Working Overtime? Colorado Wants to Stop Taxing Those Extra Hours

The Bottom Line

The federal government recently stopped taxing overtime pay, but under current law, Colorado plans to keep taxing it starting in 2026. This bill would eliminate that state tax on your overtime wages starting in 2027, letting you keep every dime of those extra hours. But because of Colorado's highly interconnected tax code, giving workers this overtime break triggers an automatic chain reaction that shrinks other family tax credits, creating a fascinating policy showdown at the Capitol.

What This Bill Actually Does

To understand this bill, you have to look at what's happening in Washington D.C. In 2025, Congress passed the One Big Beautiful Bill Act (OBBBA), which included a massive new perk for hourly workers: a federal income tax deduction for qualified overtime pay between 2025 and 2028. That means the IRS won't touch your time-and-a-half wages. But state taxes are a different beast. Under current Colorado law (specifically, a bill passed last year known as HB 25-1296), the state requires you to take that tax-free federal overtime and "add it back" to your taxable income when calculating your state taxes starting in 2026. In plain English: Uncle Sam isn't taxing your overtime, but Colorado still plans to.

Enter Senate Bill 26-056. This legislation proposes a truce for your paycheck by repealing that state-level overtime compensation addback beginning in tax year 2027. If passed, the state would only force you to pay state income tax on your federally exempted overtime pay for a single year (2026). After that, Colorado would align perfectly with the federal government, letting you keep your overtime wages completely free of state income tax until the federal program expires at the end of 2028.

Here is exactly how the timeline plays out under this proposed legislation:

• Tax Year 2025: Overtime is federally tax-free; Colorado state laws are still aligning, so no addback exists yet.
• Tax Year 2026: Overtime remains federally tax-free, but Colorado will tax it (this is the one year the state addback applies).
• Tax Years 2027 & 2028: Overtime is completely tax-free at both the federal and state levels.
• Tax Year 2029: The federal OBBBA deduction expires, and all taxation goes back to business as usual.

What It Means for You

If you are an hourly worker who pulls regular overtime—whether you are picking up extra night shifts at the hospital, grinding through the busy season in construction, or working retail through the holidays—this bill puts real cash back in your pocket. Right now, Colorado's flat income tax rate means the state takes a 4.4% cut of every dollar you earn. By aligning state law with the federal overtime deduction starting in tax year 2027, this bill effectively gives you a permanent state tax break on those hard-earned extra hours through the end of the federal program. When you work a 50-hour week, the pay for those last 10 hours will go entirely to you, free of state and federal income grabs.

But here is the catch, and it's a big one if you have kids or rely on income-based tax credits: this bill sets off a bizarre mathematical chain reaction in the Colorado tax code. Because the state loses money by choosing not to tax your overtime, overall state revenues dip. By law, that specific revenue dip automatically triggers a reduction in other state assistance programs—specifically, the Family Affordability Tax Credit and the Expanded Earned Income Tax Credit.

So, we are looking at a classic policy tradeoff. If you work a lot of overtime, your paychecks get noticeably bigger. But if you rely heavily on the Family Affordability Tax Credit or the Earned Income Tax Credit to balance your household budget at tax time, you might see those end-of-year credits shrink in 2027 and 2028. It is highly recommended that you sit down with your accountant or use tax-prep software to look at your specific household income mix. You will want to compare your expected overtime earnings against your typical family tax credits to see exactly how this legislative seesaw will affect your family's bottom line.

What It Means for Your Business

For Colorado employers, this bill is fundamentally a workforce management story disguised as tax policy. If you run a business that relies heavily on overtime—think general contractors fighting weather delays, restaurants managing seasonal rushes, or logistics companies handling peak shipping—you already know how hard it is to incentivize workers to take those grueling extra shifts. When employees realize their overtime is completely tax-free at both the federal and state levels starting in 2027, time-and-a-half suddenly becomes substantially more lucrative. This could make it significantly easier to staff hard-to-fill weekend or evening shifts without having to bump base wages just to make the extra hours worth the effort for your team.

On the administrative side, your payroll department or third-party HR vendor is going to have to do a multi-step dance over the next few years. Because this bill intentionally keeps the state tax addback in place for the 2026 income tax year, your systems will need to accurately report that overtime data so employees can calculate their state tax liability for that specific year. Then, for tax years 2027 and 2028, your software will need to pivot again, ensuring that the state addback is removed from the equation completely.

You don't need to change your gross payroll calculations, but you should absolutely prepare to communicate these changes clearly to your workforce. Workers look closely at their net pay. When their withholdings and end-of-year tax liabilities change wildly between 2026 and 2027 due to shifting state rules, they are going to knock on HR's door asking if payroll made a mistake. Get ahead of it. Talk to your payroll provider to ensure their software is actively tracking the One Big Beautiful Bill Act federal changes and is prepared to seamlessly handle Colorado's unique 2026-only addback structure.

Follow the Money

The fiscal math on this bill is one of the most fascinating examples of Colorado's interconnected tax code you will ever see. By choosing not to tax overtime pay, the state directly loses an estimated $58.5 million in FY 2026-27 and $117.8 million in FY 2027-28. In a normal state, that would be the end of the story—a straightforward tax cut resulting in lost government revenue.

But Colorado is not a normal state. Because of the state's complex tax credit triggers, that initial drop in revenue causes the state to severely reduce the amount it pays out to lower-income households for the Family Affordability Tax Credit and Earned Income Tax Credit. By shrinking those credits automatically, the state actually keeps an extra $124.4 million in FY 2026-27. When the dust settles, giving workers an overtime tax break actually nets the state government a positive gain of $65.9 million in the first year. Because individual income tax is subject to the Taxpayer's Bill of Rights (TABOR), that extra $65.9 million doesn't get spent by lawmakers; it will simply be added to the pool of money required to be refunded to all Colorado taxpayers the following year.

Where This Bill Stands

SB26-056 is currently In Committee. The latest official action came on 05/14/2026: Senate Committee on Appropriations Lay Over Unamended - Amendment(s) Failed.

That means the bill is still in the committee stage, and it is currently sitting in the State, Veterans, & Military Affairs. To keep moving, it would need to clear committee and then survive floor votes in both chambers.