The One Big Beautiful Bill Act (OBBBA) brings sweeping changes to the way compensation is taxed, tracked, and reported. HR teams, payroll providers, and nonprofit leaders will play a central role in preparing their organizations for these requirements, particularly as temporary IRS relief expires after tax year 2025.
In a statement released November 5, the IRS confirmed that for tax year 2025, employers will not be penalized for failing to separately identify:
- Amounts reasonably designated as cash tips, or
- Total qualified overtime compensation
The relief applies only if standard returns and statements remain complete and accurate. This is a one-year transition period. Full enforcement begins with tax year 2026, making 2025 a critical preparation window.
Below are 14 key takeaways for HR professionals navigating the changes.
1. Distinguish Weekly FLSA Overtime from All Other Overtime
The OBBBA creates a new “qualified overtime” deduction for employees for tax years 2025–2028, but only for overtime earned under the Fair Labor Standards Act (meaning hours worked beyond 40 in a week).
States such as California, Alaska, Colorado, and Nevada, and Oregon in specific industries, impose daily overtime rules that exceed federal law. Employers must adopt systems that clearly separate:
- FLSA overtime eligible for the deduction
- State-mandated or employer-specific overtime not eligible
Failing to differentiate these categories will create reporting errors once enforcement resumes.
2. Prepare to Update Withholding Procedures in 2026
Beginning with tax year 2026, payroll systems must incorporate new withholding requirements tied to the overtime and tip deductions. HR needs to plan for:
- Updated payroll tables
- Revised employee communication templates
- Early coordination with payroll vendors
3. Avoid Improperly Converting Nonexempt Employees to Exempt
Some employers may consider shifting nonexempt employees to exempt status to avoid tracking detailed overtime information. This approach creates significant risk.
Exemption classifications still require meeting strict federal and state duties tests. Misclassification creates exposure to wage claims, penalties, and back pay. The OBBBA does not change exemption criteria.
4. Understand Caps on the Overtime Deduction
Employees who work substantial overtime hours may see meaningful tax savings. However, the deduction has limits:
- Up to $12,500 for individuals
- Up to $25,000 for joint filers
The deduction gradually phases out for higher-income earners once modified adjusted gross income exceeds:
- $150,000 for individuals
- $300,000 for joint filers
HR must consider helping employees set realistic expectations about potential benefits.
5. Know What Counts as a Qualified Tip
Not all gratuities qualify for the new deduction. Mandatory service charges, automatic gratuities for large parties, or fees added to a customer bill do not qualify. The tip deduction runs 2025–2028, is capped at $25,000, and phases out for higher-income taxpayers.
6. Communicate the Limitations to Employees
Employees may assume all overtime and all tips will generate tax savings. HR can help prevent confusion by explaining:
- Only FLSA overtime qualifies
- Only eligible tips qualify
- These deductions apply only to federal income tax, not Social Security or Medicare
Clear messaging now can reduce frustration during tax filing season.
7. Align Tracking, Reporting, and Pay Stub Practices
HR needs to work closely with payroll and HRIS partners to ensure systems can accommodate new data requirements. Consider:
- Audit existing capabilities: Can your current software isolate FLSA overtime from other overtime? Can it identify qualified tips? Ask vendors about their implementation timeline for OBBBA compliance.
- Consider voluntary information sharing for 2025: While penalties are suspended for one year, the IRS encourages employers to begin providing updated information to employees if feasible.
- Educate your workforce: As systems are updated, employees may need to track some information themselves for their 2025 tax returns. Encourage them to consult tax professionals and rely on IRS guidance as it is released.
- Monitor state pay-stub rules: Several states require detailed, accurate pay-stub reporting. Misalignment between federal transition rules and state requirements could create compliance risk.
8. Prepare for the Elimination of the Employer-Provided Food Deduction
The OBBBA generally removes the deduction for employer-provided meals. Organizations may revisit their current practices, especially smaller nonprofits where these costs matter more. Still, many employers will continue offering food-related perks due to their positive effect on engagement and morale.
9. Use the Student Loan Reimbursement Tax Exclusion
The OBBBA permanently extends the tax exclusion for employer-paid student loan repayment under IRC Section 127. Nonprofit employers with recruiting or retention challenges may find this especially valuable.
10. Consider Using the Permanent Paid Family and Medical Leave Tax Credit
Employers can permanently access a tax credit for offering paid family and medical leave, providing a potential financial incentive to enhance benefits.
11. Understand Key Changes to HSAs and Telehealth
The Act revises rules for Health Savings Accounts, including retroactively extending telehealth flexibility that existed under the CARES Act. Actions for HR:
- Clarify eligibility requirements
- Update plan materials
- Verify that third-party administrators have adjusted systems accordingly
12. Note the Increase to Dependent Care FSA Exclusions Beginning in 2026
The annual exclusion for dependent care FSA contributions will increase in 2026, creating an opportunity to enhance employee benefits. HR may want to begin planning communications and open enrollment updates.
13. Factor in Expanded Tax Relief for Childcare and Adoption Assistance
The OBBBA improves tax treatment for employer-provided childcare and expands the adoption assistance credit, which now becomes partially refundable. These provisions may strengthen organizational efforts to support working parents.
14. Prepare for Increased Worksite Immigration Enforcement
The Act allocates a dramatic increase, nearly $30 billion, to Immigration and Customs Enforcement (ICE). Industries such as construction, hospitality, and agriculture can expect more:
- Audits
- Worksite inspections
- Enforcement activity
HR needs to ensure I-9 processes, retention practices, and reverification procedures are current and consistently followed.
Conclusion
The OBBBA introduces meaningful shifts in payroll reporting, employee tax benefits, and compliance obligations. While the IRS has granted employers a temporary buffer for tax year 2025, organizations that use this window to update systems, train managers, audit processes, and strengthen communication will be better prepared for full enforcement in 2026.
HR teams play a central role in guiding their organizations through these changes and supporting employees as they navigate new tax rules and benefit opportunities.
If you have any questions regarding this topic or other HR questions or concerns, please contact us at HRServices@501c.com or (800) 358-2163.
About Us
For more than 40 years, 501(c) Services has been a leader in offering solutions for unemployment costs, claims management, and HR support to nonprofit organizations. Two of our most popular programs are the 501(c) Agencies Trust and 501(c) HR Services. We understand the importance of compliance and accuracy and are committed to providing our clients with customized plans that fit their needs.
Contact us today to see if your organization could benefit from our services.
Are you already working with us and need assistance with an HR or unemployment issue? Contact us here.
The information contained in this article is not a substitute for legal advice or counsel and has been pulled from multiple sources.
(Images by Freepik)
