Decoding Paychecks: What's the Difference Between Gross Pay and Net Pay

What is Gross Pay?

Your gross pay is the total amount of money that you earn from your labor before any deductions are subtracted from your paycheck. If an employee's annual salary is $60,000, their monthly gross pay is $5,000. If paid monthly, they receive 12 paychecks of $5,000 each. If they are paid semi-monthly (24 pay periods per year), their gross pay is $2,500 for each paycheck, and so on.

Gross pay before deductions is calculated whether an employee is salaried or paid hourly. Overtime pay before deductions is also added to an employee's gross pay total. The same goes for performance bonuses or any other employee remuneration for their labor.

How to Calculate Gross Pay

A full-time employee's gross pay is calculated by dividing their annual salary by the number of pay periods in the calendar year. Using the example above, a $60,000 salary is divided by 12 pay periods to reach a gross pay figure of $5,000 monthly.

For hourly employees, gross pay is calculated by multiplying their hourly rate by the number of hours they worked in a pay period. For example, if employees work 70 hours in a two-week pay period and make $15 an hour, their gross pay is $1,050.

What is Net Pay?

Employees' net pay is also called their "take-home pay." Net pay is the amount of money that a worker takes home after all the deductions are made from their paycheck. Some deductions, such as taxes and social security, are mandatory, while others are voluntary.

Federal income taxes, as are state income taxes, are one of the mandatory deductions. In states that do not have an income tax, there's obviously no deduction for this category. 170 municipalities in the US charge a local income tax, so if your employee works in one of those cities, those taxes will also be deducted.

Medicare and Social Security taxes, also known as Federal Insurance Contribution Act (FICA) taxes, are also withheld. The current social security rate is 6.2 percent, and the Medicare rate to withhold is 1.45%.

Whenever a new employee is hired, they fill out Form W-4. This form lists their dependents, filing status (single, married, or head of household), and other information that impacts how much federal tax is withheld from their paychecks.

Voluntary deductions that might be withheld from an employee's paycheck include retirement plans and health insurance premiums. These are pre-tax contributions, which are calculated first before deducting income taxes.

How to Calculate Net Pay

To calculate an employee's net pay, you must first calculate their gross pay. As explained above, this is done by multiplying the hourly rate by the number of hours worked or by dividing the annual salary by the number of pay periods in a year. Health insurance premium amounts, 401k contributions, and other pre-tax deductions are first subtracted from the gross pay amount.

Next, subtract the employee's federal, state, or local taxes and their FICA taxes from the remaining amount. If additional withholdings exist, such as a court-ordered wage garnishment for child support or alimony, subtract that as well.

The final number after all deductions have been subtracted from the gross pay is the employee's net pay or take-home pay.

Key Differences Between Gross Pay and Net Pay

An employee's gross pay is the amount of money that they actually earn for their labor. However, that's not the amount of money that ultimately ends up in their bank account. Net pay is the final amount that they end up with after all withholdings are subtracted from their wages or salary. A single person with no dependents earning a gross pay of $5,000 per month might take home only $3,800 to $4,000 in net pay after all their withholdings (depending on their state).

Understanding Gross Pay and Net Pay with the help of a Payroll Partner

Employers and employees need to understand the differences between gross and net pay. Employers are required by law to make accurate withholdings from their employees' paychecks. Calculating an employee's net pay based on withholdings is important for running any business.

For employees, it's important to understand the difference as well, especially when they are just entering the workforce. You might be getting paid a salary of $5,000 a month in gross pay, but that's not how much money you will have to plan your monthly household budget. Your personal budgeting needs to be based on your net pay since that amount ultimately ends up in your bank account.

If you need assistance with figuring out monthly payroll for employees or want to know how to streamline your payroll process so that it's much faster every month, contact us at Exact Payroll.