With the updates for the FLSA going into effect, several people in my office are moving to be paid hourly vs. salary.
In short, their hourly rate will be calculated using what they currently earn weekly based on a 42.5 hour week.
Example (figures approximate):
Current salary is $40,000 annually (=$769/week).
Hourly rate will be $17.45 ((40 x 17.59)+(26.39 x 2.5)) = $769
My question is, will their income tax rate be any different? A few here seem to think OT pay is taxed at a higher rate. I am under the assumption it would only be at a higher rate if the OT moves them into a higher tax bracket.
You are correct. Income tax rates are not determined by how many hours a week you work but based upon your total income.
However, withholding rates (the amount of tax your employer withholds from your check) will vary based upon your pay per period and the nature of incremental pay. So the amount of tax withheld from your overtime pay may be at a greater rate than your normal pay. This has nothing to do with how much tax you will owe on your final tax return, but may determine if you owe more or less, due to the amount that was withheld throughout the year.
However, withholding rates (the amount of tax your employer withholds from your check) will vary based upon your pay per period and the nature of incremental pay. So the amount of tax withheld from your overtime pay may be at a greater rate than your normal pay.
This is actually what I was curious about. This change is causing a bit of an uproar (change always does) and management if framing it as nothing will change as long as the employee works the 2.5 OT hours per week. I anticipate there may be additional grumbling after the first pay period if employees withholding is increased.
I don’t have a dog in this fight as I will remain on salary, but I empathize with those being affected.
Tell them it is forced savings by the federal and state governments. If their total pay doesn’t change, but the their withholdings go up, they’ll just get a larger refund when they file their taxes. Money for vacation or a new flat-screen! An interest free loan to the government!!
This I’m a little fuzzy on this in the case the OP has presented. The salaried employees get the same amount each paycheck, so withholding is the same. The hourly employees are also getting the same amount each paycheck, and this is the same for the salaried employees, withhold should be the same for all.
Correct me if I’m wrong, but withholding is based on the dollar amount of the paycheck and the pay period. Let’s assume the same pay period throughout the year, then we calculate withholding assuming the amount of the pay for this pay period is also the same throughout the year. The confusion comes when in any particular pay period a worker works an extra ten hours. Their pay for that one pay period is much larger, but withholding assumes that the worker makes this amount every pay period, thus withholding is substantially higher. Thus at the time the worker gets their pay check, it “looks like” they’re paying a much higher rate of taxes. However in truth, the worker is just overpaying their taxes on that one paycheck, and this extra amount of taxes paid is refunded to them after they file their tax return.
Again, in the case the OP has presented, I believe the $769 paycheck should be taxed the same whether it’s a salary or hourly wages …
The problem with hourly pay plus overtime is that you will probably have to clock in and out. Some employers make people punch the clock (or swipe their card) at the lunch break too which is a PITA.
Another problem can be that when you need a mortgage, they will not take overtime into account as your salary on the grounds that it may not be permanent. Employers may well look at overtime reduction as a means of cutting costs.
Download IRS Pub 15. Look the actual numbers up in the actual tables.
The folks will find that as long as their pay is the same every week, their witholding will be the same every week. And will be the exactly the same as it was before when they were salaried at the same gross pay per week.
Where it gets different is if under the new system one week they make $600 and the next week they make $1000 then the next week it’s 900, then 800, then 600 again and so forth. Where their pay is jumping around a bunch from week to week.
What they would discover in that case is they’d be withheld for *slightly *more percentagewise on the $1000 weeks than on the $600 weeks. The reason is NOT that overtime is withheld differently.
The reason is that in $600 weeks their withholding is based on the assumption their annual pay is $600 * 52 = $31,200. And in the $1000 weeks their withholding is based on the assumption their annual pay is $1000 * 52 = $52,000. Because US income taxation is progressive the total tax take from a $52K worker is a (slightly) bigger percentage than from a $32K worker.
The difference here is pennies around the edge. And again, there will be no difference in withholding as long as they make the same amount every week going forward as they used to make every week under salary.
If the actual amount of overtime is variable week to week, then by year end some will have total earnings less than $40K and some will earn more than $40K. Their actual (not withholding) taxes will change accordingly. In any case their total withholding will match their total taxes about as well as it used to.
From a witholding vs. actual taxes perspective, the simplest case where the two numbers are likely to align best is somebody on salary. The worst case is somebody who only works one week per year and gets all his her income in one big lump. That person will be overwitheld by a bunch.
For the vast majority of hourly base plus overtime workers between those extremes the difference is too small to even notice.
Now if a new “hourly” employee works many hours of OT, and get a much larger check for one week, WH will be taken out of that check as if they were earning that all year. no bid deal it all evens out.
There are lots of payroll calculators on the web, even if no one at the company knows how to wrangle IRS publications. One of the things those calculators share: they don’t even ask about overtime, just total wages.
As others have said, the perception that overtime is taxed differently just has to do with a larger pay amounts on certain checks. If you have $500 withheld on 40 hours of work, you might have $1000 withheld on 50 hours because the payroll system annualizes each paycheck and treats your annual income as being 25% higher. But if my salaried check is $2000 and your overtime check is $2000, the withholding will be the same.
PDF link to Pub 15. Note that it has different tables starting on page 44 depending on if your paychecks come weekly, fortnightly, semi-monthly, monthly, etc.
Overtime is not taxed differently unless the employer does something semi-sketchy, like codes it as a bonus that is separate from your wages (see around page 18), which normally has higher withholding rates (but the actual tax is identical).
Overtime is taxed at marginally higher rate, but not because it’s overtime - it’s simply money on top of the lower base of wages that are taxed at a lower rate. The rates of withholding do not care about how many hours someone worked, only: how much they made, what percentage of the year the pay period covers, whether they are married, and how many withholding exemptions they are claiming.
At my current job I worked one less day (Labor Day) the second two weeks than the first two weeks, but my net pay was effectively the same thing. The guy in charge of this 5-person CPA office accidentally ran my first check as weekly, probably since that’s the default and they hadn’t hired anyone else in the time that he’d been running the place. So the system thought I would make twice as much money as I actually did, and that meant it was withheld from at a higher rate.