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A new federal law enacted last year provides a tax benefit to employees who receive overtime pay – but calling it a “No Tax on Overtime” law is a bit of misnomer. For starters, OT pay remains taxable and subject to withholding rules. And while a new income tax deduction may be available to some employees who work overtime, only a limited portion of federally required overtime compensation is tax deductible. We’ll clear up some of the biggest misconceptions surrounding these new rules and provide some key employer takeaways – which will become especially important this tax season and beyond as more employees learn the realities of these rules and the IRS cracks down on employers’ new filing and information reporting obligations.
Overview of “No Tax on Overtime”
The One Big Beautiful Bill Act (OBBBA), which President Trump signed into law last year, includes a new federal income tax deduction related to overtime pay. This new deduction:
The deduction is allowed for both itemizers and non-itemizers, so long as the individual includes their social security number on their tax return. If an individual is married, they must file a joint return in order to claim this deduction.
The Big Question: What Does “Qualified Overtime Compensation” Mean?
The law defines “qualified overtime compensation” as “overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act” (FLSA) that exceeds the individual’s “regular rate” (as determined by the FLSA), excluding qualified tips. This language expressly conditions an employee’s right to claim the federal tax benefit on federal labor law requirements, specifically excluding overtime compensation mandated solely by state law.
Is “No Tax on Overtime” a Misnomer? Top 3 Misconceptions and Employer Challenges
There are plenty of misconceptions floating around related to the implications of the Big Beautiful Bill, especially related to the “No Tax on Overtime” provisions. In order to separate myth from reality, here are three key clarifications on the top mistaken beliefs.
1. The new tax deduction is only available for overtime pay required by the FLSA.
The FLSA generally requires employers to pay covered, nonexempt employees at least 1.5 times their “regular rate” of pay for all hours worked beyond 40 hours in a given workweek. This is very important to keep in mind because some states have overtime laws that overlap with, but also go beyond, the requirements of the FLSA. For example:
Therefore, if an employee receives overtime pay that is required by state, but not federal, law, such amounts are not “qualified overtime compensation” under the OBBBA, and no portion is deductible by the employee for federal income tax purposes.
2. The deductible amount may be less than you think.
As explained above, the new deduction related to overtime pay is capped at $12,500 ($25,000 for joint filers) and is reduced or phased out completely based on an individual’s MAGI for the year. In addition, the amount that is deductible is not the full amount of the individual’s FLSA-required overtime compensation – rather, it is the portion that exceeds the individual’s “regular rate” of pay as determined under federal law.
Here’s an example:
3. All overtime pay remains subject to payroll taxes and withholding rules.
The phrase “No Tax on Overtime” is misleading because it doesn’t actually mean that overtime pay is no longer taxable. To the contrary, all OT pay remains subject to federal income tax (though, as explained above, employees may be eligible to claim a limited income tax deduction for qualified overtime compensation) and therefore subject to income tax withholding rules. However, employees may opt to adjust their Forms W-4 to reflect any expected deductions for qualified overtime compensation.
In addition, all overtime compensation remains fully subject to other payroll taxes, such as Social Security and Medicare taxes (both the employer’s share and the employee’s share), because the OBBBA’s new tax deduction applies only for federal income tax purposes.
Why Should Employers Care About Any of This?
While the OBBBA’s new overtime deduction is a tax benefit for employees filing individual tax returns, it impacts employers in several important ways.
Conclusion
Overtime pay remains taxable – though some employees may be allowed to claim a portion of it as a federal income tax deduction. Employers should work with counsel on filing, reporting, and withholding issues, as well as employee communications, related to qualified overtime compensation.
Article courtesy of Fisher Phillips
The U.S. Department of Labor has increased the Fair Labor Standards Act’s (FLSA’s) annual salary-level threshold from $35,568 to $58,656 as of Jan. 1, 2025, for white-collar exemptions to overtime requirements. Effective July 1, 2024, the salary threshold will increase to $43,888. Employees making less than the salary-level threshold, such as hourly workers, can be eligible for overtime if they work enough hours.
Starting July 1, 2027, the department also will automatically increase the overtime threshold every three years..
