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Permeable sediments, which make up almost half of the continental shelf worldwide, are potential sources of the important greenhouse gas N2O from coastal regions. Yet, the extent to which interactions between these sediments and anthropogenic pollution produce N2O is still unknown. Here we use laboratory experiments and modeling to explore the factors controlling N2O production at a eutrophic site in a temperate shallow marine embayment (Port Phillip Bay, Australia). Our results show that denitrification is the main source of N2O production within permeable sediments, but the extent to which N2O is actually released is determined by the rate of seawater exchange with the sediment bed (which governs solute residence time within the bed). In wave‐dominated coastal areas, shallower water with more intense waves (wave height >> 1 m) release the most N2O, with up to 0.5% of dissolved inorganic nitrogen pumped into biologically active eutrophic sediment being released as N2O. Our results suggest rates of N2O production in coastal permeable sediments are generally low compared to other environments.