Is Overtime Taxed Differently From Your Regular Pay?

Many people mistakenly believe overtime pay is taxed at a higher rate than regular earnings. This often happens because a larger portion of overtime pay is withheld from paychecks. However, the underlying tax treatment of overtime is generally the same as regular wages. Effective January 1, 2025, new federal legislation introduces a deduction for qualified overtime, further shaping the tax picture for those working extra hours.

How Overtime is Taxed

Overtime pay is not taxed at a different rate than standard earnings. It is part of your total gross income and subject to the same taxes as regular wages, including federal income tax, state income tax (if applicable), Social Security, and Medicare. Your overall income bracket and filing status determine the specific tax rate applied to your income.

Starting January 1, 2025, new federal legislation, the One Big Beautiful Bill Act, introduced a temporary deduction for qualified overtime. This allows eligible individuals to deduct up to $12,500, or $25,000 for those filing jointly, from their federal taxable income. This deduction applies only to federal income tax and does not affect Social Security or Medicare taxes. To qualify, overtime must meet the criteria of the federal Fair Labor Standards Act, typically involving time-and-a-half pay for hours worked beyond 40 in a week.

Understanding Overtime Withholding

The perception that overtime is taxed at a higher rate often stems from how employers withhold taxes from these payments. Overtime is classified as “supplemental wages,” a category that includes other payments beyond regular salary, such as bonuses and commissions. The Internal Revenue Service provides employers with specific methods for calculating federal income tax withholding on these wages, which can differ from regular payroll calculations.

One common approach is the percentage method, also known as the flat rate method. If overtime is paid separately from regular wages or is clearly identified on a pay stub, employers may withhold federal income tax at a flat rate of 22% for amounts up to $1 million in supplemental wages within a calendar year. For supplemental wages exceeding $1 million in a year, the withholding rate for the excess increases to 37%. This is merely a withholding rate, an estimate of what you might owe, not your final tax rate.

Another method employers use is the aggregate method. This approach is typically applied when overtime is paid concurrently with regular wages or combined for withholding purposes. Under this method, the employer adds the supplemental wages to the employee’s regular wages for the current or most recent payroll period. They then calculate the tax as if it were a single, larger payment, using the employee’s Form W-4 information and withholding tables. The amount already withheld from regular wages is then subtracted, and the remaining tax is withheld from the combined payment.

These differing federal withholding methods can lead to varying amounts being taken from an overtime paycheck compared to a regular one, contributing to the appearance of different taxation. State income tax withholding rules for supplemental wages also vary, with some states having their own flat rates for certain payments, while others require the aggregate method. For the 2025 tax year, despite the new federal income tax deduction for qualified overtime, employers will continue withholding federal income tax on overtime pay as they normally would. The benefit of the new deduction will be realized when individuals file their annual tax returns.

Impact on Your Paycheck and Tax Liability

While the withholding methods for overtime may result in more tax taken from an individual paycheck, it does not mean overtime is ultimately taxed at a higher rate. Your actual tax liability for the year’s earnings, including all regular and overtime pay, is determined when you file your annual income tax return. Your total gross income, along with any applicable deductions and credits, calculates your final tax owed.

Any over-withholding that occurred throughout the year, perhaps due to the 22% flat rate method on supplemental wages, typically leads to a larger tax refund. Conversely, if too little tax was withheld, you might owe a balance when you file. Your annual W-2 form, provided by your employer, summarizes your total wages earned and taxes withheld for the year, providing a comprehensive view of your income and payments. Starting with the 2025 tax year, employers must separately report qualified overtime compensation on your W-2 form.

The new federal income tax deduction for qualified overtime, effective for tax years 2025 through 2028, is claimed directly on your individual federal income tax return. This deduction reduces your overall taxable income, which in turn lowers your final federal income tax liability. Withholding is an estimate designed to collect taxes throughout the year, but the definitive calculation of your tax burden occurs during the annual tax filing process.