Is Overtime Pay Taxed? Explaining the New Deduction
Demystify overtime pay taxation. Learn how it impacts your total income and understand the difference between withholding and your true tax obligation.
Overtime pay is subject to taxation, similar to regular wages. It is considered part of an individual’s total taxable earnings. This affects the net amount received in a paycheck and contributes to an individual’s overall tax liability.
Federal Income Taxation of Overtime
Overtime pay is treated as ordinary income for federal income tax purposes. This means it is subject to federal income tax withholding, similar to the base wages earned during regular hours. Employers calculate this withholding based on an annualized projection of an individual’s total income, which includes any overtime earnings.
It is a common misconception that overtime is taxed at a higher rate. While the amount withheld from an overtime-heavy paycheck might appear larger, the actual federal income tax rate applied to an individual’s annual income remains consistent. The United States employs a progressive tax system, meaning higher total income can result in a larger portion of earnings falling into higher marginal tax brackets. This does not mean overtime hours are taxed at a unique, elevated rate; they simply contribute to overall taxable income.
Other Taxes on Overtime
Beyond federal income tax, overtime pay is also subject to other mandatory payroll taxes. These include Social Security and Medicare taxes, often referred to collectively as Federal Insurance Contributions Act (FICA) taxes. Overtime earnings count towards the base for these contributions, which fund social insurance programs.
Social Security taxes apply up to a certain annual income limit, while Medicare taxes apply to all earned income without a cap. Both employees and employers contribute a specific percentage of wages to FICA taxes. Most states and some local jurisdictions also levy income taxes on overtime pay, treating it as part of an individual’s total taxable income.
How Withholding Affects Your Overtime Pay
Many individuals perceive their overtime pay as being “taxed more heavily” at the time of payment due to the amount withheld. This perception often arises from the mechanics of tax withholding rather than a higher tax rate. Employers typically calculate withholding by annualizing the income from a given pay period.
When a large amount of overtime is earned in a single pay period, the employer’s payroll system might project a significantly higher annual income. This projection can lead to a larger amount of federal income tax, FICA taxes, and state/local taxes being withheld from that specific check. This increased withholding does not mean the overtime itself is taxed at a higher rate; it is an estimate designed to ensure sufficient taxes are collected throughout the year. The actual tax liability for the entire year is determined when an individual files their annual tax return. Any over-withholding that occurred during the year, including from overtime earnings, will be reconciled at that time, often resulting in a tax refund. Reviewing pay stubs regularly helps individuals understand how their gross overtime pay is reduced by these various withholdings.