How to Calculate the Tax on Your Overtime Pay

Overtime pay often appears to be taxed at a higher rate than regular wages, leading many individuals to question why their extra earnings result in a disproportionate reduction in their take-home pay. Overtime refers to hours worked beyond a standard workweek, typically 40 hours, for which employees receive increased hourly compensation, often one and a half times their regular rate.

Overtime as Taxable Earnings

For tax purposes, overtime pay is not categorized separately from an individual’s regular wages; instead, it is considered part of their total taxable income. This means that overtime earnings are subject to the same federal income tax, Social Security and Medicare taxes (FICA), and any applicable state or local income taxes as standard pay. Social Security tax is 6.2% on earnings up to an annual wage base limit, while Medicare tax is 1.45% on all earnings, with no wage base limit.

A common misconception is that overtime is taxed at a special, higher rate. While the amount withheld from an overtime paycheck might seem larger, the actual tax rate applied is simply an individual’s marginal tax rate, which depends on their total annual income. Marginal tax rates mean that different portions of income are taxed at increasing rates. Overtime earnings can push an individual’s total income into a higher tax bracket, meaning that the additional income is taxed at a higher marginal rate, but the earlier portions of income remain taxed at their original, lower rates.

Employer Withholding Methods for Overtime

Employers are mandated to withhold taxes from all wages, including overtime, and often treat overtime as “supplemental wages” for withholding purposes. The IRS provides specific guidelines for how employers should calculate withholding on these types of payments. Two primary methods are commonly used for federal income tax withholding from supplemental wages: the percentage method (flat rate method) and the aggregate method.

Under the percentage method, employers can elect to withhold federal income tax at a flat rate from supplemental wages, provided certain conditions are met. The optional flat rate for withholding is 22%. This method can often result in over-withholding for employees whose actual marginal tax rate is lower than the 22% flat rate, creating the impression that overtime is taxed more heavily on a per-paycheck basis.

The aggregate method involves combining the supplemental wages, such as overtime, with the employee’s regular wages for the current pay period. The employer then calculates the income tax withholding on this combined total as if it were one larger regular payment. The tax already withheld from the regular wages is then subtracted, with the remainder being withheld from the supplemental wages. This approach can also lead to higher withholding in specific pay periods because the combined income might temporarily push the employee’s earnings into a higher apparent tax bracket for that single period, even if their annual income does not place them consistently in that bracket.

Your Overall Tax Liability and Overtime

The taxes withheld from your paycheck by your employer are merely estimates designed to help you meet your annual tax obligations; your true tax liability is calculated when you file your annual tax return. The information provided on your Form W-4 significantly influences how much tax your employer withholds from each paycheck. Adjusting your W-4 can help align your withholding more closely with your actual tax liability, potentially reducing instances of over-withholding.

All income earned throughout the year, including all overtime pay, is aggregated to determine your total annual taxable income. This total income is then subjected to the progressive tax rates to determine your final tax bill. Deductions, credits, and other income sources, such as investments or additional jobs, also play a significant role in reducing or increasing your overall tax burden. While overtime might be subject to higher withholding due to the methods employers use, its actual tax burden is determined by your total annual income and applicable tax rates, not by a special “overtime tax.”