January/February 2026 Issue

Also in this issue: Municipal Utilities and Bankruptcy Practice: What Wisconsin Utilities Need to Know     |     Wisconsin Water Utilities Adding Value with Advanced Metering Infrastructure

Municipal Obligations for Police and Fire Employees Under the New “No Tax on Overtime” Rules

Eric B. Hagen , Brian P. Goodman | 02.04.26

Municipalities should be mindful of their obligations under the One Big Beautiful Bill Act, which reduces some of the federal income tax rules affecting how overtime is tracked and reported. Effective for the 2025 through 2028 tax years (unless further extended), individuals who receive qualified overtime compensation may deduct the pay that exceeds their ​“regular rate of pay” that is required by the Fair Labor Standards Act (FLSA)¹ and that is reported on a Form W‑2. The maximum annual deduction is $12,500 ($25,000 for joint filers). Employers will be required to file information returns with the IRS and furnish statements (likely on Form W‑2) to employees showing the total amount of qualified overtime compensation paid during the year.

Many municipal employers pay overtime more generously than the FLSA requires, particularly for police and fire employees covered by a collective bargaining agreement. For purposes of calculating the new overtime tax credits, only the hours worked that exceed the FLSA overtime threshold will count, rather than all of the more generous overtime provided by municipal employment policies and collective bargaining agreements. However, figuring out the amount of FLSA overtime and applicable ​“regular rate of pay” to calculate the tax credits can be complicated.

Municipal employers need to keep track of the number of hours worked that would be considered FLSA overtime during a given ​“work week” or ​“work period.” For most employees FLSA overtime would only start to accrue when working more than 40 hours in a 7‑day period (considered a ​“work week” under the FLSA). However, there is a partial exception in the FLSA for police and fire employees that permits higher hourly thresholds before requiring FLSA overtime compensation to be paid. For police and fire employees, the FLSA also permits overtime hours to be computed over a ​“work period” that may be longer than the regular 7‑day ​“work week” (up to 28 days). The chart below shows the different overtime thresholds for police and fire employees depending on the ​“work period.”

Municipalities will need to be mindful of which ​“work periods” are set in their collective bargaining agreements for police and fire employees to ensure FLSA overtime hours are properly computed and tracked for these employees. Many collective bargaining agreements for police officers and firefighters set different ​“work periods” than the regular 7‑day ​“work week.” Therefore, it is possible for police officers and firefighters to work more than 40 hours in a given 7‑day period, but, due to this FLSA exception, the time worked over 40 hours might not qualify as FLSA overtime, provided the total hours worked within the ​“work period” is below the thresholds noted above. For example, many collective bargaining agreements set a 14-day ​“work period” for departments using a 12 hour shift, with 3 days worked one week and 4 days worked the second week, for a total of 84 hours worked within the 14-day ​“work period.” In such a situation, FLSA overtime would not start to accrue until police officers had worked more than the 86-hour threshold and firefighters had worked more than the 106-hour threshold during a given 14-day ​“work period.” Only the hours in excess of the applicable threshold would count for purposes of calculating the tax credits under the ​“no tax on overtime” rules.

Any FLSA overtime converted to ​“FLSA compensatory” time also will need to be tracked to calculate the tax credits under the ​“no tax on overtime” rules. FLSA overtime converted to FLSA compensatory time counts towards the tax credits if the FLSA compensatory time is used for paid time off or paid out during the year in which the FLSA overtime converted from was earned.² For purposes of calculating the credit, ¹⁄₃ of the wages for the paid time off taken with applicable FLSA compensatory time or ¹⁄₃ of the payout for applicable FLSA compensatory time paid out would count towards the credit.³

Municipalities also need to be mindful of how the FLSA ​“regular rate of pay” is calculated during any ​“pay periods” in which FLSA overtime is accrued or applicable FLSA compensatory time is paid out or used for paid time off. The regular rate of pay, not just the basic hourly rate, is used to determine the amount of the no ​“tax on overtime” tax credits earned during a particular ​“pay period.” The ​“regular rate of pay” is all ​“FLSA compensation” earned during the ​“work period” divided by the actual hours worked in the ​“work period”. In addition to the regular pay rate, common types of ​“FLSA Compensation” for police and fire employees include shift differentials, longevity pay, training pay, cash-in-lieu of health insurance pay, and education or other incentive pay. Municipalities should confer with their legal counsel to determine what is considered ​“FLSA compensation.”⁴

While not related to the calculation of the tax credits under the ​“no tax on overtime” rules, municipalities may want to take this opportunity to review whether they are meeting their FLSA overtime payment liabilities. Municipalities should be aware that the FLSA allows employers to offset their FLSA overtime liabilities by the more generous overtime payments many municipal policies and collective bargaining agreements provide. However, in some circumstances, employers may find they are paying less than the FLSA requires. Failure to meet FLSA overtime payment obligations could lead to legal action for back pay and damages, which basically doubles the amount of unpaid wages, in addition the employee’s attorney’s fees. Many insurance policies will not cover liability for failure to pay overtime, although some policies might cover a municipality’s defense costs.

In conclusion, the ​“no tax on overtime” rules require municipalities to track what qualifies as FLSA overtime, the amount of FLSA overtime converted to FLSA compensatory time, and the applicable FLSA ​“regular rate of pay” for each ​“work period” or ​“work week” during which FLSA overtime accumulates or applicable FLSA compensatory time is paid out or used for paid time off. It will probably take some adjustment to track FLSA overtime and FLSA compensatory time. Many payroll providers and systems are working on rolling out updates to make this tracking easier. Municipalities are encouraged to contact their payroll provider or software vendor to see if any adjustments are coming to make easier implementation.