No Tax on Overtime Arizona 2026: Federal + State Subtraction Explained

Arizona Overtime Workers Get a Real State-Level Tax Break in 2026

Arizona is one of the few states that has passed its own matching state-level tax break for overtime pay, rather than simply leaving the federal One Big Beautiful Bill Act (OBBBA) deduction untouched or ignored. House Bill 4168, signed by Governor Katie Hobbs on June 13, 2026, creates an Arizona individual income tax subtraction equal to the amount of qualified overtime compensation you deduct on your federal return under Internal Revenue Code §225 (the OBBBA overtime provision). The subtraction applies retroactively to taxable years beginning from and after December 31, 2024 (HB 4168 became Chapter 140 of the 2026 session laws).

Because Arizona uses a single flat 2.5% income tax rate instead of progressive brackets, the math is simple: whatever overtime premium pay you exclude federally (up to $12,500 single / $25,000 married filing jointly) is also excluded from your Arizona taxable income, worth an additional 2.5% saving on top of your federal benefit. This guide covers exactly how the federal deduction works, how Arizona's mirrored subtraction is calculated, what still gets taxed (FICA, and overtime above the cap), and worked dollar examples for common Arizona overtime occupations.

What HB 4168 Actually Did

Before June 2026, Arizona had not conformed to the federal OBBBA overtime provision — overtime pay was subject to Arizona's flat 2.5% tax with no state-level relief, even as the federal deduction reduced the federal side. Earlier attempts to add a matching Arizona subtraction, including SB 1106 and an earlier version of HB 2785, were vetoed by Governor Hobbs.

The provision that ultimately became law is House Bill 4168 ("taxation; omnibus; 2026–2027"), part of the final bipartisan state budget deal. HB 4168 rewrote large sections of Arizona's Title 43 income tax code to align with the federal OBBBA, and it creates a subtraction from Arizona gross income equal to "the amount of qualified overtime compensation received during the taxable year that is deducted under" the federal qualified-overtime deduction (IRC §225). In practice: whatever dollar figure you claim as your federal overtime deduction on Schedule 1-A of Form 1040, you also subtract that same figure from your Arizona income.

This is enacted law, applying retroactively to tax years beginning January 1, 2025 — available on both your 2025 return (filed in 2026) and your 2026 return. The Arizona Department of Revenue (ADOR) has published a Middle Class Tax Cuts Package (MCTCP) worksheet to calculate the subtraction; before filing, confirm the current instructions at azdor.gov.

How the Federal OBBBA Overtime Deduction Works

The federal starting point is identical for every state. The OBBBA created a deduction — not a full exemption — for qualifying overtime premium pay:

• Cap: Up to $12,500 for single filers and heads of household; up to $25,000 for married filing jointly (married taxpayers must file jointly to claim it).
• Type: A deduction claimed on Schedule 1-A of Form 1040 that reduces federal taxable income (it does not reduce AGI). It is not a credit and does not reduce your tax bill dollar-for-dollar.
• Who qualifies: Only FLSA non-exempt employees who receive time-and-a-half overtime premium for hours over 40/week. Exempt salaried employees and 1099 contractors do not qualify.
• Phase-out: Begins at $150,000 modified AGI (single) and $300,000 (married filing jointly), reducing the deduction by $100 for each $1,000 above the threshold.
• FICA is untouched: Social Security and Medicare still apply to every dollar of overtime pay.
• Sunset: Expires December 31, 2028 unless Congress extends it.

Workers whose modified AGI is at or below the $150,000 (single) threshold are not affected by the phase-out. For the full federal mechanics, see the OBBBA Overtime Deduction Explainer.

How Arizona's Subtraction Stacks on Top

Arizona's tax return starts from your federal AGI and layers on state-specific additions and subtractions. Because the OBBBA overtime deduction is claimed below AGI, it does not reach your Arizona return on its own, so HB 4168 creates a matching Arizona subtraction — the opposite of what non-conforming states like California do.

Concretely: if you claimed a $10,000 federal overtime deduction, your Arizona return also allows a $10,000 subtraction from Arizona gross income. At Arizona's flat 2.5% rate, that's worth $250 in Arizona income tax savings ($10,000 × 2.5%), on top of whatever you saved federally.

Because Arizona uses one flat rate rather than progressive brackets, the formula is simple: Arizona tax saving = subtraction amount × 2.5%. At the maximum single-filer cap of $12,500, that's a maximum Arizona-level saving of $312.50; at the maximum MFJ cap of $25,000, the maximum Arizona saving is $625. The state-level dollar amount is modest compared to the federal saving (which depends on your marginal federal bracket, often 12%–24%), but it's genuine relief Arizona chose to extend rather than claw back.

FICA and Overtime Above the Cap

Neither the federal deduction nor Arizona's mirrored subtraction changes payroll tax obligations. Every Arizona worker earning overtime still owes FICA on 100% of that pay:

• Social Security: 6.2% on combined wages and overtime, up to the annual wage base.
• Medicare: 1.45% on all wages and overtime, no cap (plus an additional 0.9% surtax above $200,000 for single filers).

On $18,000 of overtime pay, FICA alone is $18,000 × 7.65% = $1,377 — owed regardless of either deduction.

Overtime premium pay above the $12,500 single / $25,000 MFJ federal cap is also fully taxable at both the federal and Arizona level, since Arizona's subtraction only mirrors the amount that was federally deductible. A single Arizona worker earning $18,000 in overtime premium can deduct/subtract $12,500; the remaining $5,500 is ordinary taxable income for both federal and Arizona purposes.

Worked Example: Arizona Nurse, $85,000 Base + $14,000 Overtime

Scenario: single Arizona registered nurse, $85,000 base salary + $14,000 in FLSA-qualifying overtime premium pay = $99,000 gross income. AGI is well under the $150,000 phase-out, so the full deduction is available (though capped below the actual overtime premium earned).

Arizona taxable income uses the Arizona standard deduction ($15,750 single, the 2025 amount; Arizona indexes it to the federal basic standard deduction under A.R.S. 43-1041(H), so the 2026 figure is expected to be $16,100 and the tax slightly lower). This is a simplified illustration of the subtraction mechanic, not a complete return. Verify your exact figures with the ADOR MCTCP worksheet or a tax professional.

Worked Example: Married Construction Worker Couple, $25,000 Combined Overtime

Scenario: married filing jointly, combined base wages of $95,000, combined FLSA overtime premium of $25,000 (right at the MFJ cap) = $120,000 gross income.

Because this couple's combined overtime exactly matches the $25,000 MFJ cap, they receive the maximum possible Arizona-level saving of $625 from the subtraction, plus their federal saving at their marginal bracket. Combined modified AGI above $300,000 would begin to reduce both the federal deduction and, by extension, the Arizona subtraction, by $100 for each $1,000 above the threshold.