Last year, a new federal tax deduction for overtime pay took effect under the One Big Beautiful Bill Act. What followed? Colorado chose not to conform to this deduction, so overtime pay remains fully taxable at the state level.
The Colorado state legislature created a new rule, but only for one year. How can one government tax it and the other not? This article is meant to help you understand what this tax mismatch means for your taxes and your overtime pay this year.
What is the Modification to Colorado’s Overtime Tax Break?
Last year, the federal government introduced a new overtime tax break for individuals, excluding this pay from their taxable income. Colorado didn’t adopt it. The legislature decoupled from the federal break in 2025 through HB25-1296, meaning the addback already applied to 2025 overtime pay.
This June, Colorado’s governor, Jared Polis, signed HB26-1289, which extends that addback specifically through the 2026 tax year, requiring residents to add back any overtime compensation deducted on their federal return to their Colorado taxable income.
This is for tax year 2026 only, but starting in 2027, gains excluded federally from Qualified Opportunity Fund investments must be added back:
- Addback: This type of income was left out of the calculation, but now put back in. If your income was excused from taxes in one place, this rule un-excuses it somewhere else, usually because a different government (like your state) doesn’t agree with the exclusion.
The federal government excluded overtime pay. Colorado’s new law adds that overtime pay right back, but only on your state return. Those hours that you picked up to cover a coworker’s leave or to save up for a down payment are the hours you have to add back into your taxable income.
How Does Colorado’s Overtime Tax Affect Residents?
Your federal tax bill reflects the “overtime is tax-free” headline that you saw last year. But your Colorado state tax bill does not. Without a warning, you might be caught off guard when you unexpectedly owe more state tax than you budgeted for.
This addback affects anyone who:
- Works substantial overtime hours: many industries, like healthcare, manufacturing, construction, emergency services, and more are included.
- Is part of a two-income household: Either spouse worked significant overtime and the couple files one combined state return. The addback applies to the household total.
- Owns a small business and pays overtime to employees or to themselves: business owners may have set up payroll assuming federal and state treatment matched, and the Colorado withholding may now be too low.
If you’re expecting a refund in 2027 and instead find out that you owe, you’ve run out of time to set money aside. There is an opportunity now to check for surprises you could face in April due to this temporary mismatch.
What to Expect in Future Colorado Law
The overtime addback is capturing headlines because it’s happening right now. But the same law also includes two other changes that don’t kick in until 2027.
Think of these as “save the date” items to flag:
- Opportunity Zone investments: Qualified Opportunity Funds are a type of investment that lets people put money into designated lower-income areas for a federal tax break on the investment gains. Starting with the 2027 tax year, Colorado will require investors to add those federally tax-free gains back, too. The one exception is if 90% of your investment is inside Colorado’s own designated zones. Where your money is invested will now be a factor in how much you owe and whether the addback applies.
- Combined corporate finances: When a company has related entities in different places, it has to decide how to report all income together for tax purposes. Colorado’s new law changes the default method, but gives companies the option to elect a different method. This mainly affects C-corporation structures. Whichever option a company chooses is a 10-year commitment.
Colorado residents might face changes to their personal income tax in upcoming tax years. It’s worth looking at how that’ll affect you now.
What Colorado Residents Should Do Now
For the Colorado residents who are thinking, “this applies to me,” there are a few steps you can add to your tax preparation plan this year.
- Pull your 2026 pay records.
- Estimate the extra Colorado tax on your overtime.
- Adjust your withholding or make an estimated payment before year-end.
- Understand where your Qualified Opportunity Fund is invested.
- For C-corporations, learn more about the 2027 filing election.
With significant overtime pay or multiple filing options left undecided, consider scheduling time to meet with your CPA. Our team at MBE CPAs can help identify where the new rules apply to you and suggest ways to help manage the timing of what you owe. With an office in Colorado, we’re happy to help residents find out whether they need to construct a new tax plan.