Every year sees subtle shifts in the tax code that have small effects on payroll processes and filing requirements. This year, however, has some dramatic changes to what is taxed and that will affect many employers as well as their employees. Overtime hours and tips are no longer taxed in most scenarios and 401k catch-up contributions are now taxable for certain employees. Here’s some specifics on the impacts of these changes and how CSSI is handling them.
No taxes on overtime
Starting in 2025, retro-active to the beginning of the year, tips and, more applicably to our customer base, overtime earnings are not taxable. There’s a lot of caveats to this one though, so let’s take a closer look.
First, this is a deduction taken when an individual files their taxes. Overtime wages still have tax withheld as they always have, but filers will specify how much of their earnings came from overtime (or tips) on their 1040. This is similar to a mortgage interest deduction in that you take the deduction when you file, not as a pre-tax deduction to earnings.
I mean, mostly…
Second, there are restrictions on how much can be deducted and how much of the overtime wages are subject to the deduction based on your earnings. The ceiling for deductions is $12,500 for single filers or $25,000 for married, joint filers. An added restriction is applied for those earning over $150,000 ($300,000 for joint filers). For each $1,000 over this threshold, the ceiling is lowered by $100. In practice, this means a single filer with $15,000 in overtime earnings can only claim $12,500 of that as tax free earnings. If that person made $175,000 in 2025, they would be reduced to claiming $10,000 with the remaining balance taxed at the normal rate.
What do I need to do?
If you use CSSI’s payroll, there is nothing for you to do. We already track the overtime hours separately from regular earnings and will simply report this on the W-2 in Box 14. Currently, there are no changes proposed to the W-2 for the 2026 filing season, and employers are instructed only to make an effort to have the information available to their employees. Our best guess is that this will eventually be formalized as a line in Box 12 with its own specific code. Particularly given the transient nature of this change—it expires after 2028—we don’t expect a new box to be added to the W-2 dedicated to this relief.
Yes taxes on trad-401k catch-ups (with ifs and buts)
The other notable change to tax withholding in 2026 affects participants in traditional 401k plans. Participants who made more than $145,000 in FICA earnings in 2025 must pay tax on their catch-up contributions in 2026 by having those switched to a Roth plan. This presents much more of a headache as there is now yet another strand in the web of contribution limits. Now a Roth 401k is required as a backup to your traditional 401k in order to ensure your company can support catch-up payments for all of your participants.
Here are the buts
SIMPLE 401k plans are not affected by the new rules. While they do have catch-up options, participants may continue to use the catch-up contribution as a pre-tax item. Also all flavors of IRA are unaffected as this taxation rule applies only to 401k plans.
What do I need to do?
This new regulation will require you to make a change in the CSSI system. You will need to set a Roth 401k deduction code for the regular 401k deductions. If this code is not set, and the participant is over the earnings threshold, they will not be allowed to make catch-up contributions in 2026. That is per the federal regulations, not a CSSI choice about how to handle the situation.
Buckle up for the 2026 tax season!
We’ll have an update ready in plenty of time for the 2026 tax year. Look for our usual end of year information packets where we’ll have reminders about these two changes plus any other relevant changes you need to know about. We’ll be offering all the same services for submitting W-2s and 1099s as we had last year. Sign-ups and pricing will be available on the first Tuesday in November. Happy 2026 tax season!