To be exempt from overtime under the FLSA’s “white collar” executive, administrative and professional exemptions—the so-called white-collar exemptions—employees must be paid a salary of at least the threshold amount and meet certain duties tests. If they are paid less or do not meet the tests, they must be paid 1 1/2 times their regular hourly rate for hours worked in excess of 40 in a workweek.
Takeaway for employers: Employers now must decide whether to raise the salary of those employees who earn above the overtime threshold under the old standard but below it under the new standard so they remain exempt. Employers that choose not to raise these employees’ salaries should be prepared to pay overtime to these employees when they work more than 40 hours in a workweek. Schedules for those employees whose salaries are not raised above the new threshold may need adjusting to limit overtime costs. Careful communication should be rolled out to explain why employees formerly categorized as exempt are now nonexempt.
We have awaited to see where the U.S. Department of Labor would land with its much anticipated revised “overtime rule” and late yesterday the agency delivered. The USDOL released its long-awaited proposed rule which, if adopted, would set the minimum salary threshold at $679 per week, or $35,308 per year. For now, the proposed rule does not include an automatic update provision (which many were concerned would simply serve to periodically inflate the threshold level), nor does it revise the duties test that accompanies the rule.
Once published in the Federal Register, the public will have 60 days to submit comments regarding, among other things, the proposed minimum salary threshold.
Proposed Rule In A Nutshell
Rules Will Not Take Effect On December 1; Future Thereafter Uncertain
In a dramatic last-minute development, a federal judge in Texas on Tuesday (11/22/16) blocked the U.S. Department of Labor’s (DOL) overtime rule from taking effect on December 1. The judge issued a preliminary injunction preventing the rules from being implemented on a nationwide basis.
The fate of the overtime rules is now uncertain. The Trump administration will take over the DOL in less than two months’ time, and the incoming administration has repeatedly indicated that it wants to eliminate unnecessary regulations hampering the business community. Unless an appeals court reverses course in the next several weeks and breathes new life into the rules, it is quite possible that the rules will be further delayed, completely overhauled, or altogether scrapped once President Trump takes office.
Almost immediately, an outcry sprung from the business community, especially those advocating on behalf of small businesses. By doubling the existing salary threshold, the DOL’s actions would likely reduce the proportion of exempt workers sharply while increasing the compensation of many who will remain exempt, rather than engaging in the fundamentally definition process called for under the FLSA. As many pointed out, manipulating exemption requirements to “give employees a raise” has never been an authorized or legitimate pursuit.
Moreover, publishing what amounts to an automatic “update” to the minimum salary threshold is something that has never before happened in the more-than-75-year history of the FLSA exemptions. This departs from the prior DOL practice of engaging in what should instead ultimately be a qualitative evaluation that would take into account a variety of considerations.
The challengers argued that the DOL did not properly carry out its responsibility under the FLSA to define these exemptions, failing to take into account the duties of white-collar workers as the best indicator for whether threshold increases were needed. The plaintiffs also argued that the automatic indexing mechanism which would ratchet up the salary levels every three years was improper because it would ignore current economic conditions or the effect on public and private resources.
The judge recognized that, for 75 years, the salary levels that served as part of the DOL’s overtime exemption test acted as a floor and not a ceiling. He said during last week’s oral argument the new rule’s proposed salary jump was “a much more drastic change.” During that argument, in fact, he pointed out that the proposed substantial increase in the salary threshold could lead to inconsistent treatment of workers who each fulfill white collar duties but are paid differently. An example is a convenience store manager who clearly acts as an executive and who is paid a salary annualizing to only $47,000 a year, for example, would be treated differently than a similarly situated manager who is paid a salary equating to $47,500 a year.
Assuming that the injunction survives the remainder of President Obama’s term, it is difficult to predict what President Trump will do with the rules once in the White House. Perhaps President Trump will direct his DOL to commence a new rulemaking process, subject to notice and comment, with the goals of setting lower thresholds for the salary requirement and eliminating the three-year update, among other changes. How long and what form such a process would take, and what could or would be done in the meantime, are currently unpredictable.
At the same time, a series of measures have been introduced in Congress hoping to prevent or stall the rules changes. While one of the proposed legislative changes would scrap the increases altogether, another proposed change would delay implementation for a period of time to provide a longer period of preparation. Still, another would push the date that the full increase would take effect to 2019, introducing more forgiving gradual increases on an annual basis for the next three years.
