Is Overtime Taxed More Than Your Regular Income?

Many individuals wonder if their overtime earnings are taxed at a higher rate than their regular wages. This common belief often stems from observing a larger amount of tax withheld from paychecks that include overtime. The reality is more complex, as the federal income tax system applies the same tax rates to all earned income, whether it comes from regular hours or additional overtime work. This article aims to clarify how overtime pay is treated for tax purposes and explain why the perception of higher taxation arises.

How Income Tax Withholding Works

Employers are legally required to withhold federal income tax from employee paychecks. This helps the federal government collect taxes throughout the year. The amount withheld is an estimate of an individual’s total annual tax liability, based on Form W-4 information.

Form W-4 allows employees to communicate their filing status, dependents, and any additional income or deductions. These details influence estimated tax withholding. While withholding approximates the final tax owed, it is not the actual tax itself.

Employers use the W-4 information, along with IRS wage bracket tables or the percentage method, to determine the appropriate withholding for each pay period. This system ensures a pay-as-you-go approach to tax collection.

Overtime as Supplemental Wages

For federal income tax purposes, overtime pay is categorized as “supplemental wages.” The IRS defines supplemental wages as payments other than regular wages, such as bonuses, commissions, severance pay, and overtime. Employers use specific methods to calculate federal income tax withholding on these payments, as detailed in IRS Publication 15.

Employers have two primary methods for withholding federal income tax from supplemental wages. The first is the percentage, or flat rate, method. If supplemental wages are paid separately or identified separately, employers can withhold federal income tax at a flat 22% rate on amounts up to $1,000,000. For supplemental wages exceeding $1,000,000 paid within a calendar year, employers must withhold at the highest income tax rate.

The second method is the aggregate method, which applies when supplemental wages are paid concurrently with regular wages and are not separately identified. In this scenario, the employer adds the supplemental wages to the regular wages for the most recent payroll period. The income tax withholding is then calculated as if the total amount was a single, larger payment for that period.

Why Overtime Withholding Can Seem Higher

The methods used for withholding taxes on supplemental wages can create the impression that overtime is taxed more heavily. When the percentage method is applied, a flat 22% rate is withheld from overtime earnings. For many, this 22% rate might exceed their effective or marginal tax rate, especially in lower income tax brackets. This difference can noticeably reduce net take-home pay for that period.

Similarly, the aggregate method can also contribute to this perception. By combining overtime pay with regular wages for a single pay period, the total income for that period significantly increases. This larger sum might push income for that paycheck into a higher withholding bracket. Consequently, more tax is withheld, creating the impression that overtime was subjected to a higher tax rate. This effect pertains only to the withholding calculation for that payroll period, not to the actual annual tax liability.

Reconciling Withholding and Actual Tax Liability

Actual federal income tax liability for an individual is determined annually based on their total taxable income, not on individual paychecks or specific types of earnings like overtime. The United States operates under a progressive income tax system, meaning different portions of income are taxed at increasing marginal rates. All earned income, whether from regular hours or overtime, is combined to calculate the total annual taxable income.

At the end of the tax year, individuals file a federal income tax return, typically using Form 1040. This return calculates the actual tax owed based on total annual income, deductions, and credits. The total federal income tax withheld from all paychecks, including overtime, is then compared to this final tax liability.

If the total amount withheld during the year exceeds the actual tax owed, the taxpayer receives a refund. Conversely, if less is withheld, the taxpayer must pay the remaining balance. This annual reconciliation ensures all income is taxed at the correct progressive rates, regardless of how or when earned or withheld.