OBBBA: What Tax Pros Need to Know About the New Compliance and Overtime Rules

Congress’ newly enacted One Big Beautiful Bill Act (OBBBA) is already making waves — and not in a good way — for states, local governments, public employers, and ultimately the taxpayers who fund them. While it’s been touted as a comprehensive fix for budget and benefits programs, many of its provisions add costly new recordkeeping requirements and complex tax rules that will impact payroll departments and tax preparers alike.

New Administrative Burdens for States and Localities

OBBBA brings major changes to federally funded programs like the Supplemental Nutrition Assistance Program (SNAP) and Medicaid:

• SNAP: Starting next year, administrative cost reimbursements will be reduced.

• Medicaid: Changes to statutory qualification requirements take effect in 2027, but states will need expensive IT upgrades as early as next year to prepare.

Estimated costs:

• Counties alone face an extra $850 million annually.

• Subnational governments (states, counties, municipalities) could see costs reach $1 trillion over 10 years, factoring in benefit payouts and administrative expenses.

• Transitional administrative costs for states are likely to exceed $1 billion a year.

  
  

The Overtime Tax Deduction: Far Less Than Promised

One of the most misunderstood aspects of OBBBA is its overtime pay tax provision. While campaign promises made it sound like overtime pay would be tax-free, the reality is much narrower:

• Workers may get a federal income tax deduction for only a portion of their overtime pay — typically the “half” in time-and-a-half.

• Social Security, Medicare, and state income taxes will still apply to all pay.

• W-2 reporting will be far more complicated for payroll departments.

  
  

Public employees will be especially affected, as most state and local overtime policies exceed the federal minimums — and that extra generosity won’t qualify for the deduction.

The FLSA Cutoff Problem

OBBBA ties its deduction eligibility to the Fair Labor Standards Act (FLSA) rules, which:

• Require overtime pay only after 40 hours worked in a week (paid leave doesn’t count as hours worked).

• Exclude overtime pay based on paid holidays, vacation, or sick leave.

• Disqualify double-time and other enhanced overtime rates unless FLSA mandates them.

  
  

This means two-thirds or more of overtime pay for public employees may not qualify for the deduction.

Why It’s a Payroll Nightmare

For many public employers:

• Payroll systems that don’t track actual hours worked separately from paid leave will need costly software patches — or manual per-employee calculations.

• Roughly 5 million state and local employees could require individual overtime tax calculations for 2025.

• Non-conforming systems will need manual adjustments for W-2 reporting.

  
  

Real-World Example

A patrol officer earning $40/hour works a holiday weekend:

• Four regular shifts, one paid holiday off, and 10 hours of double-time on Saturday.

• Expected tax deduction: $800.

• Actual deduction under OBBBA: $40.

  
  

If that overtime was worked Sunday in the next workweek, the deduction might be $200. The gap between expectation and reality will cause confusion — and frustration.

Compliance Challenges Ahead

Public employers can’t simply overreport overtime on W-2s — independent audits would expose and penalize violations. Until the IRS issues final regulations, employees should lower their expectations for the 2025 deduction.

What’s Needed from the IRS

To reduce confusion and cost, the IRS should provide:

• Plain-English guidance with clear examples.

• Safe harbor provisions for handling paid leave in overtime calculations.

• De minimis thresholds to avoid excessive record keeping for small overtime amounts.

  
  

Key Takeaways for Tax Pros

• Expect client confusion about the overtime deduction’s scope.

• Prepare for potentially complex W-2 reporting and payroll data requests.

• Stay updated — IRS regulations later this year could clarify (or change) these rules.

• Watch for state and local government clients who may be especially burdened by these changes.

  
  

The bottom line? OBBBA’s overtime and administrative provisions are far more complicated — and costly — than most realize. For tax preparers, now’s the time to study the details, prepare clients for the reality, and watch closely for IRS guidance in the coming months.

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Disclaimer: This article is for informational and educational purposes only and does not constitute legal tax advice. Advanced Tax Solutions is not liable or responsible for any damages resulting from or related to your use of this information. It is your responsibility to refer to official IRS documentation for information regarding any tax laws or tax information shown here.