22 May 2025 House-passed tax bill contains provisions affecting compensation and benefits, including eliminating taxes on tips and overtime
The tax reconciliation bill (the Bill) with the manager's amendment (which was approved by the House of Representatives on May 22, 2025), would modify many of the provisions affecting compensation and benefits.
Tips are generally includible in gross income and may also be subject to federal income tax withholding, Social Security/Medicare (FICA) and federal unemployment insurance (FUTA) taxes. Tips are defined differently in different contexts and may include cash tips received directly from customers, electronically-paid tips from credit and debit card charge customers and tips received under a tip-splitting or tip-pooling arrangement. Employees generally must report their tips to their employers. Employers must keep the employee tip reports; pay FUTA and the employer's share of FICA; and withhold federal income tax and the employee's share of FICA on tips paid to employees. IRC Section 45B allows certain food and beverage establishments to elect to claim a business tax credit equal to the employer share of FICA taxes paid on tips that exceed those treated as wages for purposes of meeting the federal minimum wage requirements as in effect on January 1, 2007. The Bill would create a federal income tax deduction under a new IRC Section 224 equal to the qualified tips that an individual receives during any tax year. This deduction would not be available for qualified tips paid to highly compensated individuals (5% owners, compensation over $160,000). The Bill would also expand the business tax credit for the portion of FICA/payroll taxes an employer pays on certain tips to include payroll taxes paid on tips received in connection with certain beauty services. The proposed income tax deduction would sunset after December 31, 2028. This provision would apply only to "cash tips," which is not defined in the Bill and has different meanings in different contexts under current law. Because the tip deduction is taken on the individual return, the changes to the employer's reporting requirements for tips would be minimal. Tips subject to Social Security taxes are currently reported in Box 7 of the Form W-2. The Bill would codify a requirement that the Form W-2 include the total tips the employee reports to the employer. Thus, if the Bill became law in its current form, employers would separately report all tips, including tips over the Social Security wage base. Tips would still be included in Box 1 income, but Treasury would be directed to modify the withholding tables to take the new deduction into account. The retroactivity of this provision may present practical challenges for employers. Overtime is generally includible in gross income and subject to federal income and employment taxes. Employers must keep certain records for employees eligible for overtime. Overtime must be reported by employers on Form W-2, but there is no separate reporting of overtime compensation for tax purposes. The Bill would create a new IRC Section 225 with a deduction for qualified overtime compensation that is reported on Form W-2. Qualified overtime compensation is overtime required by Section 7 of the Fair Labor Standards Act of 1938 (that is, federal overtime). This deduction would not be available for qualified overtime payments to highly compensated individuals (5% owners, compensation over $160,000). The overtime deduction would be in addition to the standard deduction. The provision would apply through December 31, 2028. As with tips, overtime payments would still be included in Form W-2, Box 1 income, and Treasury would modify the withholding tables to take the new deduction into account. The Bill would also add a requirement, as with tips, that the Form W-2 separately report federal overtime. Unlike tips, there is currently no requirement to separately report federal overtime on the Form W-2. Although employers must already comply with federal overtime requirements, some employers are also subject to other pay differential rules for overtime (e.g., under state law or collective bargaining agreements) and could face practical challenges distinguishing the portion of the pay differential that is attributable to federal overtime in the manner needed to comply with this new reporting requirement. The retroactivity of this provision may present additional practical challenges for employers. Under IRC Section 162(m), an employer cannot deduct compensation of more than $1 million for covered employees of a publicly held corporation. Covered employees include (1) anyone serving as CEO or CFO during the year, (2) the next three highest compensated officers, and (3) any individual who was a covered employee in any previous tax year beginning after December 31, 2016. For tax years starting in 2027 and thereafter, covered employees also include the five highest compensated employees — not limited