Do They Tax Overtime? Explaining the New Tax Deduction

Overtime wages are subject to taxation. Like regular income, any additional pay received for working beyond standard hours contributes to an individual’s total taxable income. Understanding how these extra earnings are taxed is important for accurate financial planning and managing expectations regarding take-home pay.

Taxability of Overtime Wages

Overtime pay is treated as regular income for federal tax purposes, subject to the same federal income tax rules as standard earnings. This pay is included in an employee’s gross income, which is the total amount earned before deductions. Beyond federal income tax, overtime wages are also subject to Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare.

For Social Security, employees contribute 6.2% of their wages, up to an annual wage base limit of $176,100 for 2025. The Medicare tax rate is 1.45% for employees, applied to all covered earnings without any wage base limit. An additional Medicare tax of 0.9% applies to wages exceeding $200,000 for individuals, with employers required to withhold this extra amount.

Understanding Overtime Withholding

The amount of tax withheld from an overtime paycheck might appear disproportionately higher than from a regular paycheck. This is because overtime pay is classified by the Internal Revenue Service (IRS) as “supplemental wages,” which include payments like bonuses and commissions. Employers use specific methods to calculate federal income tax withholding on these payments.

One common method is the percentage method, where a flat rate of 22% is withheld from supplemental wages up to $1 million within a calendar year. If an employee’s supplemental wages for the year exceed $1 million, the excess portion is subject to a 37% withholding rate. Alternatively, employers may use the aggregate method, combining the overtime pay with regular wages for the current or most recent payroll period. The employer then calculates withholding as if the total amount were a single regular payment, using the employee’s Form W-4 information. This approach can result in a higher withholding for that specific pay period, even though the actual annual tax rate on the income may not be higher.

Annual Tax Impact of Overtime

While withholding on overtime may seem higher in a particular pay period, an individual’s actual tax liability is determined by their total annual income, not just individual paychecks. The progressive federal income tax system means different portions of income are taxed at increasing rates. Earning overtime can increase an individual’s overall taxable income, potentially moving some of their earnings into a higher tax bracket for the entire year.

This adjustment in tax bracket applies to all income that falls within that higher bracket, not just the overtime portion itself. For example, if overtime pushes an individual’s total income above a certain threshold, the income beyond that threshold will be taxed at the next higher rate. Any over-withholding that occurred throughout the year will be reconciled when the individual files their annual tax return. If more tax was withheld than what is actually owed, the taxpayer will receive the difference as a refund.

State and Local Overtime Taxes

In addition to federal taxes, overtime wages may also be subject to state and local income taxes, depending on residence and work location. State tax laws vary significantly, with some states imposing a flat income tax rate, others using a progressive system, and some having no state income tax. Generally, states that levy an income tax treat overtime wages similarly to regular wages.

Local jurisdictions, such as cities or counties, may also impose their own income taxes, which apply to overtime earnings. These local taxes are typically a percentage of gross income and are withheld from paychecks. Due to the wide variation in state and local tax regulations, individuals should consult their specific state and local tax authorities or a tax professional to understand the tax implications of overtime earnings in their area.