2026 California Employment Law Updates

1. Impact on overtime and tip pay

• Creates a temporary deduction from gross income for overtime hours and capped the deduction at $12,500 (or $25,000, in the case of a joint return) for all employees.
• Employers are required to separately report on Form W-2 the portion of the employee’s pay that is qualified overtime compensation.
• Effective for tax years beginning after Dec. 31, 2025, the procedures for withholding are to be modified to take into account this deduction
• Transition rules permit employers to approximate a separate accounting of amounts as qualified overtime compensation by any reasonable method specified by the IRS.
• Creates a separate deduction for tipped workers, allowing them to deduct up to $25,000 of qualified tips earned.
• Tips paid voluntarily by the customer may be deducted; earnings from mandatory service charges assessed automatically to customers are not deductible. Tips received under tip-sharing arrangements count as qualified tips.
• Deduction only for tips earned in “traditionally and customarily tipped industries,” (e.g., hospitality industry, barber shops, hair and nail salons, spas).

2. Impact on Immigration 

• Introduces immigration-related changes that are likely to affect employers who recruit, employ, and sponsor foreign workers.
• Increases funding for Customs and Border Protection (CBP) and Immigration and Customs Enforcement (ICE), likely leading to more I-9 audits and worksite enforcement actions.
• Outlines new and increased fees on an array of immigration-related applications and processes, many of which cannot be waived or reduced (e.g., increased to $550 for EADs and $275 for Protected Status (TPS).
• Employers who hire individuals under these categories may encounter higher costs or potential delays as employees work to obtain or renew their work authorization.

3. Impact on Benefits

The OBBBA introduces significant enhancements to employer-provided benefits.

• Dependent care flexible spending accounts and FSAs have been increased from $5,000 to $7,500 ($3,750 for separate returns filed by married individuals).
• Increases the employer-provided childcare credit and increased the maximum credit amount to $2,200 per qualifying child beginning in 2025. 
• Allows employers to offer telehealth services pre-deductible to employees HSA and a high-deductible health plan (HDHP); permanent change, retroactively Dec. 31, 2024.

Suggested Action Plan

• Update payroll and reporting systems to meet new IRS rules on tips, overtime, and tax credit
• For CA employers -update payroll systems to separately track and report qualified tips and FLSA-required overtime premiums on W-2 forms for tax years 2025 through 2028.
• Work closely with your payroll provider, CPA and HR Consultant for applicable updates
• Ensure HSA’s flexibility with telemedicine
• Be on the lookout for specific IRS guidance
• Ensure your I-9s have been audited recently
• Develop a Rapid Response Team to be prepared for an ICE Enforcement Action

To further discuss these updates, evaluate their impact on your organization, and to develop a tailored HR strategy and implementation plan, please contact your dedicated Consultant or contact our CA/Nationwide HR office at info@CAHRservice.com or 858-228-5535.