to officers — who are not already treated as covered employees under (1) or (2) (although these may include individuals included in (3)). The Bill would change the aggregation rule that applies for purposes of IRC Section 162(m). Where a specified covered employee is paid by different members of a controlled group, the amounts would be combined for purposes of the $1 million limit based on rules under IRC Section 414 rather than IRC Section 1504, as under longstanding regulations. The deduction would be divided among the members based on how much each contributed to the total. This provision would have only modest effects for most affected taxpayers. Although IRC Section 414 applies to all types of entities and IRC Section 1504 only applies to corporations, existing regulations already apply IRC Section 162(m) to a corporation's distributive share of a partnership's compensation deduction. Thus, IRC Section 162(m) already applies to some extent in corporate structures commonly referred to as "Up-Cs" and "Up-REITs." The provision would have the greatest impact on corporations that are not aggregated with a publicly held corporation under IRC Section 1504 but would be aggregated under IRC Section 414. A prototypical example of that situation would be a taxable REIT subsidiary (commonly known as a "TRS") owned by a partnership (commonly known as an "operating partnership" or "OP"). Modification of excise tax on excess compensation for tax-exempt organizations and related taxpayers IRC Section 4960 imposes a 21% excise tax on employers that pay over $1 million in compensation or pay an excess parachute payment to covered employees of tax-exempt organizations. Covered employees are defined as one of the five highest compensated current or former employees for the applicable tax year. The Bill would amend IRC Section 4960(c)(2) to modify the definition of covered employee to include any current or former employee. The provision removes the five-employee limit on the number of new employees that are added to the list of covered employees each year. For tax-exempt entities with more than five employees with compensation over $1 million, this would expand the number of covered employees whose compensation is subject to the excise tax. For organizations whose five highest compensated employees have compensation under $1 million, it would eliminate the need to track their covered employee status. Under current law, a tax-exempt organization with all of its employees in a single legal entity could have fewer covered employees than it would have if its employees were employed by separate legal entities, a disparity that would be eliminated by this provision. IRC Section 274(o), added by the TCJA and effective for amounts paid or incurred after December 31, 2025, will disallow deductions for expenses for all food, beverage and operational expenses associated with an employer-operated eating facility, and any expense for meals provided to employees on the business premises for the convenience of the employer. The Bill would add an exception to this disallowance by cross-reference to IRC Section 274(e)(8), which excepts expenses for goods or services sold by the taxpayer in a bona fide transaction for adequate and full consideration. The addition of the IRC Section 274(e)(8) exception will help taxpayers such as restaurants who are in the business of selling food to customers and also provide food to employees. The exception has previously been interpreted by the Joint Committee on Taxation to include food prepared for customers that is also provided to on-shift employees. This interpretation was adopted into Treasury regulations applying IRC Section 274(e)(8) to IRC Section 274(n), the 50% deduction disallowance for food and beverage expenses. It is not clear that the exception is available in the case of an employer who is not in the business of selling food to customers but sells food to employees at a discount. Employer-provided childcare credit: The Bill would amend IRC Section 45F(a) by increasing the employer-provided childcare credit from 25% to 40% of qualified childcare expenditures (and from 25% to 50% for eligible small businesses). The total credit limit would increase from $150,000 to $500,000 ($600,000 for small businesses) per tax year. This would be effective for amounts paid or incurred after December 31, 2025. Paid family and medical leave credit: The bill would permanently extend, with some modifications, the paid family and medical leave credit, which is a general business credit under IRC Section 45S equal to 12.5% of eligible wages paid to qualifying employees during any period they are on family and medical leave. The credit currently disqualifies employers that would not meet the required base of offered leave after subtracting out the base required under state or local law. The credit is supposed to sunset at the end of 2025. The Bill would allow employers that would be disqualified by the