Does Overtime Pay Get Taxed? Here’s What’s Changed

Overtime pay, which provides additional compensation for hours worked beyond standard limits, is generally considered taxable income. Many individuals often wonder if this extra pay is taxed at a higher rate than their regular wages. While overtime is indeed subject to taxation, recent legislation has introduced a significant change that could impact the federal income tax burden on a portion of these earnings. This article will explain how overtime is typically treated for tax purposes and how new provisions may affect your overall tax liability.

Overtime Pay as Taxable Income

Overtime earnings are subject to the same taxes as standard wages: federal income tax, state income tax (where applicable), and Federal Insurance Contributions Act (FICA) taxes. There is no separate or higher tax rate for overtime pay; it is simply additional income that increases an individual’s total gross income.

Federal income tax applies to overtime pay, contributing to total gross income. This income is subject to the progressive tax bracket system. Starting January 1, 2025, new legislation introduces a federal income tax deduction for qualified overtime pay. Eligible workers can deduct up to $12,500 (or $25,000 for joint filers) from their federal taxable income. This deduction phases out for higher earners.

State income taxes also apply to overtime pay in states that levy an income tax. State tax treatment can vary, as states may not conform to the new federal deduction. Some states are considering their own legislation regarding overtime tax exemptions.

FICA taxes, comprising Social Security and Medicare, also apply to overtime pay at their standard rates, funding Social Security and Medicare benefits. For 2025, Social Security tax applies up to a wage base limit, while Medicare tax applies to all covered wages. An additional Medicare tax applies to higher earners. The new federal deduction for overtime pay does not affect FICA taxes; these taxes will continue to be withheld from all overtime earnings.

How Overtime Withholding Works

A common point of confusion for employees is why their take-home overtime pay often appears disproportionately lower than expected. This is largely due to how federal income tax is withheld from supplemental wages, which include overtime pay. While the new federal deduction for overtime begins in 2025, employers are expected to continue withholding federal income tax on overtime pay as they normally would throughout 2025. The benefit of the deduction will be realized by employees when they file their annual tax returns.

Employers typically use one of two primary methods for withholding federal income tax on supplemental wages like overtime. The first is the percentage method, which withholds a flat rate. This flat rate is a withholding mechanism designed to ensure sufficient taxes are collected, not an indication that overtime is ultimately taxed at this rate.

The second method is the aggregate method, where the employer combines supplemental wages with regular wages for a given pay period. Withholding is calculated on this combined amount using the employee’s Form W-4. This can lead to higher withholding for that pay period, making it seem as if overtime is taxed at an elevated rate.

These are withholding practices, not the final tax rate applied to your income. The amount withheld is an estimate of your annual tax liability, intended to prevent a large tax bill at year-end. The actual federal income tax rate on your overtime pay, after any eligible deduction, is determined by your total annual income and tax bracket when you file your tax return. State and local withholding generally follows similar principles.

Impact on Your Paycheck and Overall Tax Liability

Employer withholding methods for overtime can noticeably affect an employee’s net take-home pay. The aggregate method, combining overtime with regular wages, can result in higher federal income tax withheld from a paycheck. This often leads employees to perceive overtime is taxed at a higher rate, though the actual annual rate may be lower. The new federal deduction will not immediately change this withholding practice.

Earning overtime increases gross income, influencing annual tax liability. While overtime is not taxed at a higher rate, additional income could push a taxpayer into a higher marginal tax bracket. The federal deduction for qualified overtime will mitigate this impact by reducing the amount of income subject to federal income tax.

Accurate withholding helps manage annual tax obligations. If too much tax is withheld, it can result in a larger tax refund. Conversely, if too little is withheld, you may owe additional taxes at year-end. For eligible individuals, the new federal overtime deduction will reduce federal income tax liability, potentially leading to a larger refund or a smaller amount due when filing their 2025 tax return.