The 'No Tax' Overtime Myth: Employer Payroll And Reporting Obligations Under The One Big Beautiful Bill Act Explained

There has been some confusion among employers regarding the "One Big Beautiful Bill." Despite the shorthand references to "no tax on overtime" and "no tax on tips," the law does not eliminate payroll taxes or change how employers calculate or pay overtime. Instead, it creates a temporary "individual income tax deduction" for employees, which in turn triggers new (and evolving) employer reporting obligations.

No Change to Overtime Pay Obligations

Employers must continue paying overtime exactly as required under federal and state law. Under the federal Fair Labor Standards Act (FLSA), nonexempt employees must receive overtime at one-and-one-half times their regular rate of pay for all hours worked over 40 in a workweek. In California, nonexempt employees are entitled to overtime at 1.5 times their regular rate for (i) hours worked in excess of 8 hours up to and including 12 hours in a workday, (ii) hours worked over 40 in a workweek, and (iii) the first 8 hours worked on the seventh consecutive day in a workweek. Double time (2.0 times the regular rate) is required for (i) hours worked over 12 in a workday and (ii) hours worked over 8 on the seventh consecutive day in a workweek.

The new federal tax deduction does not alter an employer's overtime pay obligations. Instead, it allows for a temporary deduction for eligible employees regarding the FLSA-required overtime premium portion (the additional 0.5 above the regular rate for hours over 40 in a workweek). Overtime or double time that was paid to an employee solely because of California (or another state's) law does not independently qualify for the federal deduction. The annual deduction is capped at $12,500 ($25,000 for married employees filing jointly) and phases out for individuals with modified adjusted gross income above certain thresholds.

No Change to Payroll Tax Withholding

Importantly, employers must continue withholding and remitting federal income tax, Social Security, and Medicare taxes on overtime and tips as usual. The law does not create a payroll-level exemption. The benefit is realized by employees when they file their individual tax returns. Employers should ensure payroll teams understand that nothing changes operationally with respect to withholding.

Anticipated Separate Reporting

Beginning with tax year 2026 (forms issued in early 2027), employers are expected to separately report qualified overtime premium amounts and qualified tips on revised Forms W-2 and other applicable information returns. Employers should work now with their payroll providers to ensure systems can track: (i) the FLSA overtime premium portion separately from base wages, and (ii) tip income consistent with existing federal reporting rules. Advance system configuration will reduce compliance risk once the IRS finalizes reporting instructions.

Practical Compliance Steps

Employers should (a) confirm payroll systems can distinguish the FLSA overtime premium from state-law required overtime amounts; (b) communicate internally that withholding rules remain unchanged; (c) monitor IRS guidance and form revisions; and (d) avoid making employee-facing statements suggesting overtime or tips are "tax-free." Employers may receive additional questions from employees during the upcoming tax season about what amounts may qualify. Employers should exercise caution in providing specific "deduction" amounts to employees and/or providing tax advice, and if needed, should direct employees to consult with their personal tax advisors. Mischaracterizing the deduction could create employee-relations issues and wage-claim liability. As always, multi-state employers should carefully review state overtime rules to avoid errors when calculating and reporting qualified overtime premium amounts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.