No Tax on Overtime? Not Exactly. Compliance Changes You Need to Know in 2025

Speaker A: The employees who are in roles not on the list will not be eligible for the tipped income deduction. And the reason is because the government does not want employers changing, you know, salaried regular wages employees to become tipped employees. And then we have tipping economy everywhere.

Speaker B: Hello, and welcome to this episode of HR Unplugged. No tax on overtime. Not exactly compliance changes you need to know in 2025. I'm your host, Vanessa Brulot. With changes from the One Big Beautiful bill, you might be feeling out of the loop with new compliance requirements. Join us in this episode of HR Unplugged as we sit down with Colleen Brin, Senior Manager of Payroll services compliance at BambooHR, to separate fact from fiction. We'll explore the real compliance implications behind the buzz and cover what your HR team needs to know to stay compliant and avoid costly mistakes. Hey, everyone. Welcome to today's episode of HR Unplugged. Let's introduce our gu, Colleen Rin. Colleen is the senior manager of Payroll services compliance at BambooHR. Another great bamboo Ligon. With over a decade of experience in the payroll and HR tech industry and a legal background as a licensed attorney in Florida and North Carolina, Colleen specializes in helping organizations navigate complex regulatory changes with confidence.

Speaker A: Um, what a background.

Speaker B: Colleen, this is amazing. And prior to joining Bamboo, you held senior compliance roles at UKG and Ultimate Software. Can you tell us, you know, our audience, anything else about you? Maybe anything I missed or what you did over the weekend? Whatever sings to you?

Speaker A: Well, nothing very exciting over the weekend, but yeah, I'm currently based in Florida, in South Florida, and have just spent, I think, the majority of my career just researching and analyzing and speaking with employers about legislation that impacts them and their employees. It's really run the gamut of, uh, i9 updates to ACA, to GDPR, to payroll.

Speaker B: Well, before we get into our conversation today, let's. Let's kind of set the stage. Like, talk to us about what the, the big beautiful bill is and who should be listening to this conversation today. Like, who is this episode for?

Speaker A: So this episode is really for anyone in payroll or hr. If you are responsible for employees paychecks or dealing with employees, then I think this episode is going to provide some benefit to you because you're probably going to receive questions from your employees, if you haven't already. And you're probably wondering yourself, what do I do in response to the big beautiful bill? Or I've, uh, heard it called OB3 now that it has passed and what are my next steps? How does this impact me? So, um, I'm hoping that we can provide some guidance and some next steps for. For the people listening today.

Speaker B: Let's kind of dive into maybe some of the basics first. So what. What exactly does the. The no tax on overtime and no tax on tips provisions in the big beautiful bill deal?

Speaker A: Yeah. So no tax on overtime and no tax on tips both allow employees who receive qualified tips and employees who received qualified overtime compensation to make those deductions as part of their tax returns. When OB3 was passed, these provisions, not all provisions, but these two provisions on tips and overtime were made retroactive back to January 1, 2025, but they're temporary in nature, so they are going to both expire at the end of 2028. Both of these provisions have caps on to how much can be deducted. For qualified tips, employees will be able to deduct up to $25,000, and then for overtime, it is $12,500. So here's the caveat. So I just mentioned how there's caps of $25,000 or $12,500, but that is for employees who earn up to $150,000 if you're a single filer, or up to $300,000 if you're a joint filer. If you earn more than 150,000 or more than 300,000 if you're joint filing, then your cap for these deductions decreases. It decreases by $100 for every $1,000 you're over the limit. So an example is if you have earned $160,000 in 2025 and you are a single filer, you are now $10,000 over that initial cap. And then you'll be able to deduct $24,000 instead of $25,000 in tips. Or you could deduct up to $11,500 instead of $12,500 in qualified overtime compensation. We're waiting for a lot of guidance from the IRS on this, and they've been tasked with providing that guidance. And hopefully they'll have some helpful charts like that, or maybe some third party will step in and provide that for employers and taxpayers as well.

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Speaker B: well, talk to me about the overtime provision. Like how does the no tax on overtime part work?

