What is Shift Differential Pay: Calculation & Tax Rules

Shift differential can be a confusing topic for employees, especially for those new to non-standard work or undesirable hours. As HR, it is important to explain how this extra pay works so that employees understand what they’re earning and why.

According to a 2024 report, about 16% of U.S. workers have schedules outside the regular 9-to-5. Many of these employees work night shifts or weekends, which is common in industries like customer service, retail, healthcare, and manufacturing, where 24/7 coverage is needed.

What is shift differential pay?

Shift differential refers to premium pay provided to employees for working during non-standard hours, such as nights, weekends, and holidays. It is not legally required, but it is a common practice used to attract employees, especially in businesses that operate around the clock.

Jobs that often receive shift differential pay include:

• Nurses

• Cashiers

• Servers

• Customer service representatives

• Front desk clerks

• Machine operators

• Police officers

• Truck drivers

Moreover, a good shift differential typically ranges from $0.50 to $1.25 per hour or 5% to 15%. According to the BLS, shift differentials account for less than 2% of cash compensation, with rates ranging from 0.14% for legal occupations to 3.31% for healthcare roles.

For organizations looking to ensure their shift differential compensation is competitive, Salary.com compensation consultants can help design pay programs and benefits that offer a strategic advantage while controlling costs.

How does shift differential pay work?

Shift differential pay works based on the hours worked during specific times. The day shift often runs from 9:00 a.m. to 5:00 p.m., evening hours usually start at 6:00 p.m. and end at 12:00 a.m., while night hours begin at 12:01 a.m. and end at 6:00 a.m. Employees receive differential pay only for the hours worked within the two shifts: evening and night shifts.

For example, an employee working from 2:00 p.m. to 10:00 p.m. would get the evening differential for four hours and regular pay for four hours. An employee working from 11:00 p.m. to 7:00 a.m. would receive the night shift differential for six hours and regular pay for the rest.

Evening hours receive an extra [amount] per hour, and night hours receive an extra [amount] per hour, depending on the company's pay structure. So, how much premium pay? If the rate is 3.31%, employees earn 3.31% more for hours worked during evening or graveyard shifts, with a higher differential for night hours.

Why do organizations offer shift differential pay?

Organizations often offer such pay for a few key reasons:

1. To incentivize workers to work hard-to-fill, undesirable shifts

   Night, weekend, and holiday shifts are usually less popular. Extra pay makes them more appealing and helps companies find people to cover them.

2. To attract employees who work non-traditional hours

   Companies with unusual or long hours may find it hard to hire for certain shifts. It helps by making the overnight shift or other shifts outside normal hours more attractive to candidates.

3. To ensure adequate staffing and maintain operations

   In industries like healthcare, manufacturing, or transportation, shift differential compensation helps keep all shifts covered. It keeps operations running smoothly by encouraging employees to work outside the usual 9-to-5 hours.

4. To meet seasonal or peak demands

   During busy seasons or high-demand periods, businesses often need more staff. Shift differentials encourage employees to work extra hours or off-hours, which helps the company manage the workload without delays.

Achieving these benefits needs to be strategically planned. Salary.com consultants are ready to help with your compensation strategy, solve challenges, and make pay decisions easier with clear recommendations.

Shift differential pay: tax rules

The Fair Labor Standards Act (FLSA) does not require shift differential pay. However, many 24/7 businesses offer it to hourly employees, while it's less common for salaried employees. It is considered supplemental or additional compensation, so shift differential is subject to applicable federal, state, and local taxes.

The Internal Revenue Service (IRS) notes that it is considered employee compensation for tax purposes but is not subject to Social Security, Medicare, or FUTA taxes. Employers must report it on Form W-2 (Box 1) or Form 499R-2/W-2PR (Box 7).

In addition to federal taxes, shift pay is also taxed at the state and local levels, which vary by location. Employers must adjust withholdings based on local tax rates.

For example, California requires shift differentials to be included when calculating overtime pay. In New York, they are included in both minimum wage and overtime pay calculations.

If a U.S. government civilian employee is paid extra for working abroad, those payments, including differentials, are taxable. Employers are required to report it on Form W-2 (Box 1) or on Form 499R-2/W-2PR (Box 7).

How do you calculate shift differential pay?

Now that you know what shift differential pay is and its tax rules, let's calculate it step by step. But before calculating, ensure to know the formula: Shift differential pay = (base pay rate x shift differential percentage) x hours worked.

1. Find the regular hourly wage: This is the pay an employee receives for regular hours. For example, an employee earns $13 per hour, based on a monthly salary of $2,080 for 160 hours worked.

2. Find the shift differential rate: This is extra pay for working a less desirable shift, like the night shift, usually a percentage of the regular pay.

3. Calculate the shift differential amount: Multiply the regular pay by the shift differential percentage. For example, if the regular pay is $13 per hour and the shift differential is 5%, you calculate: 13 x 0.05 = 0.65. The extra pay is $0.65.

4. Add the extra pay to the regular pay: This gives you the new hourly rate for the shift. For example: 13 + 0.65 = 13.65. So, the new hourly rate for that shift is $13.65.

5. Multiply by the number of hours worked: Multiply the new hourly rate by how many hours the employee worked during the shift. Let's say the employee worked 10 hours: 13.65 x 10 = $136.5. So, the shift differential compensation is $136.5.

Take note that differential pay for overtime hours is calculated separately. Overtime hours (over 40 in a week) are paid at time and a half, and the shift differential is added to the overtime rate. Adjust accordingly when calculating overtime.

Having a properly established shift differential policy is critical. If your organization is still unsure where to start, it’s best to consult with experts to align it with your total rewards strategy.

FAQs

Here are some common questions about shift differential pay:

What is a typical shift differential?

As mentioned, a typical shift differential usually ranges from 5% to 15% of the base hourly rate. However, according to the BLS, it varies by industry, from as low as 0.14% for legal jobs to 3.31% for healthcare roles.

Is shift differential worth it?

As an employer, yes, offering shift differential pay is worth it. This type of pay helps attract and retain employees for less popular or hard to fill shifts, such as the second or third shift, ensuring proper staffing at all hours—especially important for businesses with extended or 24/7 operations.

Is night differential pay mandatory?

No, night differential pay is not mandatory by law; it depends on an agreement between the employer and the employee or may be outlined in collective bargaining agreements. The Fair Labor Standards Act (FLSA) does not require extra pay for night shifts, but it does require overtime pay—time and a half—for hours worked over 40 in a week.