The recently enacted “One Big, Beautiful Bill Act” introduced new federal income tax deduction opportunities and changes in multiple areas related to employment law for eligible employees, independent contractors, and employers. Below is a breakdown of key provisions and considerations for workers and employers to keep in mind related to the Act.
Qualified Overtime Deduction – H.R.1 119th Congress Sec. 70202
- The Act permits eligible non-exempt employees to deduct the premium portion of overtime pay from their federal taxable income. Specifically, when an employee receives time-and-a-half pay for overtime work, only the additional “half” portion is deductible.
- For example, if an employee’s standard wage is $10 per hour, and they receive $15 per hour for overtime, they may deduct the $5 premium (time-and-a-half pay) per overtime hour worked.
- To be eligible for the deduction, the overtime must be considered “qualified overtime” under the Fair Labor Standards Act (“FLSA”). Overtime not required by the FLSA is not eligible, such as potentially more generous overtime requirements under state law, overtime earned through a collective bargaining agreement, or discretionary overtime or bonuses paid by the employer.
- The maximum deduction for qualified overtime is capped at $12,500 per individualor$25,000 for joint filers.
Qualified Tip Deduction – H.R.1 119th Congress Sec. 70201
- The qualified tip deduction applies only to “cash” tips (including charged tips and amounts received through valid tip-sharing arrangements) that are paid and determined voluntarily by the customer.
- Tips must not be negotiated or mandatory. Therefore, mandatory service charges or automatically applied gratuities are excluded from the deduction.
- To be eligible for the deduction, an independent contractor or employee must work in an occupation that customarily and regularly received tipsas of December 31, 2024.The Secretary of the U.S. Department of the Treasury is required to publish a list of qualifying occupations within 90 days of the Act’s enactment (on or around October 2, 2025). The Act specifically excludes employees in certain professions from claiming deduction, including those in accounting, healthcare, law, actuarial science, athletics, brokerage services, consulting, financial services, and the performing arts.
- The maximum deduction for qualified cash tips is capped at $25,000 per individual.
Limitations and Additional Requirements for Both Deductions
The following limitations and requirements apply to both the qualified overtime and qualified tip deductions:
- Workers will be able to take advantage of the deductions when they file their 2025 tax return, and they will not be available on their next paycheck.
- The deductions are available regardless of whether an individual chooses to itemize deductions or take the standard deduction.
- The deductions do not affect payroll taxes, and qualified wages and tips remain subject to FICA (Social Security and Medicare) taxes. [KS1]
- The overtime and tip deductions apply to federal income tax. However, payroll is a different category of tax. Income tax is paid by employees to the government based on their earnings minus deductions and credits, while payroll taxes are paid by both employees and employers based on wages.
- Both deductions are subject to a phase-out for high-income earners. The phase-out begins at a modified adjusted gross income (“MAGI”) of $150,000 for individualsand$300,000 for married couples filing jointly. The MAGI will be adjusted annually for inflation.
- For every $1,000 of income above these thresholds, the available deduction is reduced by $100.
- These provisions are temporary and are currently scheduled to expire in 2029 (through the end of tax year 2028), unless they are extended by future legislation.
Retroactive Application & Transition Rule
- As stated above, both deductions apply retroactively to income earned beginning January 1, 2025. In the near future, the U.S. Department of the Treasury is expected to issue guidance outlining acceptable estimation methodologies, updates to tax forms, and instructions for employers and tax preparers regarding how to report these deductions for tax years 2025 through 2028.
- To address potential challenges in tracking income for the retroactive period, the Act includes a transition rule that allows employers to use “any reasonable method” (as defined by the forthcoming guidance from the U.S. Department of the Treasury) to estimate the amount of qualified overtime and tips for the 2025 tax year.
Executive Compensation – H.R.1 119th Congress Sec. 70603
- Internal Revenue Code Section 162(m) prohibits any publicly held corporation from deducting compensation (including performance and equity-based compensation) that exceeds $1 million paid to “covered employees.” The Act has also expanded the definition of “covered employees.”
- A “covered employee” means: the CEO and CFO, employees whose compensation must be reported to shareholders as the top three paid employees other than the CEO and CFO, the top five paid employees of a company (not counting the previously mentioned employees), and any employee who was a covered employee in the prior year.
- If a public company is a member of a controlled group of companies, then it will need to include all members of the controlled group (the “specified covered employees”) when determining the top five paid employees of the company to include as covered employees.
