Is Overtime Taxed at a Higher Rate?

Earning extra income through overtime can boost finances. A common question is whether overtime income is subject to a higher tax rate than regular wages. Overtime pay refers to compensation for hours worked beyond a standard 40-hour workweek, as defined by federal law. It is often calculated at one and a half times an employee’s regular hourly rate.

How Overtime is Taxed

Overtime pay is taxed the same as regular wages for federal income tax purposes; it is not subject to a separate, higher tax rate. Overtime income is added to your total gross pay for the pay period. This combined amount is then subject to federal income tax withholding and other payroll taxes.

The Internal Revenue Service (IRS) classifies overtime as “supplemental wages.” Supplemental wages include payments beyond regular salary or hourly wages, such as bonuses, commissions, and overtime. Employers use different methods for withholding federal income tax from supplemental wages. One common method is the percentage method, where the supplemental wage is added to regular wages for the pay period, and withholding is calculated on the total. Another method is a flat 22% rate for federal income tax withholding on supplemental wages up to $1 million in a calendar year, if separately identified.

It is important to distinguish between the withholding rate and the actual tax rate. While withholding on overtime might appear higher due to the flat 22% rate or increased taxable income for that pay period, this is merely an estimate of your tax liability. Your actual tax rate is determined when you file your annual tax return, based on your total income for the year and applicable deductions and credits. In addition to federal income tax, overtime pay is also subject to Federal Insurance Contributions Act (FICA) taxes. These include Social Security and Medicare taxes, which apply to all wages, including overtime, up to annual limits for Social Security.

Understanding Tax Brackets and Withholding

The United States operates under a progressive income tax system, taxing different portions of income at increasing rates. This system is structured with tax brackets, where each corresponds to an income range and marginal tax rate. As income increases, portions of that income fall into subsequent brackets, subject to higher marginal rates. Overtime pay adds to your overall gross income for the year, and this additional income is taxed according to the marginal tax bracket it falls into.

A common misconception is that earning overtime automatically pushes all income into a higher tax bracket. This is not accurate; only the portion of income exceeding a lower bracket’s threshold is taxed at the next higher marginal rate. For instance, if your regular income places you in the 12% tax bracket, and overtime earnings extend into the 22% bracket, only that specific portion is taxed at 22%. The rest of your income remains taxed at the lower rates applicable to its respective brackets.

Tax withheld from your paycheck is an estimate designed to ensure you meet your tax obligations throughout the year. Employers use information on your Form W-4, Employee’s Withholding Certificate, to determine federal income tax withholding. Factors such as marital status, number of dependents, and any additional income or deductions you anticipate can influence this calculation. If you earn significant overtime, your employer’s payroll system might withhold more from larger paychecks to reflect a potentially higher annual income, even though your final tax liability is determined at year-end.

Impact of Overtime on Your Overall Tax Picture

Substantial overtime can increase your Adjusted Gross Income (AGI), an important figure on your tax return. A higher AGI can influence your eligibility for certain tax deductions and credits. Many tax benefits have income phase-outs, meaning their value is reduced or eliminated once your AGI exceeds specific thresholds. For example, certain education credits, such as the American Opportunity Tax Credit or the Lifetime Learning Credit, can be limited by your AGI. The Child Tax Credit also begins to phase out for higher-income taxpayers.

Increased income from overtime can affect the deductibility of certain itemized deductions if you itemize rather than take the standard deduction. Some deductions are subject to AGI limitations, where only the amount exceeding a certain percentage of your AGI is deductible. While most states generally follow the federal approach of taxing overtime as regular income, it is advisable to be aware of your specific state’s income tax laws, as some may have unique rules or thresholds.

If you consistently earn significant overtime, review your pay stubs regularly to monitor your year-to-date income and withholding. If your withholding appears insufficient relative to your increased earnings, consider adjusting your Form W-4 to have more tax withheld from each paycheck. Alternatively, make estimated tax payments directly to the IRS throughout the year to avoid potential underpayment penalties. Underpayment penalties can apply if you do not pay enough tax through withholding or estimated payments by the due dates, typically quarterly.