Is Overtime Taxed More? Everything You Need To Know

If you are responsible for managing payroll responsibilities and withholding tax from employees at your small business, you may be concerned about how overtime taxes are going to impact your taxes. There is some good news for you: working overtime will not directly impact taxes unless they reach a higher tax bracket due to their increased earnings. 

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Key Takeaways:

  • While there are no specific taxes for overtime earnings, taxes must be withheld from overtime earnings in the same way that they must be withheld from regular wages. 
  • Overtime earnings refer to any hours worked outside of the regular full-time 40-hour work week. The legal overtime rate for earnings is 1.5 times an employee’s regular rate. 
  • The only time overtime taxes will be taxed more is if these extra earnings bring you to a higher tax bracket. You can determine your tax bracket by referring to IRS Publication 15-T.

Facts and Statistics:

  • The FICA tax rate is 7.65% total: 6.2% for Social Security and 1.45% for Medicare. 

Is Overtime Taxed More?

Overtime hours are considered by the Department of Labor to be any hours worked outside of the regular full-time 40-hour work week. Employees who work more than 40 hours a week will not have to claim their taxes differently with overtime pay than they would have to with their regular wages.

Furthermore, even if an employee makes overtime earnings, you will only need to make one calculation when withholding state, federal, and FICA (Federal Insurance Contributions Act, such as Social Security and Medicare) taxes from their earnings. 

How Much Are Overtime Earnings?

The legal overtime rate for earnings is 1.5 times an employee’s regular hourly rate. For this reason, it can get extremely costly for businesses to afford to pay overtime. It is important for payroll managers to stay on top of all the overtime work being conducted within the business during the workweek to ensure they can afford to pay the increased pay level.

Why Are Overtime Earnings Taxed?

The reason overtime earnings are taxed is that these funds are still considered a part of the employee’s total earnings by the IRS. Even though there are no specific taxes for the money earned by working overtime, federal taxes will still need to be collected from these earnings.

How Do Overtime Taxes Work?

If you are an employer who is figuring out how to manage payroll taxes for employees who earned overtime wages, the process is simple. 

1. Calculate the sum of their entire earnings, including their regular wages and overtime earnings.

2. Withhold employee-paid taxes from the employee’s paycheck. 

The two types of employee-paid taxes that must be withheld from their paychecks include federal income taxes and FICA taxes. Federal income taxes are organized based on the employee’s W-4 withholding allowance and salary. As for FICA taxes, 6.2% will go toward Social Security and 1.45% will go to Medicare. 

3. Withhold employer-paid taxes from the employee’s paycheck.

The two types of employer-paid taxes include FUTA (Federal Unemployment Tax Act) taxes and SUI (State Unemployment Insurance). Employers are responsible for paying a 6.0% tax on the first $7,000 an employee earns. The SUI tax is paid based on the specific state rate. 

Calculating Overtime Taxes

Calculating overtime taxes is no different than calculating regular withholding taxes from your employee’s paychecks. For those responsible for running the payroll for a company, here are the steps for how to calculate FITW (Federal Income Tax Withholdings) from a generic full-time employee, John Doe, who earns a wage of $20 an hour.

1. Calculate the employee’s total taxable income.

If John Doe earns an hourly wage of $20 and works a regular 40-hour week, his gross income  is $800 for that week. If John also works 10 hours of overtime, his 1.5 overtime rate is $35 an hour, so he will earn an additional $350 for those extra hours.

John Doe’s total taxable income for this week is as follows:

$800 (regular hourly earnings) + $350 (overtime earnings) = $1,150 (total taxable income)

2. Determine the filing status of the employee.

The filing status of your employee as listed on their IRS W-4 form will inform how their taxes should be withheld. People filing their taxes can list their status as single or married. If they are married, they can elect to file their taxes alone or joint with their spouse. The filing status will also require the taxpayer to claim any dependents.

If John Doe files his taxes as a single individual without any dependents or other withholdings, the maximum FITW will be withheld from his paycheck. 

3. Refer to IRS Publication 15-T to determine the employee’s income tax bracket.

On page 11 of this publication, you will find the ‘Wage Bracket Method Tables for Manual Payroll Systems with Forms W-4 from 2020 or Later.’ You can use the worksheet or the Weekly Payroll Period tables to determine the appropriate wage bracket for that week. 

How Tax Brackets Impact Taxes

Tax brackets describe the tax rate you will pay for each portion of your income. Overtime earnings can impact your tax bracket if the additional income brings you to a higher tax bracket. In this case, being in a higher tax bracket could cause you to owe more in taxes and overall earn less than you would if you were in a lower tax bracket. 

Qualifying taxpayers can claim tax benefits such as credits and standard deductions, and itemized deductions as a strategy to bring themselves back down a tax bracket.

Exemptions To The Overtime Tax Laws

Employers who manage payroll are also responsible for determining if their employees are exempt from overtime tax laws. The FLSA (Fair Labor Standards Act) outlines the parameters for the individuals who are exempt from overtime tax laws as follows:

  • Employees who are paid on a salary basis

Employees who are paid on a salary basis instead of at an hourly rate are exempt from overtime tax laws.

  • Employees who are paid the Federal weekly minimum requirement

If employees are paid above the Federal weekly minimum requirement of $684, then they are not entitled to overtime pay, as of January 2020. 

  • Employees whose responsibilities pass the duties test for exempt white-collar workers

If the job description passes the duties test for white-collar workers, such as executive, administrative, and professional employees, employers do not have to pay overtime. 

The tax season can be a stressful time for anyone, but employers have the additional challenge of worrying about maintaining adequate tax records for their business, employees, and personal taxes. If you have any questions about taxes, claiming a credit or deduction, or need assistance filing your tax return, consulting with professionals at Ideal Tax can help you solve your tax burdens and save money this tax season.