Federal Budget Reconciliation Bill Changes HSA Rules and Impacts Income Taxes

Quick Hits

• The budget reconciliation bill makes important changes to health savings account (HSA) eligibility and reimbursements, including retroactively restoring the telehealth relief provided by the CARES Act.
• It also addresses tax relief provided to several fringe benefits.
• The law also eliminates income taxes on tips and overtime pay.

Coverage for Telehealth Services

The law makes permanent the telehealth provisions from the CARES Act in 2020 and subsequent guidance that allow high-deductible health plans (HDHPs) to cover telehealth and other remote medical services before the deductible and still qualify as an HSA-eligible plan. This provision had expired at the end of 2024, leaving employers providing telehealth services in the difficult position of having to choose to restrict access to employees contributing to HSAs or cutting off HSA contributions. The law makes the change retroactive to January 1, 2025, when the exclusion had expired, allowing employers to avoid having to recharacterize any HSA contributions for such period.

Impact on HSAs

While numerous changes to HSAs were contemplated while the legislation was being finalized, ultimately only one significant change was adopted: provisions relating to direct primary care arrangements (DPCAs). Specifically, the law allows individuals to participate in DPCAs and remain HSA-eligible and also allows payment of DPCA periodic (e.g., monthly) fees from HSAs as medical expenses.

DPCAs are arrangements where participants pay a periodic fee of up to $150 per month for primary care services from primary care providers, and no other fees are charged to participants. These are often referred to colloquially as “concierge” medicine practices. Under the new law, DPCAs cannot provide lab work that is not typically provided in an ambulatory care setting, prescriptions other than vaccines, or any procedure requiring general anesthesia. If the arrangement provides those benefits, the arrangement will not be a DPCA, and the individual will not be eligible to contribute to an HSA, as the individual will be deemed to have “other coverage” beyond a HDHP and/or DPCA. Also, the HSA cannot pay or reimburse a DPCA for these types of expenses.

Some industry groups lobbied for changes specifically addressing employer on-site clinics, which were not included in the finalized law. But employers might consider how to apply the DPCA exclusion to their on-site clinics to achieve similar results.

Student Loan Relief

The new law permanently extends the tax exclusion for employer-paid reimbursement of qualified student loans under a Code Section 127 educational assistance program. The annual tax exclusion that was set to expire at the end of 2025 has now been made permanent, and the $5,250 cap on the tax exclusion for all education assistance under Code Section 127 will be indexed for inflation, starting in 2026.

Dependent Care Reimbursements

The new law provides additional tax relief, beginning in 2026, in the form of an increase to the annual exclusion from taxable income for dependent care flexible spending arrangements (FSAs). The longstanding annual limit of $5,000 will increase to $7,500, and the $2,500 limit for married individuals filing separately will increase to $3,750.

Childcare and Adoption Tax Credits

Employees receiving childcare and adoption assistance from their employers will benefit from improved tax treatment of these benefits, with the maximum employer-provided childcare credit increasing and the adoption assistance credit becoming partially refundable.

Transportation Benefits

While the exclusion from taxable income for up to $20 per month as a qualified bicycle commuting reimbursement has been permanently eliminated, other qualified Code Section 132(f) transportation benefits will see additional increases based on inflation.

No Tax On Tips and Overtime Pay

The law makes tips exempt from federal income taxes through the end of 2028, when the tax break will expire. The law caps the federal tax deduction on tips at $25,000. It only includes tips voluntarily paid by customers, not mandatory gratuities. The law phases out the tip exemption for workers whose income exceeds $150,000 or couples whose joint income exceeds $300,000. Eligible occupations include waiters, bartenders, hairdressers, barbers, nail technicians, and spa treatment providers.

Overtime pay is exempt from federal income taxes under the new law. The overtime tax break is set to expire at the end of 2028.

The deduction is capped at $12,500 per year for single filers and $25,000 for joint filers; however, married individuals must file a joint return for this section to apply.  This deduction is subject to a phase-out: for every $1,000 by which a taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 for joint returns), the allowable deduction is reduced by $100, potentially eliminating the benefit for higher earners.

Both tips and overtime pay will continue to be subject to Medicare tax, Social Security tax, state income tax, and local income tax. Guidance on how employers are to adjust withholding on qualifying tips and overtime is forthcoming from the Internal Revenue Service (IRS).

Next Steps

When combined, the provisions in the law may reduce health care costs for some individuals with HSAs but increase health care costs for others with individual health plans and Medicaid.

Employers that provide coverage for telehealth services will be relieved that plan amendments and administrative changes from their 2024 approach will not be needed for 2025 as a result of the retroactive relief the law provides. Employers will want to review their Code Section 125 cafeteria plan documents and upcoming open enrollment materials for changes relating to HSA contribution eligibility and dependent care FSAs, as well as reimbursement policies relating to educational assistance, adoption assistance, and commuter benefit adjustments for 2026.

Changes in overtime and tip taxation may have other implications for employers, including adjustments for payroll tax withholding and reporting and implications for other benefit plans with contributions linked to taxable income.  Employers also may wish to consult with their third-party payroll vendors and inform their employees about any changes to taxation on tips or overtime pay. Employees may want to adjust the amount of taxes withheld from their paychecks.

Ogletree Deakins’ Employee Benefits and Executive Compensation Practice Group and Wage and Hour Practice Group will continue to monitor developments and will provide updates on the Employee Benefits and Executive Compensation, Governmental Affairs, and Wage and Hour blogs as new information becomes available.

This article and more information on how the Trump administration’s actions impact employers can be found on Ogletree Deakins’ New Administration Resource Hub.

Carly E. Grey is a shareholder in Ogletree Deakins’ Washington, D.C., office.

Michael K. Mahoney is a shareholder in Ogletree Deakins’ Morristown office.

Stephanie A. Smithey is a shareholder in Ogletree Deakins’ Indianapolis office.

This article was co-authored by Leah J. Shepherd, who is a writer in Ogletree Deakins’ Washington, D.C., office.

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