When it comes to payroll and paychecks, there are two important terms to understand for your payroll process: gross pay and net pay. But what’s the difference? The post dives into each term in detail, so keep reading!
What do the terms “gross pay” and “net pay” mean?
- Gross pay is the amount of money your employees receive before any taxes and deductions are taken out. For example, when you tell an employee, “I’ll pay you $50,000 a year,” it means you will pay them $50,000 in gross wages.
- Net pay is the amount of money your employees take home after all deductions have been taken out. This is the money they actually get on payday.
Both terms appear on your employee’s pay stub. Gross income or earnings usually appears at the top of the pay stub, while net income appears towards the bottom, typically after a list of your employee’s payroll deductions.
Okay, great. But how do you actually calculate gross pay and net pay for your hourly and salaried employees?
Let’s walk through some examples so you can see exactly how each term impacts your team’s take-home pay—and your employer payroll taxes.
How do I calculate gross pay for an hourly employee?
To calculate the gross pay for an hourly employee, multiply their hourly rate by the number of hours worked. Then add any other applicable sources of total amount of income, such as overtime pay, tips, and commissions.
For example, you pay Betty $18 an hour and Betty works 80 hours per pay period (about 40 hours per week). When you run payroll, you’ll calculate Betty’s gross wages like this:
$18 x 80 = $1,440
Betty’s gross wages for that pay period are $1,440. To calculate her total gross pay, you will need to add her other sources of income too.
If your hourly workers clock overtime, multiply their overtime hours by their overtime pay rate, which is 1.5 times their regular hourly wage. Then, add the overtime wages to their regular wages.
For example, one week, Betty covers an extra shift and works eight hours of overtime, for a total of 48 hours worked. Betty will be paid her regular hourly rate of $18 for the first 40 hours, and then her overtime rate of $27 for the 8 hours of overtime.
Here’s how it looks for a two-week pay period:
|Hours worked||Hourly rate||Gross pay|
|Total gross pay||$1,656|
How do I calculate gross pay for a salaried employee?
To calculate the gross salary, first, determine the number of pay periods you have throughout the year. A pay period is the time frame that you’re paying your employee for.
These are the different types of pay periods and how many times they occur in a year.
|Pay period||Definition||Periods per year|
|Weekly||You pay your employee every week on a specific day of the week (like Friday)||52 payrolls per year|
|Bi-weekly||You pay your employee every two weeks on a specific day of the week (like every other Friday)||26 payrolls per year|
|Semi-monthly||You pay your employee twice a month on a specific date (like the 5th and the 20th)||24 payrolls per year|
|Monthly||You pay your employee once a month on a specific day (like the 25th)||12 payrolls per year|
Once you know your pay frequency and how many payroll periods you have in the year, divide your employee’s annual salary by the number of payroll periods.
For example, Jorge’s annual income is $225,000, and you run payroll on a semi-monthly schedule, which is 24 payrolls per year. Here’s how to calculate Jorge’s gross pay per payroll period:
$225,000 / 24 = $9,375
You’ll pay Jorge $9,375 in gross wages every time you run payroll. As with hourly employees, you will also add any other required sources of income to calculate gross pay.
How do I calculate my employee’s net pay?
Before you calculate your employee’s net pay, you need to know their gross pay. This is your starting point.
Next, you need to know what deductions your employee has from their paycheck. Some deductions, like FICA payroll taxes and income tax withholdings, are mandatory. Additional withholding like health insurance and retirement contributions are voluntary.
Finally, you’ll need to know your employee’s withholding allowance and filing status, which you can find on the W-4 form, Employee’s Withholding Allowance Certificate. Your employee filled out this form when they were hired.
Step 1: Calculate the voluntary pre-tax deductions
The first step to calculating your employee’s net pay is to subtract their voluntary pre-tax deductions from their gross pay.
Voluntary deductions are payroll deductions that your employee chooses to have withheld from their paycheck, but aren’t required by law. Pre-tax means that the deduction is taken out of your employee’s gross pay before they pay mandatory payroll taxes. Pre-tax deductions lower your employee’s taxable income and payroll taxes.
Types of pre-tax payroll deductions that may qualify:
- Retirement contributions
- Health benefits
- Commuter benefits
For example, Betty contributes $150 to her traditional 401(k) plan every paycheck, and she contributes $90 toward her health insurance premium.
Here’s how the pre-tax deductions will get deducted from Betty’s paycheck:
|Taxable gross pay||$1,200|
Step 2: Calculate and subtract mandatory payroll taxes
The next step is to calculate and subtract your employee’s mandatory payroll taxes.
There are two types of mandatory payroll taxes: FICA taxes and federal income tax withholdings. Depending on where you live, you may also have state and local income tax withholdings.
