What Is the Tax Rate on Overtime Pay?

Overtime pay is additional compensation for working beyond standard hours, typically over 40 hours in a workweek. Many believe this extra income faces a special, higher tax rate. However, overtime income is not subject to a unique “overtime tax rate.” It is considered regular income and fully included in your total earnings for the tax year.

The perception of higher taxation often stems from how taxes are withheld from overtime earnings, which can appear larger than withholding on regular pay. This difference arises from specific payroll calculations and rules employers follow, not a separate tax imposed solely on overtime. Understanding the distinction between actual tax liability and estimated amounts withheld from each paycheck is important.

How Overtime Is Taxed

Overtime earnings are fully integrated into an individual’s total gross income for the tax year. Every dollar earned from overtime is added to wages, salaries, and other taxable income sources. This combined sum becomes the basis for calculating federal income tax liability.

There is no distinct, elevated tax rate applied solely to overtime pay. All taxable income, including overtime, is subject to the standard federal income tax brackets established by the Internal Revenue Service (IRS). State income taxes, where applicable, also apply to this total income following their own specific tax schedules.

Earning more income through overtime can potentially push a portion of an individual’s total earnings into a higher marginal tax bracket. A marginal tax rate applies to the last dollar earned, meaning only the income falling within that higher bracket is taxed at the elevated rate. An individual’s effective tax rate, the average rate paid on all taxable income, increases gradually as total income rises, reflecting the progressive nature of the tax system.

Understanding Overtime Withholding

Tax withholding represents an employer’s estimate of an individual’s annual tax liability, collected directly from each paycheck and remitted to taxing authorities. This process ensures taxes are paid throughout the year, preventing a large tax bill at year-end. The amount withheld from overtime pay often appears larger than regular pay withholding due to specific IRS rules governing “supplemental wages.”

Supplemental wages include compensation beyond regular pay, such as overtime, bonuses, commissions, severance pay, and accumulated sick leave. Employers use one of two main methods to calculate withholding on these amounts, as outlined in IRS Publication 15. The chosen method significantly affects the immediate withholding amount.

Percentage Method

If supplemental wages are identified separately or paid in a separate check, employers can withhold federal income tax at a flat rate. The current flat rate for supplemental wage withholding is 22% for amounts up to $1 million paid to an employee within a calendar year. This flat rate can appear disproportionately high compared to an individual’s average tax rate, especially for those in lower income tax brackets, leading to the misconception that overtime is taxed at a higher rate.

Aggregate Method

Employers may use the aggregate method if supplemental wages are paid concurrently with regular wages and not separately identified. In this scenario, the employer combines supplemental wages with regular wages for the current pay period. They then calculate income tax withholding as if this combined amount were the employee’s regular pay for that period, annualizing it to project yearly earnings. This temporary increase in projected annual income can result in a substantially larger amount withheld from that specific paycheck, even if the individual’s actual annual income does not place them in a significantly higher tax bracket. Any over-withholding is reconciled when the individual files their annual income tax return, resulting in a refund or reduced tax liability.

Factors Influencing Overtime Withholding

An employee’s W-4 Form, officially known as the Employee’s Withholding Certificate, directly impacts the amount of tax withheld from all earnings, including overtime. This form allows employees to provide information to their employer, such as filing status, claims for dependents, or any additional amounts they wish to have withheld. Adjustments made on the W-4, like claiming fewer dependents or requesting extra withholding, will increase the amount withheld from each paycheck. Reviewing and updating the W-4 form with an employer helps align withholding more closely with actual tax liability.

The frequency of pay also influences how withholding calculations are performed by payroll systems. Whether an employee is paid weekly, bi-weekly, or monthly, the payroll system annualizes income based on the specific pay period to determine appropriate withholding. For instance, inconsistent overtime earnings on a bi-weekly schedule might cause the system to project a higher annual income for that period, potentially leading to a larger withholding amount on that paycheck.

Other income sources and various deductions can modify the amount of tax withheld from overtime. Pre-tax deductions, such as contributions to a 401(k) retirement plan, health insurance premiums, or amounts for Section 125 cafeteria plans, reduce an employee’s taxable income before withholding is calculated. This reduction can lead to lower federal income tax withheld. Conversely, individuals with other significant taxable income not accounted for on their W-4, such as income from a side business, might find themselves under-withheld on their total income, even with proper overtime withholding.

State and local income taxes also apply to overtime pay in jurisdictions where they are imposed. These taxes contribute to the total amount withheld from an employee’s paycheck and are calculated according to the specific rules and rates of those tax authorities. The combined effect of federal, state, and local withholding can make the total tax deduction from an overtime-heavy paycheck appear substantial.

Reviewing Your Pay Stub

Understanding a pay stub is important for any employee, especially with overtime earnings. A typical pay stub provides a detailed breakdown of compensation and deductions for a specific pay period. Key components include gross pay, the total earnings before any deductions, often separating regular hours and pay from overtime hours and pay.

The pay stub also lists pre-tax deductions, such as contributions to retirement plans or health insurance premiums, which reduce the taxable portion of your gross income. Following these deductions, various tax withholdings are itemized. These include federal income tax, state income tax (if applicable), Social Security tax (6.2% on earnings up to an annual limit), and Medicare tax (1.45% on all earnings).

By examining the pay stub, an individual can identify their specific overtime earnings and observe how corresponding tax deductions are applied. Some pay stubs may even separately itemize the withholding calculation for overtime pay, allowing a direct comparison of the withholding percentage applied to regular wages versus supplemental wages. If questions arise about specific withholding amounts or if adjustments seem necessary, contacting the employer’s payroll department or a tax professional can provide clarity and guidance.