statute's disregard of leave required by state or local law to qualify by counting the required leave but taking the credit only on amounts not required by state or local law. The Bill would allow eligible employers to claim the credit for a percentage of premiums paid for insurance policies that cover paid family and medical leave for qualifying employees. Employers could choose to claim the credit based on either wages or premiums, but not both. This would apply to tax years beginning after December 31, 2024. Integration of HRAs with individual market coverage: The Bill would generally codify in IRC Section 9815(b) the final rules published in 2019, which permit employers to offer individual coverage HRAs (ICHRAs). The Bill would rename the arrangements as Custom Health Option and Individual Care Expense, or CHOICE, arrangements, and exempt them from certain of the group health plan requirements. This would be effective for plan years beginning after December 31, 2025. Eligibility of participants in CHOICE arrangement to purchase exchange insurance under cafeteria plan: The Bill would amend IRC Section 125(f)(3) to allow employees to enroll in a CHOICE arrangement in conjunction with a cafeteria plan, allowing the use of salary reduction to purchase health insurance coverage from a health care marketplace exchange. This would be effective for tax years beginning after December 31, 2025. Employer credit for CHOICE arrangement: The Bill would create IRC Section 45BB, establishing a new credit for certain small employers whose employees are enrolled in CHOICE arrangements maintained by the employer. The CHOICE arrangement must constitute minimum essential coverage. This would be effective for tax years beginning after December 31, 2025. Individuals entitled to Part A of Medicare by reason of age contributing to HSAs: The Bill would amend IRC Section 223 to allow individuals who are eligible for Medicare but only enrolled in Medicare Part A to still make contributions to an HSA. Individuals over age 65 who are eligible to contribute to an HSA could not use HSA funds to pay for health insurance, and the extra tax on HSA withdrawals for non-medical expenses would still apply. This would apply to months beginning after December 31, 2025. Direct primary care service arrangements: The Bill would amend IRC Section 223 to clarify that an individual covered by a direct primary care service arrangement that does not cost more than $150 per month would not be disqualified from contributing to an HSA as a result of the direct primary care service coverage. This would apply to months beginning after December 31, 2025. Bronze and catastrophic plans connected with HSAs: The Bill would amend IRC Section 223 to treat any bronze or catastrophic plan offered in the individual market on a health care exchange as a high-deductible health plan (HDHP). This would apply to months beginning after December 31, 2025. On-site employee clinics: The Bill would amend IRC Section 223 to deem an individual eligible for or receiving certain medical services at on-site employee clinics (that meet the requirements) as not having other health plan coverage, allowing these individuals to still contribute to an HSA to the extent otherwise eligible. This would apply to months beginning after December 31, 2025. Certain payments for physical activity, fitness, and exercise: The Bill would amend IRC Section 223 to treat certain sports and fitness expenses as medical care that could be paid using HSA distributions. This would be effective for tax years beginning after December 31, 2025. Catch-up contributions made by both spouses to the same HSA: The Bill would amend IRC Section 223 to allow both spouses of a married couple that are eligible for catch-up contributions to allocate the annual contribution limit between them. This would be effective for tax years beginning after December 31, 2025. FSA and HRA terminations or conversions to fund HSAs: The Bill would amend IRC Sections 106, 223 and 6051 to allow more flexible rollovers of funds to HSAs from health FSAs or HRAs. A new type of "qualified HSA distribution" would be permitted if an employee were to start coverage under an HDHP and were not covered by an HDHP in the previous four years. The total amount transferred could not exceed annual FSA contribution limits, and those transfers would reduce how much individuals could contribute to their HSA for that tax year. This would be effective for distributions made after December 31, 2025. Special rule for certain medical expenses incurred before establishment of HSA: The Bill would amend IRC Section 223 by allowing individuals to treat their HSAs as established on the start date of their HDHP if they open the HSA within 60 days of that date. Accordingly, any distributions from the HSA that were used to pay for qualified medical expenses incurred during the 60-day period after HDHP coverage begins could be excluded from gross income. This would be