What Is the Tax Rate on Overtime Pay?

Many individuals mistakenly believe that overtime pay is subject to a higher tax rate than their regular earnings. This common misconception often arises from observing larger tax withholdings on paychecks that include overtime hours. Overtime pay is taxable income, but its treatment is consistent with all other earned income. The perceived “higher tax” is generally a result of how tax withholding systems operate, rather than a distinct, elevated tax rate applied specifically to overtime wages. This guide clarifies the actual tax implications of overtime pay.

How Income Tax Works

The United States federal income tax system operates on a progressive structure. This means higher income levels are subject to higher tax rates. Income is divided into segments, known as tax brackets, and each bracket is taxed at a specific marginal rate. As an individual’s income increases, portions of that income fall into successively higher tax brackets, where they are taxed at a greater percentage.

The marginal tax rate is the rate applied to the last dollar of income earned. For instance, if an individual is in the 22% tax bracket, their marginal tax rate is 22%. This does not imply their entire income is taxed at 22%. Instead, income within lower brackets is taxed at their respective lower rates, and only the portion of income that falls into a higher bracket is taxed at that higher rate.

For example, a single filer with a taxable income of $50,000 might have the first portion taxed at 10%, the next portion at 12%, and only the remaining amount that pushes them into a higher bracket taxed at 22%. The overall effective tax rate, which is the actual percentage of gross income paid in taxes, is typically lower than the marginal tax rate.

Overtime Pay and Income Tax Withholding

The primary reason many people perceive overtime pay as being taxed at a higher rate stems from the way income tax is withheld from their paychecks. Overtime pay is classified as supplemental wages by the Internal Revenue Service (IRS), which also includes bonuses, commissions, and severance pay. Employers are required to withhold federal income tax from these payments, and the method used for withholding can make it seem like overtime is taxed more heavily.

The IRS provides employers with two main methods for withholding federal income tax on supplemental wages: the percentage method and the aggregate method. Under the percentage method, if supplemental wages are identified separately from regular wages, employers can withhold federal income tax at a flat rate, which is generally 22%. This flat 22% might be higher than an employee’s typical marginal tax rate, especially for those in lower tax brackets, leading to a noticeable reduction in their take-home overtime pay.

Alternatively, the aggregate method involves combining the supplemental wages with the regular wages for a pay period. Withholding is calculated as if the total were a single, larger payment. The employer then uses the employee’s Form W-4 and IRS withholding tables to determine the withholding amount for this combined sum. After calculating the total withholding, the amount already withheld from regular wages is subtracted, and the difference is withheld from the supplemental pay.

This method can also result in higher withholding for that specific pay period because the increased gross income pushes the calculation into higher withholding tiers, even if the annual income does not ultimately place the individual in a higher tax bracket. These withholdings are estimates, designed to ensure that enough tax is paid throughout the year, and do not necessarily reflect the final tax liability.

The Actual Tax Treatment of Overtime Pay

Overtime pay is not subject to a special, higher tax rate. Instead, it is treated as ordinary income and is simply added to an individual’s total gross income for the year. This combined income, including both regular wages and overtime earnings, is then subject to the same progressive federal income tax rates as all other earned income.

While earning additional income from overtime can push an individual’s total annual income into a higher tax bracket, it is crucial to understand how marginal tax rates work. Only the portion of income that falls within the new, higher tax bracket is taxed at that increased rate. The income that falls within lower brackets continues to be taxed at the lower rates applicable to those brackets. For instance, if an individual’s overtime pushes their income from the 12% bracket into the 22% bracket, only the income exceeding the 12% bracket’s threshold would be taxed at 22%, not their entire earnings.

A recent federal legislative change introduced a “No Tax on Overtime” provision, effective from January 1, 2025, through December 31, 2028. This provision allows eligible workers to deduct a designated amount of qualified overtime compensation from their federal taxable income. For most filers, this deduction is up to $12,500, or $25,000 for married couples filing jointly. This change provides a deduction that can reduce the federal income tax burden on overtime earnings, but it does not eliminate taxes on all overtime pay, nor does it affect federal payroll taxes like Social Security and Medicare, which still apply to all overtime compensation.

Impact of Overtime on Overall Tax Situation

While overtime pay does not inherently face a higher tax rate, the increased income it generates can influence a taxpayer’s overall financial and tax situation beyond just income tax liability. A higher gross income, which includes overtime earnings, directly impacts an individual’s Adjusted Gross Income (AGI). AGI is a crucial figure used by the IRS to determine eligibility for various tax deductions, credits, and other income-based benefits.

An increase in AGI due to overtime can sometimes reduce or eliminate eligibility for certain tax benefits that have income thresholds. For example, some tax credits, such as the Child Tax Credit or the Earned Income Tax Credit, may phase out or become unavailable once AGI exceeds specific limits. Similarly, the deductibility of certain expenses, like medical and dental expenses, is often limited to the amount exceeding a percentage of AGI. A higher AGI means a larger threshold must be met before these expenses become deductible.

The overall effect of increased income from overtime is that while it boosts total earnings, it can also lead to a higher overall tax bill if it pushes a taxpayer into a higher tax bracket or reduces access to valuable tax breaks. Tax planning strategies, such as contributing to pre-tax retirement accounts, can help reduce AGI and potentially mitigate some of these impacts.