| OBBB – No Tax on Overtime & Its Impact on CA Employers |
| Overview The One Big Beautiful Bill Act (OBBB) law allows non-exempt hourly employees under the Fair Labor Standards Act (FLSA) to take a federal income tax deduction for the total amount of “qualified overtime compensation” received. Eligible employees can claim the deduction on their federal tax returns starting with the tax year 2025 through 2028. The “no tax on overtime” provisions authorize eligible individual workers to deduct qualified tips and overtime pay from their federal taxable income for 2025–2028, but Social Security and Medicare taxes still apply. Thus, employers will still have to withhold employment taxes for their employees who receive overtime. Employers must continue to report overtime compensation on Form W-2, though there are new requirements to separately identify overtime amounts for tax reporting purposes. Payroll systems may need to be updated, including for new withholding tables and to track overtime. What does this mean for employers? Tax withholding and reporting of employee compensation is still required. The overtime provision does not create an exclusion from income subject to withholding. Overtime wages are still required to be reported to employees on Form W-2. Overtime wages are still subject to federal income tax withholding (and state and local tax withholding where applicable), as well as employment tax withholding, including Social Security and Medicare. Payroll systems may need to be updated. Payroll systems likely already track overtime wages for purposes other than tax, but new software mapping may be required to also capture overtime wages for purposes of satisfying the requirements of the overtime provision. Overtime wages need to be identified on Form W-2. Employers will be required to report overtime wages separately on Form W-2. This could be accomplished through new Box 12 or 14 reporting. It is unlikely that reporting on Form W-2, Boxes 1, 3, and 5 would change. Impact on California Employers The new tax deduction does not apply to state-specific overtime or double-time. It only applies to FLSA overtime requirements. California law often requires overtime for daily hours over 8 hours, while the new tax deduction is based on the FLSA’s weekly 40-hour standard. Workers with state-mandated daily overtime or double-time will continue to receive overtime pay and report it for state taxes, but only overtime that exceeds 40 hours in a work week will qualify for the new tax deduction. For the 2025 tax year, there will be no changes to form W-2, but employers must track overtime and provide the qualified overtime premium amounts to workers. Workers will likely receive this information in a separate year-end statement or supplemental wage statement attached to the W-2. Federal vs. California Overtime Definitions: The federal deduction only applies to “qualified overtime compensation” as defined by the Fair Labor Standards Act (FLSA), which mandates overtime pay for hours worked over 40 in a single workweek. California law is more expansive and requires overtime for daily hours worked over eight, double-time for hours over twelve in a workday, and overtime for the seventh consecutive day of work. Non-Qualifying Overtime: Overtime paid only to satisfy California’s specific daily or double-time rules is not eligible for the federal tax deduction. Employers must distinguish between the “premium” portion of FLSA-mandated overtime (the extra half-time pay) and California-only overtime premiums for reporting purposes. Employer Responsibilities & Tax Reporting Employers must track and report the overtime premium separately for each employee so workers can maximize the deduction for all eligible overtime. This is particularly important in states like California that have overtime rules that differ from the federal standard. Example 1: Employee in California works three 8-hour days + one 10-hour day. · CA mandates daily overtime pay for 2 hours of 10-hour day. · Total hours worked = 34 → No federal overtime. Not eligible for new deduction. Example 2 Employee in California works four 8-hour days + one 10-hour day. · CA mandates daily overtime pay for 2 hours of 10-hour day. · Total hours worked = 42 → 2 hours federal overtime eligible for new deduction. Employers must report the qualified overtime pay on Form W‑2 to the IRS and furnish statements to employees. The IRS will offer transition relief for tax year 2025, allowing employers to use any reasonable methods specified by the IRS. For tax year 2025, there are no changes to W‑2 formatting or withholding tables. Employers will issue the standard W-2 form for 2025. New W-2 Coming The IRS recognizes employers may not have the required information or procedures in place to be able to correctly file the additional information and provide it to employees. Accordingly, the IRS designated tax year 2025 as a transition period for IRS enforcement and administration of the OBBB’s information reporting requirements. With respect to the tax year 2026, the IRS published a draft W-2 form, with new instructions directing employers to use Box 12 to report the employee’s total amount of qualified overtime compensation using code “TT.” Since this is a draft form, it is subject to change before it is finalized for reporting. The image below is an example of how the draft W-2 form for tax year 2026 would be filled out by employers. Red Flag Tips Consult with your payroll provider to ensure compliance with the new federal reporting requirements and the interaction with California’s specific overtime laws. Continue Normal Tax Withholding: Maintain withholding of federal income tax, state income tax, Social Security, and Medicare taxes from all overtime earnings as you would regularly pay. Track and Report FLSA Overtime Separately: The deduction only applies to the premium portion (the extra half-time pay) of overtime mandated by the federal Fair Labor Standards Act (FLSA), which is for hours worked over 40 in a workweek. CA Employers must be able to distinguish between FLSA-qualifying overtime and state-mandated overtime in their payroll systems. Prepare for New W-2 Reporting: For the 2025 tax year, the IRS has announced transition relief, allowing employers to use a “reasonable method” to approximate the qualified amount and provide this information to employees, likely on a separate statement, as official W-2 forms remain unchanged for this year. For 2026 and later (through 2028), employers can expect updated W-2 forms with new fields for reporting this amount. Communicate with Employees Clearly explain that the tax benefit is an above-the-line deduction claimed when they file their personal income tax return, not an immediate reduction in paycheck taxes. For additional information, please call our office at (714) 799-1115 |
