What Percentage of Overtime Is Taxed?

Overtime pay often leads to questions about its tax implications, with many believing these additional earnings are taxed at a uniquely high rate. Understanding how overtime is treated for tax purposes can alleviate confusion. This article explains the fundamental principles governing overtime taxation and withholding.

How Overtime is Taxed

Overtime pay is not subject to a different or higher tax rate than regular wages. It is simply added to your gross income. Federal and state tax laws consider all earned income, whether regular or overtime, as part of your total taxable earnings. There is no special “overtime tax rate” applied to these additional hours.

Total income, including regular and overtime earnings, is subject to the same progressive tax brackets as all other income. A progressive tax system means higher income levels are taxed at higher marginal rates. If overtime pushes annual income into a higher tax bracket, only the portion exceeding that threshold will be taxed at the higher rate. A provision, effective January 1, 2025, allows workers below certain income thresholds to deduct up to $12,500 ($25,000 for joint filers) in qualified overtime compensation from their federal taxable income when filing annual tax returns. This deduction applies through 2028 and does not affect payroll tax calculations.

Understanding Tax Withholding

Confusion regarding overtime taxation often stems from the distinction between tax liability and tax withholding. Tax liability represents the actual amount of tax owed to federal, state, and local authorities based on your total annual income. Tax withholding, conversely, is the amount your employer deducts from each paycheck as an estimated payment towards your annual tax liability. This system ensures taxes are paid gradually throughout the year rather than in a single lump sum.

Employers use information on your Form W-4 and federal and state withholding tables to estimate federal income tax deductions. When significant overtime is earned in a single pay period, the payroll system might project a higher annual income. This can lead to a larger percentage of income being withheld from that paycheck, even though your actual annual tax rate has not necessarily changed. The increased withholding helps ensure enough tax is collected to cover a potentially higher annual tax liability, preventing a large tax bill at year-end.

Components of Overtime Withholding

Overtime pay is subject to the same taxes and deductions as regular pay, including federal income tax, state income tax, and FICA taxes. Employers calculate these withholdings based on your total gross pay for the period, encompassing both regular and overtime earnings.

Federal income tax withholding is determined by information on your Form W-4, such as filing status and anticipated credits or deductions. This withholding contributes to your federal income tax obligation, based on the progressive tax bracket system. State income tax, where applicable, is also withheld from your total earnings based on state-specific rules.

FICA taxes, which fund Social Security and Medicare, are flat percentage taxes applied to most earned income, including overtime. The Social Security tax rate is 6.2% for employees, applied to earnings up to an annual wage base limit of $168,600. There is no wage base limit for Medicare tax, which is 1.45% for employees on all earned income. An extra 0.9% Medicare tax applies to wages exceeding $200,000 for individuals.

Other deductions, such as pre-tax contributions to a 401(k) or health insurance premiums, are taken from gross pay before taxes are calculated, reducing taxable income. Post-tax deductions, like loan repayments or garnishments, are withheld after taxes.

Reviewing Your Paycheck

Understanding your paycheck components helps comprehend how overtime is taxed. Each pay stub provides a detailed breakdown of your gross earnings and all deductions. Locate your gross pay, which shows your regular and overtime hours worked, along with their respective rates and earnings.

Examine the itemized deductions section to identify amounts withheld for federal income tax, state income tax, and FICA taxes (Social Security and Medicare). Comparing a paycheck with significant overtime to a regular one can illustrate how withholding percentages may appear higher during increased earnings, even though underlying tax rates remain consistent. If you have questions or wish to adjust your withholding, consult your payroll department or a qualified tax professional.