Speaker A: Okay, so this is going to be a tricky provision. I think this provision a lot more difficult than the TIPS provision and I'll explain why. So, as I mentioned before, taxpayers will be able to deduct up to $12,500 of, uh, qualified overtime compensation. That term, qualified overtime compensation, is really important to understand and this is going to cause some confusion or likely will cause some confusion with employees and with payroll admins. And that's because of two reasons. The first reason is because taxpayers will only be able to deduct the qualified overtime compensation that is provided by FLSA or the Fair Labor Standards Act, a, uh, federal law. So this means that if you have employees who are earning overtime under specific state laws that require overtime on a daily basis or double overtime, then that overtime compensation does not apply to the deduction. If you are an employer under a collective bargaining agreement, like if you have a union or multiple unions and there are special overtime rules under that cba, because that's unique to the CBA or uh, the collective bargaining agreement and not under Fair Labor Standards act, then that overtime, uh, or those overtime provisions will also not be able to be deducted. The second reason there might be confusion is because only the premium portion of the overtime rate can be deducted. Usually we think of overtime as one and a half times an employee's regular rate of pay. If you have an employee who typically earns $20 an hour, then they will earn $30 in overtime. But under OB3, only that premium portion can be deducted, which means that only $10 of that overtime compensation, not the entire 30, can be deducted or qualifies as qualified overtime compensation. So you will take that $10 and multiply it by the number of overtime hours as allowed by FLSA, and then determine, like how much qualified overtime compensation an employee has. It's led to some discussion or consideration if payroll systems or payroll admins, you know, should Start thinking of overtime as, like the base overtime pay, like the one times, and then separating out that 0.5. And there have been some discussions on whether or not some employers may take the tact of on pay statements, separating it out. So that way it can help clue in employees as to how much. Not just see how much overtime they made and, uh, earned, but the specific qualified overtime compensation that they earned as well.

Speaker B: And what about the no tax on tips provision? What do HR folks need to know about this provision?

Speaker A: Employees will be able to deduct up to $25,000 in qualified tips. I do think that this one is not going to be quite as, um, complicated as the overtime one, because employers are typically comfortable with separately reporting the tips that an employee has earned. Now, there are some caveats here, as always, but this applies to employees or individuals who have customarily received tips in their profession. Now, what does customarily mean? We're not entirely sure yet because we're waiting on IRS guidance. And the IRS has been tasked with providing a list of occupations that have customarily received tips, and we anticipate that that will be released by early October. It's also important that to qualify or be considered as a qualified tip, the tips must have been paid voluntarily, not be subject to negotiation. And the amount of the tip has to be determined by the customer or the payor is, we are going out to dinner with some coworkers and there's 10 of us, and a restaurant has, um, included a mandatory tip because of the size of our group, then that tip would actually not be considered a qualifying tip under OB3 because it wasn't paid voluntarily. And we did not determine the amount of that tip. The business had determined the amount of that tip. So, um, it'll be interesting to see how this provision impacts some of those charges that we are frankly used to see.

Speaker B: That's interesting. Kind of, uh, a side note from that. Do you think that we'll see more of that written into bills versus the voluntary payment and just like, nope, this is what you need to pay. Like, do you think that that will become a standard potentially?

Speaker A: Well, I think if that is a standard, there could be some backlash from employees who want to be able to use these tips as a deduction, um, on their tax returns. Because if more restaurants go towards these mandatory charges, then the employees will not be able to take that portion of their tips as a deduction. So I, um, might actually see the inverse of that and maybe fewer of those mandatory charges. But it will be interesting to see I was actually reading that some employers were seeing an initial increase in the amounts of tips, um, reported by their employees because they were hearing no tax on tips, no tax on tips. So that was encouraging to them to report all of their tips. However, when they learned that the tips were not being taken or, uh, that federal taxation was still being taken out of their paychecks, then the amount of tips being reported in subsequent weeks went back to kind of the regular rate that they used to be reported.

Speaker B: That's a cool data point, but, yeah, it'll be really intriguing to see how this trends and, like, what, what gets implemented and how it's going to play out. If overtime is now deductible, does that mean that employee checks are going to look different in 2025? And if so, is that something that HR should be messaging to people?

