- Different formulas are used to calculate salaried and hourly employees’ gross pay.
- Net pay can be significantly different from gross pay, depending on individual deductions.
- Employers are required to pay half of their employees’ FICA taxes.
- This article is for business owners who want to calculate gross pay and net pay for payroll and tax responsibilities.
No matter your business’s size, handling payroll can be a daunting task. Each employee may receive a different payment amount, require various deductions and follow individual compliance requirements.
We’ll explore the difference between gross and net pay, how to calculate each type, and how best to manage payroll responsibilities.
What’s the difference between gross pay and net pay?
When you provide a job offer to a potential new hire, the contract will often include their gross pay, or the pay they receive before any taxes or deductions are taken out.
Net pay, also called “take-home-pay,” is the actual dollar amount the employee will receive via check, direct deposit or a direct deposit alternative. Net pay is calculated by subtracting any required taxes or voluntary deductions from the gross pay amount.
Gross pay is usually more than net pay since it doesn’t include taxes or deductions, which vary by state and employee choices.
Employers include net pay and gross pay on each employee’s pay stub. Gross pay usually appears first, followed by a list of taxes and deductions, followed by net pay.
Gross and net pay can vary significantly for full-time and part-time employees as well as salaried and hourly employees. After taxes and deductions, an employee’s take-home pay could be hundreds or even thousands of dollars less per pay period.
Tip: Never set personal or business budgets according to gross pay. Always use net pay as a guide for how much money you’ll have to pay your bills and have adequate cash flow.
What is gross pay?
Gross pay – also known as gross wages or gross income – reflects an employee’s overall salary or hourly wages. An employee receives this amount before any taxes or deductions are calculated.
Additionally, gross wages must meet the federal minimum wage, which is currently $7.25, or a state, county or city’s minimum wage (whichever is higher).
Gross pay is an agreed amount between the employer and employee when the worker accepts the job, gets promoted, or transfers to a new department or position.
How to calculate gross pay
Calculating gross pay differs depending on whether the employee is salaried or hourly.
How to calculate gross pay for salaried employees
Employees who receive a fixed amount each year (i.e., $40,000 annually) are salaried employees. The Fair Labor Standards Act (FLSA) considers salaried employees exempt under U.S. federal law.
Whether a salaried employee’s pay schedule is weekly, biweekly or monthly, the formula to calculate their gross income remains the same. Use this formula to calculate gross pay for a salaried worker:
Annual gross salary ÷ number of pay periods = gross pay for salaried employees
For example, if a salaried employee’s gross pay is $40,000 and you want to calculate their monthly or weekly pay, divide $40,000 by 12 or 52, respectively. Thus, a $40,000 salary results in gross pay of $3,333 monthly or $769 weekly.
How to calculate gross pay for hourly employees
Many industries use hourly workers as part of their workforce, including retail, transportation, hospitality, construction, manufacturing and government. Hourly employees are paid for each hour worked.
There is no minimum number of hours an hourly employee must work, and an employer is required to pay the employee only for the time they have logged. Therefore, hourly workers are considered nonexempt under the FLSA.
This is the formula for calculating gross pay for hourly employees:
Gross hourly rate x hours worked per pay period = gross pay for hourly employees
An hourly worker’s gross pay is calculated per pay period. If a worker earns $14 per hour for 40 hours per week and gets paid weekly, their weekly gross pay is $560 ($14 x 40). Their yearly gross pay is $29,120 ($14 x 40 x 52).
Tip: Since hourly employees may work different hours every week, your calculations must reflect the fluctuations in hours logged, including any overtime pay and bonuses.
What are gross pay deductions?
There are two types of deductions for gross pay: required and voluntary. Deductions can vary by employee and paycheck.
Each employee is required to fill out a W-4 form. The W-4, or Employee’s Withholding Certificate, declares the employee’s tax deductions and notes the number of people in their household. Use IRS tax charts to determine applicable withholdings for each employee. The deduction total equals the amount of payroll taxes you must withhold for that specific employee.
Mandatory deductions may include the following:
- Federal, state, and local income or payroll taxes
- Social Security (6.2%) and Medicare (1.45%) taxes
- State unemployment taxes (generally a tax liability for the employer only, except in a few states, including Arkansas, New Jersey and Pennsylvania)
All other deductions are voluntary and generally job-related, such as retirement contributions and health insurance premiums. These may include the following:
- Company-sponsored 401(k) plans
- Work-related tools or uniforms
- Union dues
- Health insurance
- HSA (health savings account), FSA (flexible savings account) or HRA (health reimbursement arrangement)
- Wage garnishments, including credit card loans, student loans, taxes, and unpaid child support
- Additional life insurance
- Donations to charities
The employee determines voluntary deductions based on discretionary income and benefit preferences. Keep in mind that retirement and health contributions are pretax deductions and are subtracted before any taxes are applied. Payments such as garnishments are after-tax deductions.
More on gross pay deductions
Workers originally paid income taxes in quarterly installments. In 1943, the Current Tax Payment Act shifted the burden of income taxes from workers to employers. Taxes are deducted automatically from every paycheck and withheld, so employees receive their net pay, not their gross pay. (The Current Tax Payment Act currently does not apply to contractors, freelancers, etc.)
What is net pay?
Net pay (also known as net wages or net income) is the amount you receive via check, direct deposit, or another payment method. Net pay reflects gross pay minus any taxes or deductions. Net pay will often be in larger print, bolded on your paycheck and appear at the bottom of your pay stub.
How to calculate net pay
Once you’ve calculated an employee’s gross pay, determining their net pay is straightforward. Use the following formula whether you’re working with a salaried employee or an hourly employee:
Gross pay – all taxes and deductions = net pay
Deductions and taxes include FICA payroll taxes, income taxes, health insurance premiums and retirement contributions.
What role do gross pay and net pay play in employers’ taxes?
Employers are required to pay half of their employees’ FICA taxes. FICA taxes are calculated based on an employee’s gross taxable pay. An employee’s gross taxable pay is based on their net pay after gross pay deductions but subtracted before taxes.
The FICA calculation is crucial since each employee’s pretax deductions can reduce an employer’s tax liability. Thus, in simple terms, voluntary deductions benefit both employers and employees.
FICA taxes do not apply to 1099 workers (i.e., freelancers and contractors). This is because 1099 workers must pay their own taxes (they receive gross pay). However, 1099 workers can still benefit from pretax contributions to a retirement account.
Need help with business payroll?
Since it’s beneficial for employers to ensure employee paycheck accuracy and encourage voluntary deductions, it’s an excellent idea to invest in payroll software and services. Payroll software puts accounting on autopilot, streamlining payroll management, including deductions, taxes and benefits.
Calculating payroll goes well beyond calculating gross and net pay. If you want to have accurate payroll that abides by state and federal laws, up-to-date books, error-free paychecks, and compliant payroll records storage, payroll software might be the answer.
Payroll systems aren’t just for large businesses. Small and enterprise-sized businesses alike can benefit from automated payroll solutions that stay on top of changing tax laws.
There are many payroll solutions out there, so read our in-depth reviews of the best payroll software to find the right fit for your needs. Here are some all-in-one payroll solutions that can save you time and money and offer advanced payment options for your employees: