The ‘no tax’ overtime myth: employer payroll and reporting obligations under the ‘One Big Beautiful Bill’ Act explained
The “One Big Beautiful Bill” has generated attention (and confusion) among employers. Much of the conversation has focused on “no tax on overtime” or “no tax on tips.” But for employers, that shorthand is misleading.
The law does not eliminate payroll taxes or change how overtime must be calculated or paid. Instead, it creates a temporary individual income tax deduction for employees. That distinction matters, particularly for California employers already navigating complex wage-and-hour rules.
As questions continue beyond tax season, now is a good time for employers to reset expectations and ensure payroll and reporting practices align with what the law actually requires.
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 for hours worked over 40 in a workweek.
California law is more generous.
Nonexempt employees are entitled to overtime at one-and-one-half times their regular rate for:
- Hours worked over 8 in a workday (up to 12)
- Hours worked over 40 in a workweek
- The first 8 hours on the seventh consecutive day
Double time (two times the regular rate) applies for:
- Hours worked over 12 in a workday
- Hours worked over 8 on the seventh consecutive day
None of these obligations change under the new law.
The federal deduction applies only to the FLSA-required overtime premium – the additional 0.5 above the regular rate for hours over 40 in a workweek. Overtime or double time paid solely under California law does not independently qualify.
The deduction is also capped and subject to income-based phaseouts, reinforcing that it is a limited tax benefit and not a change to wage calculations.
No change to payroll tax withholding
Despite the headlines, employers must continue to withhold and remit federal and state income tax, Social Security tax, Medicare tax, and other state payroll taxes on overtime and tips as usual.
For employers, payroll practices remain unchanged. There is no payroll-level exemption. Any benefit is realized by employees when they file their individual tax returns.
Where confusion and risk can arise
The gap between the law’s headline and its actual operation is already creating confusion.
Employees may expect higher take-home pay or assume overtime is tax-free. In California’s highly regulated wage environment, those misunderstandings can lead to disputes if employees believe their pay is being calculated incorrectly.
There is also a risk in how employers communicate. Statements suggesting overtime is ‘tax-free’ or attempting to quantify employee tax savings can lead to misunderstandings and potential disputes over pay.
New reporting requirements on the horizon
Beginning with this tax year 2026 (forms issued in early 2027), employers are expected to separately report: qualified overtime premium amounts and tip income on updated Forms W-2 and other applicable returns.
To prepare, employers should work with payroll providers now to ensure systems can:
- Distinguish the federal FLSA overtime premium from base wages
- Separate federal overtime premiums from state-law overtime and double-time amounts
- Track tip income consistent with existing federal reporting rules
Advance preparation will help reduce compliance risk as IRS guidance and form requirements are finalized.
Practical steps for California employers
For now, employers should focus on preparation, consistency, and clarity:
- Confirm payroll systems can distinguish the FLSA overtime premium from state-law required overtime and double-time amounts.
- Communicate internally that withholding rules remain unchanged.
- Monitor IRS guidance and form revisions.
- Avoid making employee-facing statements suggesting overtime or tips are “tax-free.” 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.
- Multi-state employers should carefully review state overtime rules to avoid errors when calculating and reporting qualified overtime premium amounts at year-end.
The “no tax on overtime” label is catchy, but incomplete.
For California employers, the fundamentals remain the same: comply with existing wage-and-hour laws, maintain accurate payroll practices, and prepare for evolving reporting requirements.
June Monroe is a director in Fennemore’s Orange County office and a member of the firm’s Labor & Employment practice group. She advises employers on compliance, investigations, and day-to-day employment issues. June also represents employers before government agencies and courts, defending wage-and-hour, discrimination, harassment, retaliation, and unemployment claims. She can be reached at jmonroe@fennemorelaw.com.
Elise O’Brien is a director in Fennemore’s Orange County office and a member of the firm’s Labor & Employment Law practice group. Elise has extensive experience representing employers in federal and state court litigation involving wrongful termination, discrimination, harassment, retaliation, and wage and hour claims. She can be reached at eobrien@fennemorelaw.com.