Speaker A: Paychecks will look the same. So this is not stopping the withholding of federal taxes on tips or on overtime. Um, and that is probably causing some confusion with employees, right, because the provisions themselves, no tax on overtime, no tax on tips, leads people to think, I won't have any taxes withheld on my pay statements. It will still be withheld. I highly encourage employers, especially those who are in industries where there is a high population or percentage of your employee population who receives tips or who works overtime, to have that communication ready or to proactively disseminate it to your employees that this is a deduction and you'll be seeing it in 2026, um, when you file your 2025 taxes and there's no change to the paychecks. Now, what payroll departments or HR departments could see is an increase in the number of employees who are maybe modifying their withholdings on their W4 forms because they know that they can take these deductions next year. So they may modify what they want withheld. Now, we may also see sometime in the future guidance from the IRS on withholding instructions. And there has been talk as to whether or not the W4 form itself will change, but again, waiting to see what the IRS does.

Speaker B: It seems like we're kind of in this, this limbo motion of like, waiting for until we get further information from the IRS is basically what I'm hearing.

Speaker A: Yes. And that's really typical. So that's not unique to OB3. It is typical for federal statutes, um, or legislation that has passed. It's also typical for a lot of state legislation because the legislative branch will pass the law and then the executive branch needs to enact those additional guidance or regulations that support Those minor details that were left out of the underlying law itself.

Speaker B: From a payroll processing standpoint, what are the new responsibilities for employers under this bill?

Speaker A: So I think the main thing is going to be being prepared for year end reporting, right? Because these provisions are in effect retroactively to January 1st and nobody was planning on that. January 1st, 2025 is how do we prepare for year end reporting this year? And employers will need to report on the W2s, the qualified tips, and the qualified overtime compensation. The IRS has released some like, transitional guidance that they will allow an approximate amount to be reported on, uh, the W2s. What that approximate amount or reasonable method is for approximating these amounts. We're not really sure. We're hoping for again further guidance. But think now as to how you can determine what a, uh, qualifying tip is if you're in an industry that has customarily received tips, and what your best estimate is for overtime compensation, knowing it has to be provided under FLSA and it's only that premium portion.

Speaker B: And what are the kind of the state implications from this bill like? Or is this just at the federal level?

Speaker A: So this bill is just at the federal level. And so for states that have state income tax withholding, tips and overtime will still have state taxation withheld. And employees will not be able to deduct that from their state filings unless states separately pass their own legislation excluding tips or overtime from state income tax. We have seen states in 2025 introduce that legislation into their state legislatures. Um, it was, as we all know, a big talking point in um, the last election cycle. However, to date, new state actually passed or enacted that legislation. And then Alabama, you know, who a few years ago had enacted legislation that exempted overtime from state taxation. That exemption just ended as of July 1st of this year. So currently, um, no matter where you are in the US if your state has a state income tax, then uh, you won't be able to deduct that from your state taxes and it will continue to also be withheld for state taxation. There's an interesting caveat where there are some states that just follow the federal like withholding and, or rules for withholding. And so some of those states will probably need to pass legislation as to whether or not they're going to continue to follow the state method or else there is a possibility that residents in their state will be able to deduct tips over time. Colorado recently took action where they confirmed that overtime earned in their state is still subject to state taxation and there is no deduction available. So I guess there's a long way of saying that this only applies at the federal level and you'll still have to pay taxes on tips and overtime at the state level.

Speaker B: 1 and I love that you're walking through that too, helping kind of build that roadmap for people. Because having kind of context in those examples is super helpful to, for people to visualize what, what's happening.

Speaker A: It shows really how multi layered payroll and HR because you have to look at the federal methods separately from the state methods and each state can handle things in their own way. So it's always as I think everyone here um, who is working in payroll and HR knows always like a whack ah, a mole game where you're trying to stay on top of everything that is going on and making sure you're hit and know each action that's taken.

Speaker B: I feel like any, anybody in, in payroll compliance, it's like the amount of, of knowledge you have to retain and also continuously learn to like kind of make like you said, the whack a mole making sure you're always on top of things. I'm like that's so much knowledge to continuously like retain and keep up on kind of pivoting a little bit it within the bill it mentions that the, the Treasury Secretary will release a list of the, the qualifying occupations for the tip deduction. I think you kind of mentioned a little bit earlier on this but what happens if an employee's job is not on that list?

Speaker A: Employees who are enrolled not on the list will not be eligible for the tipped income deduction. And the reason is because the government does not want employers changing, you know, salaried regular wages employees to become tipped employees. And then we have tipping economy everywhere to take advantage of that deduction. So it's really to prevent the reclassification of regular wages as tips where tipping is, is not customary. Otherwise I could put up a uh, QR code on this podcast and ask for a tip from listeners and I don't think we want to go down that path.

