Anticipating abuse: How the “Big Beautiful Bill” may reshape compensation practices

This article examines how employers may seek to recharacterise compensation to maximise deductions. It will also discuss compliance challenges, including wage and hour risks, misclassification, and increased scrutiny from regulators.

The new provisions providing for no federal tax on overtime and tip compensation are subject to manipulation

The Big Beautiful Bill provides a new tax deduction for “qualified overtime compensation”. The deduction cannot exceed USD 12,500 (or USD 25,000 for joint filers) per year. The bill also provides for a new deduction for “qualified tips” capped at USD 25,000 per year. 

Businesses should be wary of efforts to manipulate compensation to take greater advantage of the tax credits. 

Key areas of potential abuse

1. Overtime

Employers who consider changing salaried employees to hourly employees to provide a tax benefit risk scrutiny for abuse of the Act. Any manipulation of hours worked creates a secondary risk of wage and hour violations which will be costly for employers. Conceivably, an employer may seek to recharacterise compensation of salaried employees by transitioning them to hourly status and increasing overtime compensation. 

2. Tips

To prevent manipulation of the law, the Act specifies several concerns regarding creative reclassification to maximise tax credits. For example, qualified tips cannot also be claimed as qualified overtime compensation, eliminating an avenue for double dipping. 

The Act specifies that the Department of Treasury will identify a list of industries covered, to prevent the shifting of compensation to “tip” compensation to industries, such as professionals, not typically compensated via tips.

Another significant complication related to tips comes with the likelihood that employers will modify their existing tip pool arrangements to shift more tip income to employees. 

Given these creative changes by service employers, businesses must become familiar with the definition of qualified tips and those which do not qualify, such as mandatory gratuities imposed by service providers. 

3. Enforcement

The Act allows for regulations which “prevent abuse” of this deduction through manipulation and improper reclassification of income. Businesses should be mindful that any improper conduct will be subject to investigation and legal consequences. 

Conclusion

It can be anticipated that there will be a high volume of questions from employers concerning their options. While some modification of existing pay structures is permissible, care should be used to comply with these uncertain new laws.

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David Jones is a seasoned labor and employment attorney with nearly 30 years of experience defending California employers. Known for his creative, adaptable strategies, he represents management in litigation, counseling, and government investigations.