- Public companies are also required to use the compensation paid to the specified covered employee by other controlled group members, aggregated, and the $1 million deduction limit is allocated proportionally.
Employer-Provided Fringe Benefit Reimbursement and Contributions – H.R.1 119th Congress Sec. 70413, 70113, and 70204
- Employers may now permanently offer tax-free educational reimbursements under Internal Revenue Code Section 127 (“Tuition Reimbursement Programs”), and this ranges up to $5,250 annually per employee.
- These payments may go towards tuition, fees and similar expenses, books, supplies, and equipment.
- Moving expense reimbursements for employees are no longer tax-free and must be included in an employee’s income effective January 1, 2026.
- Certain exceptions apply to armed forces or intelligence personnel who are required to relocate for their work assignment.
- Employers can provide contributions of up to $2,500 (indexed for inflation starting in 2028) of the $5,000 limit to Trump Accounts for teenage employees and dependents of employees, which would not be considered taxable income.
Paid Family and Medical Leave Credit – H.R.1 119th Congress Sec. 70304
- Internal Revenue Code Section 45S is now permanent. This section allows employers to claim a tax credit for wages to qualifying employees during paid family and medical leave, and it was previously temporary. In addition to the first option of being able to claim a tax credit for wages paid, if employers have qualifying insurance policies for paid family and medical leave, they now have a second option of choosing to claim a tax credit for a portion of insurance premiums paid for an employee. This also applies in states that require paid family and medical leave for employees.
- Employers must choose either the wages-paid-during-leave credit (current option which was extended) or the insurance-based credit (new option). Employers cannot claim both.
- A qualifying paid family and medical leave program must meet certain requirements for claiming a tax credit, including the employer having a written policy, where employers are entitled to a 12.5% tax credit on the amount of eligible wages. This increases by 0.25% for each percentage point by which the amount an employer paid a qualifying employee exceeds 50% of the employee’s wages.
- “Qualifying employees” for the tax credit are those who have worked for their employer for at least one year and whose compensation does not exceed a certain threshold ($96,000 for 2026), and this is expanded to include employees who have been employed for six or more months, instead of requiring a full 12 months. This will begin on December 31, 2025.
Health Savings Accounts – H.R.1 119th Congress Sec. 71307
- Telehealth services are now permanently covered under Health Savings Account (“HSA”) qualified plans.
- Bronze and Catastrophic Affordable Care Act Plans are now considered High Deductible Health Plans (“HDHP”) effective after December 31, 2025.
- This enables individuals or families under a Bronze or Catastrophic plan to have access to an HSA account beginning in 2026. They would be able to use HSA funds for eligible services like telehealth visits, or direct care from doctors who do not bill insurance.
- HSA owners will be allowed to spend up to $150 per month on individuals and $300 per month for a family to pay for direct primary care practice memberships.
- This excludes procedures that require general anesthesia, prescription drugs other than vaccines, and laboratory services not typically administered in an ambulatory primary care setting.
- As a result of these changes, employers can now offer a wider variety of health plan options and employee benefits plan designs while maintaining HSA eligibility, including:
- Expanding HSA-compatible benefits to more employees, and
- Including virtual-first or hybrid plan options in your benefits package.
Takeaways for Employers and Employees
Further guidance from the U.S. Department of the Treasury and Internal Revenue Service is expected to clarify how these deductions and changes will be reflected on IRS Forms W-2 and 1099, including whether any changes will be made to standard reporting practices. In the meantime, there are steps that employers and workers can take to prepare for compliance with the above provisions of the Act. For example, employers should monitor forthcoming guidance and may wish to review and update their payroll systems to ensure accurate tracking of overtime premiums and voluntary tip income going forward. Employers should also review their policies and procedures for executive compensation, fringe benefits, paid family and medical leave, and medical benefits plans that include HSAs. Workers who receive overtime pay or tips should begin collecting relevant payroll and timekeeping documentation to substantiate any claims for deduction dating back to January 1, 2025, and they may want to and consult with qualified tax advisors regarding any changes related to executive compensation.
FMJ’s HR & Employment Law Practice Group is available to help review your company’s employment practices, draft new policies and practices, and create and implement strategies for future compliance. If you are interested in connecting with the team to discuss questions or concerns about any of these new changes, or any other HR and employment law matters, please contact V. John Ella or other members of our HR & Employment Law Team. Thank you to Law Clerk Sarah Wlazlo for her help preparing this article.
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