Tax on overtime pay--My cousin tells me that whenever he works overtime, he has to pay more in taxes than he makes for accepting the overtime. If that’s true, why would anybody work overtime unless forced to?
This is another urban legend. In the song, Movin’ Out, singer-songwriter Billy Joel wryly observed that “you can pay Uncle Sam with the overtime” and asked if that’s all you get for your money.
When you work overtime, (or under time, for that matter), your withholding taxes are going to be calculated based on the amount you earned during the pay period when you were working overtime, rather than your normal pay. The withholding tables assume that you made as much money all year as you did in the overtime period. So the amount being withheld is going to be more than usual, especially if you were paid time-and-a-half for a lot of hours. Many people— including Billy Joel—have noticed that when you get time-and-a-half for overtime work, the amount withheld on the overtime hours is often close to that extra half-time you got paid!
Bear in mind that what is withheld from your paycheck is not the same as the tax you will be paying. So if this was an unusual pay period and too much was withheld, you’ll get it back in the form of a bigger refund at tax time.
In our system, the more you make, the higher the rate of income tax that you pay. Here’s how it works: The first dollars that you earn are taxed at a 10-percent rate. Once you earn a little more, those first dollars are still taxed at 10 percent, but the additional dollars are taxed at 15 percent. The tax code continues to tax each additional dollar you make at increasingly higher rates. If you are fortunate to earn an income of about $375,000, any additional income is taxed at the top rate of 35 percent. But, even with that size income, you are still given the benefit of the lower rates on the lower brackets. You are only taxed 35 percent on the part of your income that’s over $375,000.
So, to actually pay more in income taxes than you made in income would require you to be in at least a 101-percent tax bracket. That’s about triple the highest current rates. Even in Sweden
But aren’t there some situations where you can end up with less because you made too much and lost a benefit?
There are some fairly unusual situations where it could be counterproductive to work. If you have a capital gain during the year and otherwise have a modest income, you’ll pay zero percent tax on the capital gain. If your income goes above the 15-percent tax bracket, you’ll have to pay 15-percent tax on the capital gain. So, if the overtime caused you to slide over that line, it could be costly. If you have a large capital gain, and are potentially in a situation like that, you might want to talk to your tax planner or preparer for advice.
Another situation occurs for those receiving Medicare. Medicare premiums are higher for upper income individuals. If you cross the line and make more money, your higher Medicare premium could cancel out the extra income. But this is a fairly rare circumstance.
Finally, depending on the program, you might qualify for something like a homebuyer assistance program or scholarship and lose eligibility because you made too much money. Sometimes the lost benefit is worth more than the additional income that you made. These situations are outside the tax code and, if they apply to you, you really have to examine them on a case-by-case basis.
Unlike those programs, most benefits given to those with lower or middle incomes are phased out as incomes rise. For example, if you are deducting student loan interest and start making “too much,” only several cents of the deduction is eliminated for every additional dollar you earn. Eventually, it’s entirely phased out, but at no point do you actually end up with less money than if did not earn the additional income.
