Compensation tax and the One Big Beautiful Bill Act

The comprehensive legislation known as the One Big Beautiful Bill Act (OBBBA) touches much of the tax code, including compensation and benefits statutes. Below are the most significant changes to the landscape taxpayers should anticipate for current and future tax years.

Section 162(m) $1 million limit on compensation deductions

Generally, Section 162(m) limits a publicly held corporation’s tax deduction to $1 million per taxable year per covered employee. Historically, the Section 162(m) regulations have applied affiliated group rules under Section 1504 when determining the nondeductible amounts of compensation. The OBBBA codifies that if a publicly held corporation is a member of a controlled group, the Section 162(m) limit applies to the aggregate compensation deduction for all members of the controlled group. This comes on the heels of changes made to Section 162(m) by the American Rescue Plan Act of 2021 (ARPA), which expands the definition of “covered employee” to add the top five highest-paid employees during the taxable year (the “ARPA five”) for tax years beginning after Dec. 31, 2026. In Jan. 2025, Treasury proposed regulations of the ARPA five. For more information about the proposed regulations, please see our Tax Insights.

The OBBBA makes it clear that a public company’s covered employee group, including the ARPA five, can include employees of its controlled group, and compensation paid to a covered employee by all members of that group is aggregated when determining if the compensation is in excess of $1 million. A controlled group is determined under Sections 414(b), (c), (m) and (o) for this purpose, which can include entities other than corporations, such as partnerships, which is a change from the affiliated group rules included in the current Section 162(m) regulations. This change is effective for taxable years beginning after Dec. 31, 2025.

Section 4960 excise tax on excess remuneration paid by tax-exempt orgs

The OBBBA significantly expands the definition of Section 4960 covered employees for taxable years beginning after Dec. 31, 2025, to include all employees (including former employees who were employed in 2017 or later years) of an applicable tax-exempt organization (ATEO). Under prior law in effect through taxable years beginning before 2026, Section 4960 covered employees were generally defined to include only (i) the five highest compensated employees of the ATEO for the current tax year, and (ii) all covered employees for any preceding tax year beginning after Dec. 31, 2016.

Section 4960 generally imposes on ATEOs a 21% excise tax on (1) remuneration paid to a covered employee in excess of $1 million, and (2) any excess parachute payments to a covered employee. 

Tips and overtime deductions and payroll reporting

Accurate employer timekeeping and payroll reporting will be more important than ever before. OBBBA allows individuals an above-the-line deduction on their Forms 1040 for “qualified tips” and “qualified overtime compensation” received in the 2025-2028 calendar years, subject to certain limitations and phaseouts. The new law also requires service recipients (e.g., employers) to report the amount of qualified tips and qualified overtime compensation to workers on a Form W-2 or 1099-NEC, as applicable. A qualified tip is an amount paid in cash or by charge card to an individual in an occupation which traditionally received tips, as long as the tip is voluntary. Service charges and automatic tips do not appear to be qualified tips. Qualified overtime compensation is defined as overtime compensation required under Section 7 of the Fair Labor Standards Act (FLSA) that is in excess of the individual’s regular rate of pay (i.e., only the overtime premium appears to be qualified overtime compensation).

We expect a significant amount of guidance from the IRS in this area. First, within 90 days of enactment of the OBBBA, the IRS is required to publish a list of the occupations that traditionally receive tips. The 2025 Forms W-2 and 1099-NEC, and their instructions, will need to be updated to reflect the new reporting requirements. For 2026-2028, the IRS will update the income tax withholding requirements to reflect the possible tax deductions by the individuals, but the withholding rates are not required to be updated for 2025. In addition, employers are permitted to use a reasonable method specified by the Treasury to approximate a separate accounting of amounts designated as qualified tips or qualified overtime compensation for 2025, which will require guidance from the Treasury and IRS.

New exceptions to meal deduction disallowance

Under current law, which takes effect in 2026, Section 274(o) disallows an employer’s deduction for the expenses of operating an eating facility and the expenses of meals provided for the convenience of the employer (which are excludible from the employees’ income under Section 119). It is currently not clear what constitutes an eating facility - for example, whether free beverages and snacks provided in a break room or employee lounge would fall within the definition. The IRS is expected to issue guidance to clarify this issue. The OBBBA provides two new exceptions to these deduction disallowances for (i) expenses related to meals sold in a bona fide business transaction for adequate and full consideration, and (ii) expenses to provide food and beverages to certain crew members of commercial vessels, oil or gas platforms, drilling rigs and support camps, fishing vessels and fish processing facilities.

Employer payment of student loans and educational assistance programs

The OBBBA makes permanent the ability for employers to pay principal and interest on student loans through a Section 127 plan without the employee recognizing compensation income. The new legislation also amends Section 127 to index for inflation the maximum annual exclusion from income under an educational assistance program (currently $5,250). The Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 provided that, prior to Jan. 1, 2026, a Section 127 employer-provided educational assistance plan can be used by employers to make payments for an employee’s qualified education loan. This amendment will apply to payments made after Dec. 31, 2025.

Other compensation and benefit impacts

The OBBBA impacts many other tax rules that taxpayers should be aware of and begin planning for:

• Qualified bicycle commuting reimbursement ꟷ permanently removes tax-free reimbursement of bicycle commuting expenses.
• Moving expense reimbursement ꟷ moving expense reimbursements are permanently includible in income of employees (and not deductible by individuals) except for members of the armed forces and, beginning in 2026, the intelligence community.
• Paid family and medical leave credit ꟷ for taxable years beginning after Dec. 31, 2025, expands the credit to be based on an applicable percentage of wages paid to employees on family or medical leave or total premiums paid by the employer for insurance related to providing paid family and medical leave.
• Employer-provided childcare credit ꟷ for taxable years beginning after Dec. 31, 2025, increases the percentage of qualified childcare expenditures eligible for the credit to 40% (50% for eligible small businesses) and the annual maximum credit amount to $500,000 ($600,000 for eligible small businesses) with further inflation adjusted increases.
• Dependent care assistance programs ꟷ beginning in 2026, increases the annual amount excludible from income under an employer-provided dependent care assistance program from $5,000 to $7,500 (or $3,750 when married filing separately).
• Employee retention credit ꟷ ERC claims for Q3 and Q4 2021 will not be issued if filed after Jan. 31, 2024, and the statute of limitations is extended to six years for Q3 and Q4 2021 claims so that the statute of limitations for those claims would now generally expire on April 15, 2028, or six years from the date on which the ERC claims were filed, if later.