February 2 Tax Policy Update

Summary

• Partial government shutdown took effect midnight, January 30; House expects to hold a vote to end it on Tuesday
• Mayor Mamdani renews call for tax increases in light of budget deficit
• IRS issues fact sheets on qualified overtime compensation and electronic payment

Vote on Bill to End Partial Government Shutdown Expected Tuesday

At midnight on January 30, funding for six of the federal government’s appropriations categories lapsed, resulting in a partial government shutdown. On January 30, the Senate voted 71-29 to pass a bill containing House-passed provisions funding five out of the six remaining appropriations categories through the end of the fiscal year, and a two-week continuing resolution (CR) funding the Department of Homeland Security. The bill was the result of negotiations between the White House and Senate Democrats.

House Republicans had hoped to hold a suspension vote Monday on the bill in order to avoid the need for the House to approve a rule. However, a suspension bill requires a two-thirds vote, which the bill is unlikely to receive on the suspension calendar. House Democratic leadership, which was not included in the White House-Senate deal, came out strongly against the bill. It appears that the bill will attract enough House Democratic votes to pass by a wide margin, if the bill can get to the House floor. However, passing a rule to bring the bill to the floor will be difficult because Democrats will likely overwhelming oppose the rule, so nearly all Republicans will be needed. Speaker Johnson (R-LA) said on Sunday that he plans for the House to pass the bill on Tuesday.

The House Republican majority will be reduced to 218-214 (meaning Speaker Johnson effectively can lose just one Republican on any party-line vote) once Rep.-elect Menefee (D-TX), who won the Saturday race to fill the open seat created by the death of former Rep. Turner (D-TX), is sworn in. That very narrow margin will mostly last until after the August recess – assuming no new House vacancies. The first round of the election for the Georgia seat vacated by former Rep. Greene (R-GA) will be held on March 10 and Republicans are expected to hold that seat, but there will be an April 7 runoff if no candidate receives an absolute majority. The New Jersey open seat created by the resignation of former Rep. Sherrill (D-NJ) after she was elected as New Jersey governor, which Democrats are expected to hold, will be on April 16. The election to fill the California seat vacated by the death of Rep. LaMalfa (R-CA), which Republicans are expected to hold, will not be until August 4.

Treasury and the IRS announced that during the shutdown all IRS employees will be exempt from furlough though February 7.

It is not clear, assuming the bill is enacted, whether two weeks will be sufficient time to negotiate a new DHS funding package, which would result in a DHS lapse in funding unless Congress enacts another CR for DHS.

Mayor Mamdani Renews Call for Tax Increases in Light of Budget Deficit

New York City Mayor Mamdani renewed his call for higher taxes on the wealthy and corporations after Mark Levine, the City Comptroller, said the city is facing a $2.18 billion budget shortfall this fiscal year, and a $10.4 billion shortfall the following fiscal year. Mayor Mamdani blamed former Mayor Adams and former Governor Cuomo for the city’s fiscal situation. He said: “We must raise taxes on the wealthiest few in New York City so that we can invest in the many.” More specifically, he advocated a corporate tax hike and a 2% tax increase on those making at least one million dollars per year. Mayor Mamdani also said that he is open to the possibility of a wealth tax, such as the one proposed in California, which would levy a one-time 5% net-worth tax on billionaires.

Governor Hochul replied: “We’re not raising taxes in the state of New York, I’m not raising taxes for the sake of raising taxes.”

As explained in this S&C policy memo, “Potential Tax Impacts of a Mamdani Mayoral Administration,” New York City can generally raise taxes only with authorizing legislation from New York State.

On January 23, Treasury and the IRS released a fact sheet (FS-2026-01) providing answers to frequently asked questions (FAQs) on the new income tax deduction for “qualified overtime compensation,” enacted as part of OBBBA. For tax years 2025 through 2028, eligible individuals may deduct the portion of their overtime pay that exceeds their regular pay rate (generally, the “half” portion of “time-and-a-half” overtime pay). The deduction is capped at $12,500 per taxpayer (or $25,000 for joint filers), and phases out for taxpayers with modified adjusted gross income above $150,000 ($300,000 for joint returns).

The FAQs highlight that the deduction applies only to overtime pay required to be paid under the Fair Labor Standards Act (FLSA) for non-exempt (overtime-eligible) employees.

The IRS guidance summarizes reporting and compliance for the new deduction. Starting in 2026, employers and other payers will be required to separately report qualified overtime pay on Forms W-2 or 1099. For 2025, employees can calculate their deductible overtime amount using IRS-provided methods outlined in Notice 2025-69 and the instructions for Form 1040.

The FAQs were not published in the Internal Revenue Bulletin, and thus cannot be relied upon by the IRS or taxpayers. However, should a taxpayer reasonably and in good faith rely on a portion of the FAQs that turns out to be mistaken, the taxpayer will not be subject to penalties.

On January 27, the IRS released a fact sheet (FS-2026-02) providing answers to frequently asked questions (FAQs) on the implementation of Executive Order 14247, “Modernizing Payments To and From America’s Bank Account.” The Executive Order, issued on March 25, directs the federal government to transition to electronic methods for federal disbursements and receipts. To implement the order, the IRS has begun phasing out paper-based tax payment transactions: notably, it generally stopped issuing paper tax refund checks after September 30, 2025 (with limited exceptions). The IRS will also sunset the Electronic Federal Tax Payment System in late 2026 in favor of IRS Direct Pay and other methods.

For individuals without bank accounts, the IRS will facilitate payment through certain mobile payment apps and prepaid debit cards, and will issue paper checks in cases of specific hardship or other legally warranted situations. For decedents, refunds will continue to come as paper checks. For businesses, the IRS is adding new direct-deposit options; paper checks and money orders are still being accepted. The agency plans to gradually curtail their use, but has not set a fixed cutoff date.