effective for coverage beginning after December 31, 2025. HSA contributions if spouse has FSA: The Bill would amend IRC Section 223 to allow individuals to disregard coverage under their spouse's health FSA for any plan year of such FSA, if certain requirements are met, for purposes of determining whether an individual is eligible to contribute to an HSA. This would be effective for plan years beginning after December 31, 2025. HSA contribution limitations: The Bill would amend IRC Section 223(b) to double the deduction limits for HSA contributions (to $8,600 for individuals with self-only coverage and to $17,100 for those with family coverage), adjusted for inflation. The increased limits would phase out for higher income levels ($75,000 to $100,000 for individuals with self-only coverage and $150,000 to $200,000 for those with family coverage), adjusted for inflation. The increased limit would only apply to the deductible amount, not to the limit for employer contributions to an employee's HSA. Thus, employer contributions above the normal limits would not be excludable from employee income. This would be effective for tax years beginning after December 31, 2025. Inclusion of unrelated business taxable income (UBTI) of certain fringe benefit expenses: The Bill would amend IRC Section 512(a) to include in the UBTI of a tax-exempt organization any amounts paid or incurred by the organization for any qualified transportation fringe or any parking facility used in connection with qualified parking for which a deduction is not allowed under IRC Section 274. Amounts connected to unrelated businesses that the organization regularly operates would be excluded from this requirement. The provision would not apply to certain organizations, such as churches and their affiliates. This would apply to amounts paid or incurred after December 31, 2025. A similar provision applicable to all tax-exempt organizations without an exemption for churches was enacted in 2017 with the TCJA but was later repealed. Permanent extension of exclusion for certain employer payments of student loans under educational assistance programs: Under IRC Section 127, an employee may exclude from gross income for income tax purposes, and the employer may exclude from wages for employment tax purposes, up to $5,250 annually of educational assistance provided by the employer to the employee, as long as certain requirements are met. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) added payments on student loans as a permitted category of educational assistance, subject to a December 31, 2020, sunset, which was later extended to December 31, 2025, by the Consolidated Appropriations Act of 2021. The Bill would make the exclusion for employer payments of qualified education loans permanent. The Bill would also adjust the maximum exclusion for inflation for tax years beginning after 2026. The Bill would apply to payments made after December 31, 2025. Bicycle commuting benefits: The Bill would terminate the exclusion for qualified bicycle commuting reimbursement under IRC Sections 132(a)(5) and 132(f) for tax years beginning after December 31, 2025. This exclusion has been suspended since 2018. Deduction for moving expenses: The Bill would permanently repeal the deduction for moving expenses under IRC Sections 62(a)(15) and 217 (except for members of the Armed Forces, or their spouse or child, to whom IRC Section 217(g) applies). The Bill would also permanently repeal the qualified moving expense reimbursement exclusion under IRC Section 132 (except for members of the Armed Forces on active duty who move under a military order and incident to a permanent change of station). The deduction and the exclusion have been suspended since 2018. Both provisions would be repealed for tax years beginning after December 31, 2025. Enforcement provisions for COVID-related employee retention credits (ERCs): The ERC is a refundable federal employment tax credit, first enacted as part of the CARES Act in 2020, that was available for qualified wages paid by eligible employers during the COVID-19 pandemic from March 13, 2020, through September 30, 2021. The statute of limitations expired on April 15, 2024, for claiming the 2020 credit, and on April 15, 2025, for claiming the 2021 credit. The ERC was generally claimed by filing a refund claim for the relevant quarter. According to the Joint Committee on Taxation report accompanying the bill (JCX-21-25), the Bill would add "a concept of ERC promoter to expand the scope of existing penalties to address conduct taking place since enactment of ERTC to the present, as well as prospective conduct. The proposal bars allowance of refunds claimed after January 31, 2024. It also coordinates and extends limitations periods for certain corrective action by the IRS. In addition, regulatory authority is provided." The change would generally be effective as of date of enactment, with some exceptions.
Document ID: 2025-1120 | ||||||