Speaker B: That's a great example because that could happen um, and I probably wouldn't even notice. Well, what are, what are the potential downsides that we should be aware of as these new changes take effect?

Speaker A: I think it's really going to be combating confusion, right Confusion at the employee level of what does it mean when they hear no tax on tips, no tax on overtime. It's confusion as a payroll professional and particularly the overtime arena of what is qualified overtime compensation. What is that premium amount, what overtime have My employees earned that is covered under FLSA and not through some other state regulation. So it's really good to proactively communicate to your employees and then also to stay on top of guidance that comes out through the IRS or through third party sources that may be beneficial. But it's also good to know that this confusion is going to be temporary in nature, not only because of the guidance coming out, but because these provisions are also temporary. So kind of once we get into a routine of how to handle tips, and over time, the provisions are likely going to expire.

Speaker B: One in the bill also brings some, some changes for working parents beyond the tip and overtime provisions. What's changing with dependent care FSAs?

Speaker A: So this is really good news for, uh, working parents. So the limit for dependent care FSA is increasing for the first time and it is increasing from $5,000 to $7,500. So this will allow working parents to have a bit of tax relief with the increasing daycare costs and summer camps and just the other expenses that parents incur while trying to juggle home and work. Um, this Provision is effective January 1, 2026, so you won't see any changes with Your Dependent Care FSAs this year, but as you enroll your company's open enrollment for 26, then you will see that increased amount.

Speaker B: Then can you walk us through the changes to the paid family and medical leave tax credit?

Speaker A: Mhm. Yeah. So OB3 has made the employer tax credit for paid family medical leave permanent. This was a tax credit already available to employers, but it was set to expire at the end of 2025. So now this, this new provision in OB3 is effective January 1, 2026, and the tax credit is now made permanent and won't expire. So what this does is it allows employers to take a tax credit for some of the wages that they pay to their employees who are on qualifying leave, or to take the tax credit on the premiums that employers pay to provide that benefit to their employees. What this also does, it is it expands the employee base for whom employers can take the tax credit. So previously in the temporary provision, an employee had to have worked for that employer for a minimum of 12 months before the employer could take the credit. Now that that time period decreases to six months, this will provide more long term certainty to employers that they can offset some of the cost of providing paid family medical leave to employees. And hopefully it will encourage more employers to provide paid family leave to their employees knowing that this is permanent.

Speaker B: Where would you recommend folks go for more information to make sure they're, they're in that compliance with all these new changes and staying on top of things.

Speaker A: I first really recommend staying in touch with your legal counsel to build that good relationship with your legal counsel, whether you have in house counsel or external counsel. Same thing with any tax professionals that you work with. Like, this is really what they live in, day in, day out. And so they'll be happy to provide the guidance that you're looking for. There's also third party sites that you can utilize. We use Bloomberg and SHRM a lot. They will provide that information and they'll alert you pretty soon after the IRS has released some of the guidance that we're waiting for. I think an untapped resource can also be, uh, law firms. So not just your own personal or, you know, professional legal counsel, but national law firms a lot of times have blogs and webinars, free webinars that they host, and they are providing you an overview of not just, you know, the budget bill or OB3, but other emerging legislation. And so it's a really good resource to tap into to follow some law firms that you trust and to see what webinars they provide.

Speaker B: Colleen, thank you so much for joining me today. This is such a heavy topic, but it's so intriguing and interesting. I'm so grateful that you're able to come on and have this conversation and can help our HR teams of one out there know kind of where can they go answering some of the questions they might have. So really appreciate all the content you've provided for us today. Just really appreciate you, Colleen, and for our listeners. Check out our show notes. You'll find the links to resources we think are helpful with this topic. We invite you to Visit us@hrumplug.com where you can sign up to be notified of all future podcast episodes and view the latest episodes in podcast format. Stay tuned for our next episode. Thank you for tuning in. If you enjoyed today's episode, the best way to support our show is by leaving a quick review. It should just take a minute and it will help us find more great listeners just like you. Today's episode is brought to you by BambooHR, the complete HR software. Simplify HR with award winning solutions for everything from hire to retire with bamboohr.