FICA payroll tax
FICA payroll tax rate is 15.3 percent of your employee’s gross pay after pre-tax payroll deductions. This amount goes toward your employees’ Social Security and Medicare taxes.
As an employer, you pay half of this tax (7.65 percent), and your employee pays the other half. The employee’s portion is deducted from their gross pay. Of the employee portion, 6.2 percent goes towards Social Security tax and 1.45 percent goes toward Medicare tax.
Here’s how to calculate the payroll taxes that will get deducted from Betty’s paycheck (our hourly employee example):
|Taxable gross pay||$1,200|
|Social security tax (6.2 %)||-$74.40|
|Medicare tax (1.45 %)||-$17.40|
There are some special cases to be aware of.
For Social Security tax, there’s a cap on the amount of gross pay that’s subject to Social Security tax. This is called the Social Security wage base, and in 2019, it’s $132,900. That means any earnings over $132,900 aren’t subject to Social Security tax.
There’s also an additional Medicare tax if your employee earns more than $200,000 in gross earnings. The additional Medicare tax is 0.9 percent of any wages over $200,000.
Now, let’s calculate the payroll taxes that will get deducted from Jorge’s paycheck after he’s reached the $200,000 threshold (our salaried employee example):
|Social Security tax (0% because Jorge’s earnings have exceeded $132,900)||$0|
|Medicare tax (2.35% because Jorge’s earnings have exceeded $200,000)||-$220.31|
Federal income tax
In addition to Social Security and Medicare tax, your employee also has income tax deducted from their paycheck. To calculate your employee’s income tax withholdings, you’ll need:
- Your employee’s filing status
- Your employee’s withholding allowance
- Your employee’s gross wages
- Your payroll schedule
- The IRS Income Tax Withholding table for the current year (found in Publication 15-A)
Let’s calculate Betty’s federal income tax withholdings:
Betty is single and has one withholding allowance. Your business runs payroll on a bi-weekly basis. This pay period, Betty’s taxable gross pay is $1,200.
To calculate Betty’s income tax withholding, first, we’ll find the Bi-Weekly Payroll Period table. Then we’ll look at the Single Persons Column and the row for one allowance. Next, we’ll find the line that corresponds with Betty’s gross wages.
Now it’s time for some math. Here’s how the calculation works:
- Subtract $369.67 from Betty’s gross wages.
- $1,200 – $369.67 = $830.33
- Multiply the total from Step 1 by 12 percent.
- $830.33 x 0.12 = $99.64
Betty’s federal income tax withholdings are $99.64. The last step is to deduct $99.64 from Betty’s taxable gross pay.
This is Betty’s total net pay:
|Taxable gross pay||$1,200|
|Social Security tax (6.2 %)||-$74.40|
|Medicare tax (1.45 %)||-$17.40|
|Federal income tax||-$99.64|
Step 3: Account for other mandatory payroll deductions
There are a few instances when your employees may have other mandatory payroll deductions, called wage garnishments. Garnishments are for back child support payments, delinquent student loans, unpaid taxes, and credit card debt.
If your employee has a mandatory wage garnishment, you’ll be notified by the government and informed of the amount that you need to withhold from each paycheck.
Helpful paycheck calculators
These tools with easy-to-use drop-down fields are payroll tax calculators that factor in federal tax, state income tax, and local taxes based on addresses, along with fringe benefits (e.g. group term life insurance), exemptions, and other qualifying details you input from your employees’ Forms W-4, such as dependent totals:
How does gross pay and net pay affect my taxes as an employer?
As an employer, you are responsible for paying half of your employee’s FICA payroll taxes, which is 7.65 percent of your employee’s gross pay. Of this 7.65 percent, 6.2 percent goes toward your employee’s Social Security and 1.45 percent goes towards their Medicare.
The Social Security wage base applies to employers. After your employee’s wages exceed the wage base, you’ll no longer pay Social Security tax. On the other hand, the additional Medicare tax doesn’t apply to employers, and only your employees will pay this extra tax.
As an employer, you do pay an additional payroll tax called FUTA, which funds the unemployment benefits program.
FUTA tax is six percent of the first $7,000 in gross wages you pay each of your employees per year. Many employers receive a FUTA tax credit of 5.4 percent if they pay their state’s unemployment taxes on time. This drops the FUTA tax down to 0.6 percent.
Remember, your employer taxes are based on your employee’s gross wages, not their net wages. The example below will show you how to calculate the employer taxes you would pay for Betty before she’s reached the $7,000 threshold for FUTA tax.
|Social Security tax||6.40%||$72.96|
You’ll pay $102.48 in employer taxes in addition to paying Betty $1,440 in gross wages.
Now you understand the real difference between gross pay and net pay, how to calculate both, and what those terms really mean when they show up on your team’s paychecks.
Want to learn more about calculating a paycheck for your small business? Watch the video below to see how it all works.