How Much Tax Do You Actually Pay on Overtime?
Clarify how overtime earnings are taxed. Understand why perceived higher taxes are often due to withholding, not a special rate.
Overtime pay offers employees the chance to earn more for additional hours worked. Many believe these extra earnings are taxed at a higher rate than regular pay, leading to confusion and hesitation about taking on extra shifts. Understanding how overtime is truly taxed can clarify these concerns and provide a clearer picture of your take-home pay.
Understanding Overtime Pay and Taxation Fundamentals
Overtime pay compensates for hours worked beyond a standard workweek. Under the Fair Labor Standards Act (FLSA), non-exempt employees typically qualify for overtime at one and one-half times their regular rate for hours worked over 40 in a workweek. Overtime earnings are considered regular income, not a special category subject to a separate, higher tax rate. All income, including regular wages and overtime, is combined to determine total annual gross income.
This total annual income places an individual into a specific tax bracket. The United States uses a progressive tax system, taxing higher income levels at higher percentages. Confusion often arises from the distinction between one’s marginal tax rate and effective tax rate. Your marginal tax rate is the rate applied to your last dollar of income, representing the highest tax bracket your income reaches. In contrast, your effective tax rate is the overall average percentage of your total income paid in taxes.
Taxes Applied to Overtime Earnings
Overtime earnings are subject to the same types of taxes as regular wages. These include federal income tax, state and local income taxes (where applicable), and FICA taxes.
Federal income tax operates on a progressive scale. While working overtime increases your total income, potentially pushing a portion of your earnings into a higher tax bracket, it does not mean your entire income is suddenly taxed at that higher rate. For instance, for the 2024 tax year, federal income tax rates range from 10% to 37% across various income thresholds. Only the income that falls within a higher bracket is taxed at that bracket’s rate.
State and local income taxes also apply to overtime earnings. These taxes vary significantly by location, with some states having no income tax, while others have flat rates or progressive structures similar to the federal system. Employees should consult their state’s tax regulations to understand these specific obligations.
FICA taxes, which fund Social Security and Medicare, apply to overtime pay. For 2024, Social Security tax is 6.2% on wages up to an annual wage base limit of $168,600. Medicare tax is 1.45% on all wages, with no wage limit. Additionally, an extra Medicare tax of 0.9% applies to wages exceeding certain thresholds: $200,000 for single filers, $250,000 for married couples filing jointly, and $125,000 for married individuals filing separately.
How Overtime Withholding is Calculated
The perception that overtime is taxed at a higher rate often stems from how employers withhold taxes from these earnings. Overtime pay is categorized as “supplemental wages” by the IRS, influencing the withholding methods employers use.
One common method for withholding federal income tax from supplemental wages is the “percentage method.” Under this method, employers may withhold a flat 22% federal income tax from supplemental wages, especially if identified separately and totaling under $1 million annually. This flat rate can sometimes be higher than an employee’s actual marginal tax rate, leading to the impression of higher taxation. For instance, if an employee’s marginal tax rate is 12% but their overtime is withheld at 22%, they will see a larger percentage taken from that specific paycheck.
Another approach is the “aggregate method,” where the employer combines supplemental wages with regular wages for a pay period. The employer then calculates the tax as if the combined amount were a single payment, using the employee’s Form W-4 information. The tax already withheld from regular wages is subtracted, and the remainder is withheld from supplemental wages. This method can also result in a larger withholding for that particular pay period, as the higher combined income temporarily pushes the calculation into a higher effective withholding bracket.
These methods are for withholding purposes only, not a reflection of the final tax rate applied to your income. The amounts withheld are estimates designed to help employees meet their annual tax obligations. The ultimate tax liability is determined when an individual files their annual tax return.
Impact on Take-Home Pay and Overall Tax Liability
The withholding methods applied to overtime can lead to a lower percentage of take-home pay for those extra hours. This is primarily due to the flat percentage method or the aggregate method momentarily pushing the income into a higher withholding bracket for that pay period. Employees may notice a smaller net gain from their overtime hours than anticipated, even though the actual annual tax rate on their total income remains consistent with the progressive tax structure.
An employee’s actual tax liability is calculated when they file their annual federal income tax return, such as Form 1040. This filing consolidates all income and deductions, determining the precise amount of tax owed. If more tax was withheld than owed, the employee receives a refund. If too little was withheld, the employee owes additional taxes.
Employees can adjust their withholding to better align with their actual tax liability, especially if they regularly work overtime. This is done by submitting a new Form W-4, Employee’s Withholding Certificate, to their employer. Adjusting the Form W-4 allows individuals to account for factors like additional income or deductions. This helps manage cash flow and can prevent a large tax bill or a substantial refund at tax time.