How Much Overtime Is Taxed With the New Deduction?

Working extra hours can significantly boost your income, yet many believe overtime is taxed at a higher rate due to withholding practices, not actual tax liability. Understanding income taxation and payroll withholding clarifies how overtime impacts your overall financial picture. This article demystifies overtime taxation, explaining it is treated as regular income integrated into your total annual earnings.

Fundamentals of Income Taxation

The United States employs a progressive income tax system, meaning that different portions of an individual’s income are taxed at increasing rates. Taxable income is divided into tax brackets, each with a corresponding marginal tax rate. For example, in 2025, federal income tax rates range from 10% to 37%. Only income within a particular bracket is taxed at that bracket’s rate.

The marginal tax rate is the percentage applied to the last dollar of income earned. This differs from the effective tax rate, which represents the average rate of tax paid on total income. To calculate the effective tax rate, total tax paid is divided by total taxable income. Due to the progressive structure, a taxpayer’s effective tax rate is lower than their highest marginal tax rate.

Overtime Withholding Methods

Overtime pay is categorized as supplemental wages by the Internal Revenue Service (IRS), similar to bonuses or commissions. Employers use different methods to calculate federal income tax withholding from these payments. These methods approximate annual tax liability but can lead to variations in the amount deducted from a paycheck.

One common approach is the percentage method, where a flat rate of 22% is applied to supplemental wages for federal income tax. If supplemental wages exceed $1 million in a calendar year, the amount above this threshold is subject to a mandatory flat withholding rate of 37%. This flat rate withholding can make overtime appear disproportionately taxed in a given pay period.

Alternatively, employers may use the aggregate method, combining supplemental wages with regular wages for a pay period. The employer calculates withholding as if the combined total were regular pay. Tax already withheld from regular wages is then subtracted from the total calculated withholding, with the remainder deducted from supplemental wages. This method can push an employee’s income for that pay period into a higher withholding bracket, leading to a larger deduction. Employers refer to IRS Publication 15-T for guidance.

Overtime and Your Annual Tax Bill

Overtime income is not subject to a special, higher tax rate. Overtime wages are added to an individual’s total annual income, becoming part of their gross income for the tax year. The entire amount of an individual’s taxable income, including overtime, is then subject to progressive federal income tax rates.

Overtime earnings are taxed at the highest marginal rate applicable to the taxpayer’s total income. For instance, if regular wages place an individual in a 12% tax bracket and overtime pushes a portion of income into the 22% bracket, only the amount exceeding the 12% bracket threshold is taxed at 22%. The amount withheld from paychecks is an estimate of this final tax liability.

Any difference between the amount withheld and the actual tax owed at year-end results in a tax refund or additional taxes due. If too much tax was withheld, the overage is returned as a refund. If too little was withheld, the taxpayer owes the remaining balance when filing their annual tax return. Withholding is a payroll calculation, while the actual tax rate applies to total income reported on the annual tax return.

Additional Tax Implications of Overtime

Beyond federal income tax, overtime earnings also have implications for other taxes and potential impacts on tax benefits. Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare, apply to overtime wages. For 2025, the Social Security tax rate is 6.2% for employees, applied to earnings up to an annual wage base limit of $176,100. There is no wage base limit for Medicare tax, which is 1.45% for employees.

Individuals with higher incomes may also be subject to an additional Medicare tax of 0.9% on earnings above certain thresholds, such as $200,000 for single filers. State and local income taxes will also apply to overtime income. These additional taxes contribute to the overall tax burden on increased earnings.

Higher overall income from overtime can affect eligibility for certain income-based tax deductions, credits, or government benefits. Some tax benefits, such as the “No Tax on Overtime” deduction, have income caps and phase-out rules. This deduction, which allows a dollar-for-dollar deduction for designated overtime pay, is capped at $12,500 for single filers and phases out for those with a modified adjusted gross income starting at $150,000. Increased income may reduce the value of certain deductions or credits or eliminate eligibility.