Many salaried employees have to work overtime and they're incentivized higher to work beyond their regular work weeks. Is working extra time worth it based on the way it's taxed? Is overtime pay taxed higher than regular pay?
Overtime is the number of hours worked by an employee beyond their normally scheduled working hours. According to the FLSA (Fair Labor Standards Act), employers must pay eligible employees at least 1.5 times their regular rate of pay for every hour worked beyond their 40-hour workweek. In some states, overtime is required for working past 8 hours. With some exceptions, the FLSA requires bonus payments to be included as part of an employee's regular rate of pay in computing overtime.
Does overtime get taxed?
Sometimes employees have a difficult time making a decision whether or not to work overtime due to tax computations. It's important to understand how your tax implications change if you work overtime. The first thing to know is that overtime does get taxed since it's classified as a type of income. Overtime pay gets taxed at the same rate as ordinary income and not at a higher tax rate.
Withholding tax on overtime
Based on your total income, part of it's withheld by the employer for federal and state taxes. If you earn overtime pay as well, the larger amount will be withheld for taxes. Withholding tax isn't calculated differently for overtime pay. The higher withholding tax is due to a higher overall gross income. If you work a large amount of overtime in a single pay period, your employer might end up withholding a larger amount for taxes compared to what your eventual salary would have entailed.
This could happen if your gross salary (base salary and overtime) bumped you up into the next tax bracket if you worked a lot of overtime during the year. In that case, you’ll receive the extra tax withheld as a refund when you file your tax return.
Overtime could push your salary into the next tax bracket.
Your overtime pay might also push your income into the next salary band, which is taxed at a higher rate. Your salary is taxed at a standard rate up to your rate band limit. Any pay above that limit gets taxed at a higher rate of tax. However, there's a general myth that earning overtime could push you into a higher tax bracket and that working overtime hurts more than it helps in terms of taxes.
Even if that’s the case, working overtime will put extra dollars in your pocket. You’ll only get charged at the higher tax rate for the amount that got bumped into the next tax bracket and not the whole income. Therefore, if you can and if you want to increase your earnings through working overtime, don’t let the higher tax myth on overtime get in the way.