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July, 2020

Everything You Need To Know About Gross Pay And Net Pay

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Everything You Need to Know About Gross Pay And Net Pay

Gross pay and net pay are two terms that can be confusing. However, because they affect employee wages, tax records, and employer taxes, it’s necessary to understand the difference.

So, let’s discuss the difference between gross pay and net pay. After you read this article, you will understand how gross and net pay impact voluntary deductions, tax withholdings, and employee wages.

What’s the Difference Between Gross Pay vs. Net Pay?

It can be difficult to understand the difference between gross pay and net pay. To help clear any confusion, remember gross pay as “pre-tax pay” and net pay as “take-home pay.”

What IS Gross Pay?

Gross pay is the amount of money an employee receives before taxes and deductions are taken out of the employee’s paycheck. For example, if your salary is $50,000 a year, you have earned a gross wage of $50,000.

What IS The Meaning of Net Pay?

Net pay is the dollar amount an employee takes home after deductions like health insurance and retirement savings are subtracted from the employee’s gross wages. So, an employee’s gross salary could be $50,000, but his or her take-home pay may only come out to $42,000.

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How To Calculate Gross Pay For A Salary Employee

To calculate gross pay for a salaried employee, you need to know the number of pay periods your company has throughout the year. Here is an example of the total number of pay periods for different frequencies of pay:

Once you determine the number of pay periods, divide your employee’s annual salary by that number.

For example, Ben’s salary is $55,000 a year. He is paid semi-monthly, a total of 24 pay periods. Divide $55,000 by 24 to determine Ben’s gross wages per payroll.

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How to Calculate Gross Pay for An Hourly Employee

To calculate gross pay for an hourly employee, you will need the employee’s hourly rate and the number of hours an employee has worked in a particular pay period. Then, follow these steps:

  1. Multiply the employee’s hourly rate by his or her number of hours worked
  2. Determine if the employee has other income streams like commissions, tips, or overtime pay
  3. Add those additional incomes to your total

For example, Julie earns $5.00 per hour as a waitress. She is paid bi-weekly and worked 40 hours a week for the past two weeks. In addition to her hourly rate, she earned $400 in tips.

To calculate her bi-weekly gross pay follow the steps below:

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For example, Julie earns $5.00 per hour as a waitress. She is paid bi-weekly and worked 40 hours a week for the past two weeks. In addition to her hourly rate, she earned $400 in tips.

To calculate her bi-weekly gross pay follow the steps below:

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How to Calculate Net Pay For An Employee

1. Determine Gross Wages

The first step in calculating an employee’s net pay is determining the gross wages. To calculate gross pay, follow the steps we previously discussed for calculating gross pay:

2. Subtract the Pre-Tax Deductions

Once you have calculated the employee’s gross pay, subtract any voluntary deductions from the employee’s gross income. Types of voluntary deductions include:

 

Healthcare
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Health Insurance Premiums

Job-Related Expenses

Life Insurance Premiums

Retirement Contributions

For example, Michael is a salaried employee who is paid semi-monthly. His gross pay is $2000 per pay period. He contributes $100 per paycheck towards his health insurance and $400 towards his retirement. After the pre-tax deductions, Michael’s gross pay is $1500.

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3. Subtract Mandatory Taxes

Once you have subtracted pre-tax deductions from the employee’s gross pay, it’s time to subtract the required payroll taxes from their taxable gross pay. The following are required tax withholdings:

FICA Taxes:

FICA taxes make up 15% of an employee’s taxable gross pay. Employers pay half of this tax at 7.65% and the employee pays the other half, which includes:

  • Social Security taxes at 6.2%
  • Medicare taxes at 1.45%

Federal Income Taxes

The U.S. currently has seven federal income tax brackets for different income levels. To determine an employee’s federal income tax status you will need the following additional pieces of information:

State and local taxes vary depending on where the employee resides. For tax rates across all 50 states, click here.

For example, Michael, whose pre-tax calculation we performed above, is paid semi-monthly and has a taxable gross income of $1500. He is single and has filed a 2020 Form W-4 with his employer. He has not checked the box in Step 2 of his W-4.

To calculate Michael’s net pay after FICA and federal taxes, we’ll determine the amount to withhold from his paycheck on the IRS 2020 Semi-Monthly Payroll Period Table (pictured right).

Gross Pay Vs. Net Pay Blog (14)
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Since Michael’s gross pay was $1500, the table tells us how much to withhold from Michael’s paycheck for federal income taxes. We will deduct the $41.10 from Michael’s taxable gross pay, and then multiply the 12% tax to that adjusted amount. Here is a breakdown of what Michael’s net pay will be after FICA and federal taxes are withheld from his paycheck.

*Note other deductions like child support, garnishments, and charitable contributions are taken out of an employee’s net pay to determine the total amount of money he or she is owed.

What Do Gross Pay and Net Pay Mean for Employers?

Employers are responsible for paying half of their employees’ Federal Insurance Contributions Act (FICA) taxes. To determine that amount, you will need to know your employee’s gross pay.

You also need to calculate employee gross pay for Federal Unemployment Tax Assessment (FUTA). These are taxes that fund the unemployment program. Companies are required to pay 6% on the first $7,000 in gross pay per employee each year.
Payroll providers can help automate these manual processes to ensure calculations are accurate each payday. With tax compliance experts on staff, all-in-one workforce management platforms help employers avoid potential payroll and tax errors while mitigating legal risks.

Gross Pay vs. Net Pay Recap

Whether your employees have questions about their paychecks or you’re handling payroll taxes for your company, understanding the difference between gross and net pay is essential. Remember, gross wages are paid before taxes and other deductions. Net pay is a wage paid after taxes and other deductions. Knowing the difference saves your company from paying tax compliance fines and ensures employees are paid correctly.

How APS Can Help

APS has been providing payroll and tax compliance services since 1996. Our solutions experts are here to help with your payroll processing, including W-2s, 1099s, payroll taxes, and ACA reporting. No matter what time of year works best for you, we’re here to make payroll and HR easier for you.

Please Note: This article should not be used as tax advice. Tax rules vary by location and change periodically, so please consult a CPA or tax advisor for guidance.

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