Blogs

By: @Morgan Leskody
This article is based on an interview with @Samantha Prall, Partner at Platinum Strategies Inc.

When Congress passed the One Big Beautiful Bill Act (OBBBA), the message many Americans heard was simple and appealing: overtime would be tax-exempt. Widely advertised as a benefit for workers, OBBBA suggested that employees who put in extra hours would keep more of their pay. However, once the legislation was analyzed and implemented, it became clear that the overtime exemption was far narrower than originally understood.

What the Bill Was Advertised to Do

The early messaging around the One Big Beautiful Bill Act focused on the idea that overtime wages would not be subject to federal income tax. Under this interpretation, if an employee earned $1,000 in regular wages and $200 in overtime during a week, the $200 in overtime would be exempt from federal taxation when filing their tax return.

What the Bill Actually Says About Overtime

Under federal wage law, overtime is paid at one and one-half times an employee’s regular rate for hours worked over 40 in a workweek. The key clarification in OBBBA is that the tax exemption applies only to the “half-rate” portion of overtime, not the full overtime wage.

In practical terms, if an employee earns $10 per hour and receives $15 per hour for overtime, only the additional $5, the half-rate premium, is eligible for the exemption. The base hourly wage portion remains taxable.

Even more significantly, the exemption applies only to overtime that meets the federal definition of “hours worked.” This distinction is where many special districts encounter challenges.

Hours Worked vs. Leave Time: A Key Distinction

Federal law defines “hours worked” as time an employee is physically working. Paid leave, such as sick leave, vacation, or holiday pay, is not considered hours worked for federal overtime purposes.

Many special districts, however, have gone beyond federal minimums. To ensure adequate staffing and encourage employees to respond to emergencies or weekend call-ins, districts often count paid leave as hours worked under their MOUs. This means an employee who takes sick leave during the week may still qualify for overtime pay if they work additional hours later in the week.

The One Big Beautiful Bill Act does not override these agreements. Employees are still paid overtime according to their MOU or handbook. What changes is whether any portion of that overtime qualifies for the federal tax exemption.

For example, if an employee uses sick leave on Monday, works their remaining scheduled hours, and is called in on Saturday, the district may still pay overtime. However, because sick leave is not “hours worked” under federal law, that overtime does not qualify for the federal tax exemption.

How This Impacts Special Districts

For special districts, the impact is not on payroll amounts but on tracking and reporting. Payroll systems must now distinguish between:

• Overtime that qualifies for the federal exemption, and
• Overtime that does not, due to the inclusion of leave time in the work week.

For 2025, employers will not be penalized for not separating out qualifying overtime for transitional relief. Beginning in 2026, employers WILL be required to report in Box 14 of the W2 the qualifying overtime. This functions like a tax credit and is applied to employees’ personal tax returns, like other credits. Tax benefits are realized when employees file their personal tax returns.

Districts with “safety employees,” such as firefighters and police officers, that often operate on an extended work period, such as 24-day cycles, face additional complexity.

Next Steps for Special Districts

Districts can take several proactive steps:

• Review MOUs and Handbooks and update as needed.
• Confirm how overtime, leave time, and hours worked are defined and ensure leadership understands how federal law differs from local agreements.
• Coordinate with Payroll and Finance Teams and stay informed about automation tools as they become available.
• Prepare for manual or supplemental tracking until payroll systems evolve.Communicate clearly with employees as they may expect all overtime to be exempt.

Payroll processes remain the same for employee pay, but districts must now track exempt versus non-exempt overtime for reporting purposes.

Moving Forward

The One Big Beautiful Bill Act illustrates the gap that can exist between policy messaging and operational reality. For special districts, understanding the nuances and planning accordingly is essential for navigating the changes smoothly.

This article is based on an interview with Samantha Prall, Partner at Platinum Strategies Inc.