How Does Overtime Affect Your Tax Return?

Overtime pay provides additional income but introduces complexities for tax purposes. Understanding how overtime is taxed is important for managing personal finances and avoiding surprises.

How Overtime Pay Is Taxed

Overtime pay is taxed as regular income for federal purposes. Hours worked beyond the standard workweek are added to your gross income. This total income, including overtime, is then subject to federal income tax.

Beyond federal income tax, overtime earnings are also subject to Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare. For 2025, the Social Security tax rate is 6.2% on wages up to an annual limit of $176,100, applied to both employees and employers. The Medicare tax rate is 1.45% on all wages, with no income limit, also split between employees and employers. Additionally, an extra 0.9% in Medicare tax applies to individual wages exceeding $200,000.

A new federal deduction for qualified overtime compensation, effective January 1, 2025, does not eliminate initial taxation of overtime pay at the payroll level. Overtime earnings remain subject to federal income tax withholding and FICA taxes as they are earned. The deduction’s benefit is realized when individuals file their annual tax returns, reducing their federal income tax liability.

Understanding Overtime Withholding and Tax Brackets

A common misunderstanding involves how overtime affects an individual’s tax bracket. Overtime pay itself does not automatically place all of a person’s income into a higher tax bracket. Instead, only the portion of income that pushes total earnings above a tax bracket threshold is taxed at the higher marginal rate, while income below that threshold remains taxed at lower rates. This distinction between marginal and effective tax rates is important.

Tax withheld from overtime pay can appear higher than from regular wages due to specific payroll withholding methods for supplemental wages. One common approach is the percentage method, where a flat rate, typically 22% for amounts under $1 million, is withheld from supplemental wages. This method can result in more tax being taken out upfront than what the final tax liability might be.

Another common approach is the aggregate method, where an employer combines the supplemental wages with the employee’s regular wages for a pay period. The total combined amount is then used to calculate withholding based on the employee’s Form W-4 and the standard withholding tables. This can also lead to higher withholding because the annualized income for that specific pay period appears significantly larger than usual, pushing a larger portion of income into higher estimated tax brackets.

These withholding practices can result in a smaller immediate take-home amount from an overtime paycheck, even though the actual tax due for the year is determined by total annual income. For 2025, employers are still expected to withhold federal income tax from overtime pay as they normally would.

Impact of Overtime on Your Final Tax Return

Overtime income is not itemized separately from regular wages on Form W-2. Instead, it is included in Box 1, which reports total “Wages, tips, other compensation.” The IRS calculates total tax liability based on all reported income, including regular and overtime earnings.

For tax years 2025 through 2028, a federal income tax deduction for qualified overtime compensation was introduced as part of the One Big Beautiful Bill Act. This provision allows eligible individuals to deduct the premium portion of their Fair Labor Standards Act (FLSA)-required overtime pay from their federal taxable income. The maximum deduction is $12,500 for single filers and $25,000 for those married filing jointly, though it phases out for higher earners.

Whether a taxpayer receives a refund or owes additional tax at year-end depends on how accurately their total tax withholding matched their final tax liability. If more tax was withheld than owed, a refund is issued; if less, additional tax is due. The higher upfront withholding often seen with overtime can contribute to a larger refund or help prevent an underpayment of taxes.

Individuals who regularly work overtime may consider adjusting their Form W-4 with their employer to better align their withholding with their expected annual tax liability. This adjustment can help ensure that the appropriate amount of tax is withheld throughout the year, potentially reducing the likelihood of a large refund or a significant tax bill at year-end.

State and Local Overtime Taxation

Beyond federal taxes, overtime pay is also subject to state and, in some cases, local income taxes. Most states consider overtime earnings as part of an individual’s regular income for state tax purposes, meaning it is taxed at the applicable state income tax rates. Similar to federal taxes, state and local withholding rules also apply to overtime compensation, and employers are required to withhold these taxes from paychecks.

The specific rules and rates for state and local overtime taxation can vary depending on the jurisdiction. Some states may have flat tax rates, while others employ a progressive tax system similar to the federal structure. The new federal deduction, effective from 2025, applies only to federal income tax and does not impact state and local income tax obligations or FICA taxes. Some states are exploring their own overtime tax exemptions, but these are separate from the federal provision and depend on individual state legislation.