How Changes to Overtime Tax Could Shift Workforce Management
As discussions around the proposed overtime tax elimination heat up, workers and employers are starting to think about what this policy change could mean for their paychecks and labor strategies. While it promises to put more money into employees’ pockets, it also hints at a potential overhaul in how companies approach labor planning and worker retention.
Recent Kiplinger article, “What’s Happening With Taxes on Overtime Pay?” explores how similar tax policy changes have historically impacted both employees and businesses, highlighting the financial and operational implications of such shifts. Building on that analysis, we take a look into what this proposal could mean for today’s workforce.
The proposal to eliminate federal income taxes on overtime pay is a key component of the “One Big Beautiful Bill Act.” The comprehensive legislative package aims to make the 2017 tax cuts permanent and introduces new tax exemptions, including those for overtime wages, tips, and auto loan interest. If enacted, the tax exemption on overtime pay would take effect starting in the 2026 tax year through the end of 2028.
The Current State of Overtime Taxation
Currently, overtime pay is treated like regular wages, which means it is subject to federal and state income taxes, Social Security, and Medicare deductions. Under the Fair Labor Standards Act (FLSA), eligible workers earn at least 1.5 times their regular pay rate for any hours worked beyond 40 hours a week. Data indicates that almost 25% of workers are currently working over 40 hours per week and in some cases the percentage is in the 40s.
Although overtime compensation can financially boost millions of workers, it also generates higher tax liabilities, discouraging some from putting in additional hours.
What Is the Overtime Tax Elimination Proposal?
The proposed Overtime Wages Tax Relief Act aims to provide financial relief to employees by allowing them to deduct a portion of their overtime earnings from their taxable income. Unlike a full tax exemption, where overtime pay would not be taxed, this deduction offers partial tax relief that workers can claim when filing their annual tax returns. If passed, this legislation could boost the take-home pay of employees working extra hours.
Under the proposal, individual workers could deduct up to $10,000 of their overtime pay, while married couples filing jointly could deduct up to $20,000. However, the deduction phases out for higher earners. For individuals with an adjusted gross income (AGI) above $100,000 and married couples with an AGI over $200,000, the deduction decreases by $50 for every $1,000 of additional income beyond these thresholds. The phase-out ensures that the benefits primarily assist those who rely on overtime pay to manage rising living costs.
The deduction is classified as an “above-the-line” deduction, allowing taxpayers to claim it even if they choose the standard deduction over itemizing. Employers would be required to report overtime earnings on annual wage and tax statements, simplifying the process for employees to claim the deduction accurately.
For instance, an employee earning $15,000 in overtime pay, under the income limit, could deduct a percentage, potentially reducing their taxable income by $3,000. This adjustment can lower their overall tax liability or increase their refund. However, workers would still pay taxes on their overtime earnings throughout the year, as the relief applies only when they file their tax returns.
Supporters of this initiative believe it could:
- Encourage workers to pick up more hours.
- Provide financial relief for those dealing with inflation and rising living costs.
- Give companies a leg up in attracting and keeping skilled workers.
Impact on Employers
While the idea of tax-free overtime sounds great for employees, it also brings significant challenges and opportunities for employers.
- Increased Dependence on Overtime Hours
If the overtime tax elimination passes, employees might be more inclined to work extra hours than seek a second job. For employers, this could mean strategically adjusting shifts to accommodate increased demand for overtime hours.
However, there’s a potential downside: businesses may lean too heavily on overtime instead of hiring more staff. While this could save money in the short run, it might lead to employee burnout and lower productivity in the long run.
- Retaining Talent Through Overtime Opportunities
With tax-free overtime on the horizon, providing overtime opportunities could become a key factor in employee retention. Companies that don’t offer overtime may struggle to hold onto their workforce, as employees gravitate toward organizations that fully utilize these tax benefits.
- Precision in Labor Planning
The move to tax-free overtime will push employers to reevaluate their labor models. Companies will need to adopt more precise workforce planning tools and strategies to balance regular hours with overtime. Leveraging a workforce management software like ShiftSwap™ can help employers manage this transition effectively by:
- Monitoring overtime hours in real-time.
- Easily post overtime opportunities when needed.
- Reducing risks of understaffing or overworking teams.
Economic Implications
Economists predict that getting rid of taxes on overtime pay could cost the federal government billions in lost tax revenue over the next decade. While this may have serious long-term fiscal effects, the immediate impact on employees and businesses could be significant.
For Employees:
With more disposable income, employees can find themselves spending more, which is fantastic for the economy. Plus, those who depend on overtime pay could experience a decrease in financial stress.
For Employers:
When employees feel financially rewarded for their extra efforts, it boosts workforce morale. However, employers must be careful with labor costs to avoid any unexpected spikes in payroll expenses.
Even though the benefits are clear, there are some risks that critics are pointing out:
- Budget constraints: Employers may face tighter budgets due to increased reliance on overtime pay.
- Workforce fatigue: Excessive overtime can lead to employee burnout and higher turnover rates.
- Inequity among employees: Workers in positions without overtime opportunities might feel left out of the financial perks.
How to Prepare
If the proposed bill becomes law, businesses will need to adapt quickly. Here’s how employers can prepare:
- Update Scheduling Practices: Ensure work schedules are flexible enough to accommodate overtime without overburdening employees.
- Invest in Workforce Management Tools: Platforms like ShiftSwap™ aid in shift management, track overtime, and provide data-driven insights to optimize labor costs.
- Prioritize Employee Well-Being: Balance overtime opportunities with efforts to prevent burnout, such as rotating shifts or pushing VTO when volume is low.
- Communicate Openly: Keep employees informed about changes in overtime policies and how they can benefit from new offerings.
The Bottom Line
The proposed elimination of overtime tax has the potential to reshape the labor landscape. While it brings exciting financial incentives for workers, it also poses new challenges for employers trying to retain talent and manage labor costs effectively.
To stay ahead of these changes, companies need to prioritize workforce management, adapt labor standards, and embrace tools that help facilitate overtime management. Whether the policy passes or not, preparing now will ensure your organization is ready to succeed in a rapidly evolving labor market.
Start Planning for Success
Schedule a demo with ShiftSwap™ today and learn how to streamline your workforce management.