Is Overtime Taxed At A Higher Rate – The Details

Unfortunately, overtime wages are taxed at a higher rate because the wage is paid to an employee for working over the standard hours they are scheduled to work. Usually, overtime tax rates are determined by the state and federal governments. Moreover, the taxes on income also vary based on “income levels.” For example, if you make 50% more money as overtime then your overall tax burden is 50% more per hour.

Key Takeaways

• Overtime refers to the amount of time that a worker works beyond normal working hours
• If you work overtime then you will be paid for those extra hours along with their fixed salary
• Overtime wages get taxed so it’s important to understand how your tax implications change if you work overtime
• Depending on your total income some parts of the income are withheld by the employer for federal and state taxes
• You should keep in mind that overtime is not taxed differently than regular pay

Does Overtime Get Taxed?

Because of tax computations, many employees find it very difficult to decide whether or not to work overtime. Overtime wages get taxed so it’s important to understand how your tax implications change if you work overtime. The first thing you should know is that overtime wages are classified as a type of income and it is taxed at the same rate as ordinary income and not at a higher tax rate.  

Is Overtime Taxed Differently?

Taxes on overtime are not different than taxes on regular wages. Your overtime taxes will calculate and withhold taxes the same way you do for regular wages. Here, you will be able to withhold taxes from the combined total of overtime and regular wages. You don’t have to separately withhold taxes from these two types of compensation.

If you are a non-exempt employee then legally you need to earn 150 percent of your usual hourly rate for any time worked beyond the 40-hour workweek. So, if you normally earn $20 per hour, then you would earn $30 for each overtime hour you work. This is your gross tax-exempt income.         

Withholding For Overtime Pay

Depending on your total income some parts of the income are withheld by the employer for federal and state taxes. Therefore, withholding tax is not calculated differently for overtime pay compare to regular pay. But when you work overtime it increases your gross pay and it might increase your salary range and might promote you into a different wage bracket with higher income tax withholding rates. For example, if you are working $20 per hour, then your gross income in one 40-hour workweek would be $800. 

So, your tax withholding on this amount would be $18.30 plus 12 percent ($83.82). Now, if you work five hours of overtime then your gross income for the week is $950 and it will push you into a higher wage bracket, where your withholding is $85.62 plus 22 percent ($115.32)! based on this calculation, you have earned an additional $150 but you also have an additional $31.50 withheld from your paycheck. Even if you have to pay extra taxes, working overtime will put extra dollars in your pocket. You will only get charged a higher-taxed rate for the amount that got bumped into the next tax bracket but not the whole income.

Is Overtime Worth It?

Because of the tax myth, many employees think that overtime is not worth it because they have to pay more taxes. But it is completely wrong. It’s true that you have to pay some extra taxes but it is also true that you will earn a handsome amount of extra money via overtime. Below are two examples to demonstrate how overtime is worth it.

Example One

Jessica is a nurse who makes $30/hour working 36 hours a week. She doesn’t do any overtime and her annual salary is $56,160. Assume that Jessica is single with no dependents so her estimated tax liability is $5,343. So, she would have only the Standard Deduction of $12,550 according to 2021 tax-year and doesn’t include any deductions she’d receive if she has student loan interest or contributes to a retirement plan, etc. So, Jessica would have roughly $206 withheld every pay period based on biweekly payments.               

Salary calculation: $30 * 36 (hours) = $1,080 * 52 (weeks) = $56,160

Estimated tax liability calculation: $56,160 – 12,550 (2021 Standard Deduction) = $43,610 – $40,525 (income cut off for 22% bracket) = $3,085 * .22 (Kate’s marginal tax bracket) = $679 + $4,664 = $5,343.

Example Two

Let’s assume that Jessica wants to start overtime to earn some extra money. So, instead of working 36 hours per week, she works 48 hours per week at $30/hour. Therefore, her annual salary would be $81,120. Now, according to the same assumption, Kate’s estimated tax liability is $10,834.  Therefore, Kate would have roughly $417 withheld every pay period.

Salary calculation: $30 * 40 (hours) = $1,200 * 52 (weeks) = $62,400; 8 (overtime hours per week) * 52 (weeks) = 416 * $45 (time and a half) = $18,720 + $62,400 = $81,120

Estimated tax liability calculation: $81,120 – 12,550 (2021 Standard Deduction) = $68,570 – $40,525 (income cut off for 22% bracket) = $28,045 * .22 (Kate’s marginal tax bracket) = $6,170 + $4,664 = $10,834.

Now, if you closely look at the above two examples then you will see that Jessica did have more taxes withheld than in Example 1. However, if you reduced the annual salary in Example 2 by the tax liability then Jessica’s income for the year is $70,286. In example 1, Jessica’s income for the year is $50,817. So, Jessica might have to pay more money withheld but she will also earn more money at the end of the year by $19,469 in this example.

FAQs About Is Overtime Taxed At A Higher Rate

References:

1. https://gocardless.com/guides/posts/overtime-tax/
2. https://www.cato.org/commentary/working-overtime-more-taxing-you-think
3. https://marketrealist.com/p/why-is-overtime-taxed-higher/

Last Updated on October 29, 2022 by Magalie D.