Colorado Will Continue Taxing Overtime Pay Despite New Federal Exemption

Adam Tahir
Jul 8
2 min read

Updated: Oct 4

With Congress having passed the “One Big Beautiful Bill”, significant tax changes are about to take effect nationwide. One provision exempts overtime wages from federal income tax between 2025–2028, aiming to reduce tax burdens for middle-income workers.

However, Colorado has announced it will not conform to this federal exemption. This means that while taxpayers will see relief on their federal returns starting next year, overtime pay will remain fully taxable at the state level.

What Does the New Federal Law Provide?

The enacted bill includes:

Exemption of overtime wages from federal income tax for the tax years 2025 through 2028.
This provision applies broadly to hourly workers across industries and is coupled with similar exemptions for tips and partial Social Security income.

Colorado’s Position

Colorado’s income tax system starts with federal AGI but allows lawmakers to “decouple” from specific federal changes. For overtime:

State legislators confirmed they will not adopt the federal exemption.
As a result, overtime pay remains part of Colorado taxable income even though it will be excluded federally.

Why This Matters for Employees and Employers

Employees in Colorado will still benefit from the federal tax exemption but must pay state income tax on overtime wages.
Payroll teams must adjust systems to withhold state taxes on overtime while excluding it from federal taxable wages.
Tax professionals will need to explain these divergent rules clearly to clients to avoid confusion when 2025 W-2s are issued.

Comparison Table: Overtime Pay Tax Treatment (2025–2028)

Jurisdiction	Tax Treatment	Notes
Federal	Exempt from income tax	New provision under “One Big Beautiful Bill”
Colorado	Fully taxable	State AGI includes overtime pay

Policy Rationale

Colorado officials cited two main reasons for decoupling:

Revenue stability – exempting overtime could cost the state budget millions annually.
Equity considerations – policymakers prefer consistent wage taxation rather than singling out overtime for relief.

Planning Implications for Tax Advisors

Ensure payroll withholding systems are updated to reflect this divergence.
Adjust Colorado estimated tax payments for clients with significant overtime income.
Communicate proactively to manage employee expectations in year-end tax planning and withholding strategy reviews.

How Bizora AI Supports Your Firm

Bizora AI tracks state conformity decisions in real time, providing:

Automated insights on federal-state decoupling provisions
Client-ready memos explaining new overtime tax treatment
Modeling tools to project net pay impacts across jurisdictions

Want a structured analysis of overtime exemptions under the new federal law and Colorado’s decoupling? Ask Bizora AI for state-specific planning support in seconds.