,550 filing single and $25,000 filing joint. Only amounts under this threshold may be deducted.
• That part of overtime compensation representing the base amount is not deductible. In other words, the component representing the regular rate of paid compensation is not deductible; only the extra (or overtime) component is. So, if the employee’s regular rate is $10 per hour and the overtime rate is 1.5 times that amount, or $15 per hour, only the $5 per hour premium will be deductible (again, provided all other requirements are met).

What H.R. 1 Does Include as Deductible Qualified Overtime

• The premium component of overtime compensation required to be paid under Section 7 of the FLSA (i.e., 1.5 times pay for hours over 40 per week), or the applicable “work period” for law enforcement and firefighters pursuant to the 7k exception.

Phase-Out by Income

Before considering any other aspects of the overtime deduction, important consideration must be given to the income limits. Because of the relatively high incomes in California for public safety personnel, many law enforcement officers and firefighters may not be eligible for this deduction in the first place, especially if they have a high-income spouse. The deduction begins to phase out for single filers with income exceeding $150,000 and for joint filers with income exceeding $300,000. The phase-out is at the rate of $100 in reduction of the permissible deduction for every $1,000 above these thresholds. Note that for married individuals, filing separate is not an option to avoid the thresholds, as the new law requires married persons to file jointly in order to use this deduction.

California State Tax

Regardless of the application of federal law to the taxation of overtime, California doesn’t conform to this new law, and given the budget issues the state currently has, it may never do so. As we mentioned, California law also imposes overtime requirements in situations where federal law does not. The prime example of which, where applicable, is the requirement to pay overtime in excess of eight hours of work on a daily basis, and this type of overtime compensation is not deductible.

FLSA 7(k) Exception

Certain professionals, including law enforcement officers, are exempt from the strict provisions of the FLSA, most notably, the 40-hour-per-week rule, which in general is the limit at which point overtime must be paid. In place of a 40-hour workweek is a so-called “work period,” and is the reason law enforcement and firefighters can work long days as a normal schedule without the requirement that overtime be paid. We need not tell you how common this type of schedule is in the law enforcement profession. The current work period under 7(k) for law enforcement officers is 171 hours in a 28-day period. Those law enforcement employees who use a work period between seven and 28 days will apply a ratio to determine the maximum number of hours.

The Problem of Clarity: Exactly What Is Qualified Overtime?

One aspect that may cause confusion is when these overtime provisions are addressed in a collective bargaining agreement (CBA). Overtime paid pursuant to a CBA (the term memorandum of understanding [MOU] is generally used to refer to a law enforcement CBA in California) is not covered under H.R. 1. Or is it? If the terms of the MOU match the terms of the FLSA exactly, then is this really the FLSA by another name? We will leave labor law and MOU interpretation to the many excellent police labor law attorneys in the state.

Be Careful When You Receive Your 2025 Form W-2

Along with many other provisions of the One Big Beautiful Bill, an employee’s W-2 could have significant differences between federal and state reportable wages. Taxpayers who prepare their own taxes must be very cautious to reflect these differences when filing their income tax returns. The State of California is very diligent in identifying these types of errors and pursuing state tax on any income reported on a Form W-2 but missing from the corresponding state tax return.

Expiration of the FLSA Overtime Deduction

As previously mentioned, the overtime deduction provision is temporary, and under the new law, is only valid until December 31, 2028.

Conclusion

We want to emphasize, since only a month has passed since the bill was signed into law on July 4 that we are issuing a strong caveat to “stay tuned,” as it were, for further interpretation and guidance. This article is meant to provide a general overview of some aspects of the new overtime deduction. We strongly urge readers to look to guidance issued by their association attorneys about what is or is not covered by the new overtime deduction in the context of their own MOUs.

About the Authors

Tim Kelly is an attorney certified as a specialist in taxation law by the Board of Legal Specialization of the State Bar of California, a distinction held by less than 500 of the state’s 200,000 attorneys. He is a retired police sergeant with 30 years of experience and an honors graduate of the McGeorge School of Law. He is admitted to practice in all courts in California and the Supreme Court of the United States. Tim is also a member of the State Bars of Idaho, Illinois and Texas.

Kevin W. Rego is also an attorney certified as a specialist in taxation law by the Board of Legal Specialization of the State Bar of California and is admitted to practice before the IRS and all California courts. He is a retired police officer with over 27 years of experience and a graduate of the Santa Clara School of Law. Kevin also holds a graduate law degree (LL.M.) in taxation from the University of Alabama. Tim and Kevin practice in the area of tax litigation, appearing on a regular basis before the IRS, the U.S. Tax Court and federal district courts in California and throughout the nation.