State Senate Panel Adopts One-Year Tax Break on Overtime & Tips (Indiana)

Indiana lawmakers are advancing a targeted tax relief proposal aimed at hourly and service-industry workers. A state Senate committee has approved legislation that would temporarily exempt overtime pay and tip income from Indiana state income tax for one year. While narrow in scope, the proposal carries meaningful implications for employers, payroll compliance, and individual tax planning across the state.

For CPAs, tax attorneys, and business owners, this development deserves close attention. Beyond its immediate effect on withholding and reporting, the proposal may signal a broader shift toward worker-focused tax relief at the state level.

What Happened

A finance-focused panel within the Indiana General Assembly approved a bill that would exclude overtime wages and tips from state taxable income for a single tax year.

Key elements of the proposal include:

• One-year duration: The exemption would apply only for a single tax year, functioning as temporary tax relief rather than a permanent change to the tax code.

• Income-specific relief: Only wages attributable to overtime hours and qualifying tips would be exempt. Regular base wages would remain fully taxable.

• State-only impact: The exemption applies solely to Indiana state income tax. Federal income tax and payroll taxes, including Social Security and Medicare, would remain unchanged.

• Legislative status: The bill has cleared committee but must still pass the full Senate, the House, and receive the governor’s signature before becoming law.

If enacted, the proposal would impact workers across hospitality, healthcare, manufacturing, construction, and retail, all industries where overtime and tipping are common.

Why It Matters for CPAs, Tax Attorneys, and Business Owners

1. Payroll and Withholding Adjustments

Employers would need to update payroll systems to properly separate overtime and tip income from regular wages for Indiana withholding purposes.

This introduces several operational considerations:

• Payroll software must accurately distinguish exempt and non-exempt wages

• Employers face increased compliance risk if payroll configurations are incorrect

• Errors may surface during Indiana Department of Revenue payroll audits

CPAs advising employers should proactively confirm whether payroll providers can implement state-specific exemptions efficiently and on schedule.

2. Individual Tax Planning Opportunities

For employees who consistently earn overtime or tips, the exemption could result in a noticeable reduction in state income tax liability.

Tax professionals should consider:

• Updating state estimated tax calculations

• Evaluating whether reduced withholding could create underpayment issues once the exemption expires

• Clearly explaining to clients that federal tax treatment does not change

This is especially important for tipped workers, who often already face complex income reporting requirements.

3. Temporary Nature Increases Compliance Risk

Because the proposal applies for only one year, it introduces a clear sunset risk. Temporary tax rules are frequently misunderstood by both employers and employees.

Advisors should prepare for:

• Year-end client communications emphasizing the limited duration

• Reversing payroll configurations in the following tax year

• Monitoring legislative activity in case the exemption is extended or modified

Historically, short-term tax provisions tend to generate more filing errors than permanent changes, increasing the value of proactive guidance.

Broader Policy Implications

Although limited to Indiana, the proposal reflects a wider national trend. States are increasingly experimenting with targeted tax relief for workers in response to inflationary pressure, labor shortages, and wage growth concerns.

Other states may closely watch Indiana to evaluate:

• Revenue impact on state budgets

• Administrative complexity for employers

• Behavioral effects related to overtime usage

For multistate employers, this could foreshadow a growing patchwork of wage-specific tax rules that complicate compliance across jurisdictions.

What’s Next

The bill must still advance through the full legislative process. Next steps include:

• A vote by the full Indiana Senate

• Consideration by the Indiana House

• Final approval or veto by the governor

If enacted, tax professionals should monitor guidance from the Indiana Department of Revenue, particularly regarding employer withholding, reporting mechanics, and effective dates.

Final Thoughts

Indiana’s proposed one-year exemption for overtime and tip income could deliver meaningful short-term tax relief for workers while creating real compliance and planning challenges for employers. For CPAs and tax attorneys, the temporary nature of the rule makes early preparation and clear communication especially important.

Advisors who act proactively will be best positioned to help clients avoid payroll errors, missed planning opportunities, and confusion when the exemption sunsets.

Try Bizora today to stay ahead of state and federal tax developments that impact planning and compliance.

Frequently Asked Questions (FAQ)

Does this exemption eliminate federal taxes on overtime or tips?

No. The proposal applies only to Indiana state income tax. Federal income tax and payroll taxes, including Social Security and Medicare, would still apply.

Would employers stop withholding Indiana tax on overtime and tips?

If enacted, employers would likely need to adjust Indiana withholding. Official instructions would be issued by the Indiana Department of Revenue.

Does the exemption apply to salaried employees?

Only income classified as overtime wages or tips would qualify. Most salaried compensation would remain fully taxable.

Could this exemption be extended beyond one year?

Possibly, but the current proposal is explicitly limited to one year. Any extension would require new legislative action.

When would the exemption take effect?

If the bill becomes law, the effective date would be specified in the final legislation or accompanying administrative guidance.