How no tax on overtime works
The clearest way to see how this works is to follow one year of pay from the timesheet to the refund.
The year as your employer sees it
Take $24.00 an hour, 40 regular hours and 10 overtime hours a week, for 48 weeks. Overtime pays $36.00, so the year brings in about $63,360 gross.
Through the year, nothing unusual happens. Federal income tax is withheld on all of it, and so are Social Security and Medicare. Your employer does not reduce anything for the overtime deduction, and is not permitted to unless you hand in a new Form W-4.
The part that qualifies
Of the $36.00 overtime rate, $24.00 is your regular rate and $12.00 is the premium. Only the premium qualifies. Ten hours a week for 48 weeks is 480 hours, so qualified overtime is $5,760.
The total overtime pay was $17,280. The qualifying slice is a third of that, because in time and a half the premium is one third of the overtime payment. That ratio holds whenever the multiplier is 1.5.
What comes back
$5,760 is under the $12,500 cap and the income is well under $150,000, so the whole amount is deductible. It comes off taxable income on Schedule 1-A and lands at line 13b of Form 1040, cutting the federal income tax by about $841.
Social Security and Medicare do not move at all. Roughly $441 of FICA on that same qualified overtime stays withheld, because the deduction does not touch employment taxes.
Why the refund is smaller than people expect. A deduction saves you your bracket, not the whole amount. At 12%, $5,760 of deduction is worth about $841, not $5,760.
Common questions
- Does my employer stop taxing my overtime?
- No. Withholding carries on as normal unless you file a new Form W-4. The deduction is settled on your return.
- What fraction of my overtime pay qualifies?
- With time and a half, exactly one third of the overtime payment, because the premium is the half on top of a rate counted as one. Hours times one half times the regular rate gives the same answer.
- Does it reduce Social Security and Medicare?
- No. Overtime stays fully subject to both. The deduction applies to federal income tax only.
- Do I get the money during the year or after?
- After, when you file, unless you adjust your Form W-4 to reduce withholding across the remaining pay periods.