Is Overtime Pay Taxable? How the New Deduction Affects You

Overtime pay often provides a welcome boost to earnings, but its tax treatment can sometimes lead to confusion for many workers. Understanding how this income is taxed is important for managing personal finances. Overtime compensation is generally considered part of regular wages and is subject to the same taxes, though recent legislative changes introduced a new federal income tax deduction for qualified overtime.

Overtime Pay as Taxable Income

Overtime pay is treated as regular income by federal and state tax authorities, subject to the same income and payroll taxes as regular wages. There are no special tax exemptions or different tax rates applied solely because income is classified as overtime. The Fair Labor Standards Act (FLSA) mandates that eligible employees receive at least one and a half times their regular rate of pay for hours worked over 40 in a workweek, and this entire amount contributes to gross income.

A notable change is the “No Tax on Overtime” provision within the “One Big Beautiful Bill” (OBBB), signed into law on July 4, 2025. This legislation creates a temporary federal income tax deduction for qualified overtime compensation. Effective for tax years 2025 through 2028, this deduction allows eligible workers to reduce their federal taxable income. This is a deduction, not a complete exemption from all taxes on overtime pay.

The deduction applies to the “premium portion” of FLSA-mandated overtime. For example, if an employee’s regular rate is $20 per hour, only the $10 per hour premium may be eligible. This benefit is capped at $12,500 annually for single filers and $25,000 for joint filers, phasing out for taxpayers with modified adjusted gross incomes exceeding $150,000, or $300,000 for joint filers. Federal payroll taxes, such as Social Security and Medicare, still apply to all overtime compensation, regardless of this new federal income tax deduction.

Federal and State Tax Withholding

Employers are obligated to withhold federal income tax from all wages, including overtime pay. The amount withheld is based on the employee’s Form W-4 and the employer’s payroll system calculations. While an overtime paycheck might appear to have more taxes withheld, this is often due to increased gross pay for that period, which can lead payroll systems to project a higher annual income.

The federal income tax rate applied to overtime earnings is the same as regular wages; there is no special higher tax rate for overtime itself. Perceived higher withholding is a function of how payroll software annualizes income for withholding purposes, which can sometimes result in over-withholding if significant, irregular overtime is earned. This over-withholding is reconciled when an individual files their annual tax return.

Beyond federal income tax, overtime pay is subject to Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare. Social Security tax applies up to an annual wage base limit, while Medicare tax applies to all earned income without a wage cap. These payroll taxes are withheld from every paycheck, including those with overtime earnings, and are not affected by the new federal overtime income tax deduction. Most states and some localities also impose income taxes on overtime pay, with specific rules varying by jurisdiction. Employers must withhold these state and local taxes from overtime compensation.

Understanding Your Overall Tax Liability

Earning income through overtime can influence an individual’s overall tax liability. While the new federal deduction for qualified overtime can reduce taxable income, total gross income, including overtime, still determines which marginal tax brackets apply. The U.S. tax system is progressive, meaning different portions of income are taxed at increasing rates. If overtime earnings push an individual’s total annual income into a higher tax bracket, only the portion of income falling within that new bracket is taxed at the higher rate, not the entire income.

The cumulative effect of overtime earnings throughout the year, even with the new deduction, contributes to total taxable income. This total calculates the final tax liability. Depending on how accurately withholding matched this liability, an individual might receive a tax refund or owe additional taxes when filing their return. The new federal deduction for qualified overtime is claimed when filing the annual tax return, not at the time of each paycheck, meaning initial withholding amounts will not reflect this deduction.

Individuals who consistently earn significant overtime may find it beneficial to review pay stubs and adjust their Form W-4. A properly adjusted W-4 can help align the amount withheld from each paycheck more closely with the actual annual tax liability, potentially reducing a large refund or preventing a tax bill at year-end. This adjustment can take into account the new federal overtime deduction to further refine withholding accuracy.