The fate of these measures is similarly uncertain at present. Even if any of these measures were fast-tracked, approved by Congress, and signed by President Obama before he leaves office, it is unclear whether they would ever take effect given the nature of the current litigation.
If you had been waiting until December 1 to implement the changes, you have the option of putting any alterations on ice and awaiting a final determination on the fate of the rules. If you do so, you might consider communicating to your workforce that the expected changes are going to be delayed given today’s court ruling, and let them know that you will continue to monitor the situation and make adjustments when and if appropriate.
We will track these developments and provide updates as issued.
President Obama has proposed expanding the availability of overtime pay, which would cause the Department of Labor to do its first overhaul of Fair Labor Standards Act (FLSA) regulations in 10 years.
The President signed a memorandum on March 13, 2014, instructing the Department of Labor to update regulations about who qualifies for overtime pay. In particular, he wants to raise the threshold level for the salary-basis test from the current $455 per week in order to account for inflation. The threshold has been raised just twice in the past 40 years. The President did not specify the exact amount the threshold should be raised though.
“Unfortunately, today, millions of Americans aren’t getting the extra pay they deserve. That’s because an exception that was originally meant for high-paid, white-collar employees now covers workers earning as little as $23,660 a year,” Obama said in his remarks on overtime pay.
The memorandum also suggests that both the primary duties and pay of some exempted employees do not truly fit in the executive, administrative and professional employees exemptions, referred to as the white-collar exemptions under FLSA.
In a fact sheet on the President’s memorandum, the White House said: “Millions of salaried workers have been left without the protections of overtime or sometimes even the minimum wage. For example, a convenience store manager or a fast food shift supervisor or an office worker may be expected to work 50 or 60 hours a week or more, making barely enough to keep a family out of poverty, and not receive a dime of overtime pay.” The FLSA’s minimum wage would not protect a salaried worker because salaried workers’ pay must satisfy the weekly salary-basis test rather than the Federal hourly minimum wage, which is $7.25 per hour. The hourly minimum wage in Florida is currently $7.93 per hour.
The memo also pointed out that “only 12% of salaried workers fall below the threshold that would guarantee them overtime and minimum wage protections.“ The fact sheet also called the current FLSA regulations outdated, noting that states such as New York and California have set higher salary thresholds.
Small businesses will be hit particularly hard by a change in the FLSA regulations.
If the regulations shrink the current white-collar exemptions, employers would have two main options to hold down costs. They would have to either increase workers’ salary above the new salary-basis threshold (to avoid paying overtime) or leave employees in the nonexempt category and pay them overtime. Companies could also hire more employees, but the other two options are more likely.
Implications for HR
Once tightened white-collar exemptions are implemented, which is not likely to happen for months now, it could result in far-reaching implications for HR, including wage and hour audits and layoffs. The money to pay for increased overtime wages has got to come from somewhere which might mean layoffs, reducing overtime and taking a fresh look at the fluctuating workweek.
When asked at a press briefing about the burden on businesses if the Obama administration succeeds in efforts to both increase the federal minimum wage and revise FLSA regulations, Betsey Stevenson, a member of the White House’s Council of Economic Advisers, said, “We think these two items are very different, but, obviously, they do feed into the same thing, which is people should be rewarded for fair work.” She suggested that some workers in the white-collar exemptions aren’t even earning minimum wage for all the work they do at low salaries.
Even though the president did not assign a number for the minimum salary-basis threshold, Stevenson said the overtime “protections have been eroded over time. This threshold in 1975 was nearly $1,000 in today’s dollars; today it’s $455.” Stevenson believes that the rule should be modernized as a matter of the “basic principle of fairness.”
We will continue to keep you abreast of any changes to FLSA as well as other regulations that can impact your business. If you have any questions about the current or proposed FLSA regulations, please contact our office.
The topic this month focuses on identifying five of the stickiest Wage & Hour issues that employers face under the Fair Labor Standards Act (FLSA).
FLSA class actions are up approximately 70% since 2000 and more than half of all the FLSA lawsuites being filed in Federal courts nationwide are being filed in Florida.
Some of these issues covered include:
Please contact our office directly if you have any Wage & Hour or FLSA questions and how it could be impacting your business.