Gross pay (also known as gross salary) is the amount of compensation a company or organization pays an employee before any required or voluntary deductions take effect, per payment period. Gross pay is the number listed at the top of each payroll statement. For example, if an employer says, “I’ll pay you $60,000 a year with a $2,000 end-of-year bonus,” the employer agrees to pay $62,000 as an annual salary, or total gross wages.
Net pay is the amount of compensation an employee receives every payment period after deductions are made from the gross pay. Deductions include but are not limited to: federal, state and local taxes, payroll taxes, benefit plans, retirement contributions, or additional legal garnishments (e.g. child support or restitution). Net pay is the number listed at the bottom of a payroll statement, or more commonly, a digital direct deposit.
For any work done outside of an employment contract (e.g. freelance or 1099-contract work), compensation is provided without any deductions, so state and federal taxes and additional costs should be taken into consideration by the individual.
The Breakdown: Know the Difference
Gross pay is the amount of compensation an employer and employee agree upon at the start of employment or work.
Net pay is the amount of compensation actually paid after required deductions take effect .
How to calculate gross pay
Gross pay can be calculated in a few ways, and it will depend on if you have hourly or salaried employees, as well as the number of payment periods.
1. How to calculate gross pay for hourly employees or contract workers
Some hourly employees or contracted workers have an expected amount of hours per week, while others have varying schedules. If hourly work differs per week, it is easiest to calculate gross pay at the end of the year based on total income.
However, for hourly employees with allocated set hours, you can simply follow this calculation:
Gross pay = Total time worked per payroll period x hourly rate
Example: If an employee’s hourly rate is $20 per hour paid bi-weekly increments, and they work 40 hours per week, their bi-weekly gross pay is $1,600.
Overtime laws: If an employee works overtime, they are paid 1.5x their rate. For example, Sam makes $26/hour in bi-weekly payments. One week, she clocks 45 hours, then 40 hours the next. To calculate her gross pay, multiply 80 hours by $26/hour, and the remaining 5 overtime hours by $39/hour. It is important to know who is exempt from overtime pay, as well as specific state laws regarding overtime work. It’s best to consult your state’s Department of Labor website for specifics.
A note on time off or holidays: For hourly contract workers, you should factor in days off and holidays when calculating or estimating gross pay. In general, paid holidays and vacation time are not paid for in 1099 contracts. For example, at 40 hours per week, with 10 U.S. holidays and 15 full days off, you would be working 1,720 hours/year. From there, you can estimate your gross pay based on your hourly rate.
2. How to calculate gross pay for salaried employees:
Salaried employees are employees who are hired with an agreed-upon monthly or annual compensation, which makes calculating their gross pay slightly easier.
Step 1: Determine how many payment periods you have in a year. Here’s a breakdown of the most common payment periods:
Weekly (every week on a specific day): 52 payrolls per year
Biweekly (every two weeks on a specific day): 26 payrolls per year
Semimonthly (2x on specific dates): 24 payrolls per year
Monthly (1x on a specific date): 12 payrolls per year
Step 2: Once you know the amount of payrolls, divide your employee’s annual salary by payrolls.
Gross pay = Annual salary ÷ the # of pay periods per year
Example: If an employee’s annual salary is $95,000/year, and there are 26 payroll periods, the bi-weekly gross pay is $3,654.
Net pay: How to calculate deductions from gross pay
Calculating net pay can be a bit more complicated than calculating gross pay. However, once you have all the necessary deductions accounted for, the calculation is quite simple. Below are general steps:
Step 1: Determine your employee’s voluntary pre-tax deductions. Voluntary pre-tax deductions lower your employee’s payroll taxes and taxable income. The following are typical pre-tax deductions:
- Health insurance plans
- Retirement contributions (e.g. 401(k) plans)
- Commuter benefits
Step 2: Subtract mandatory payroll taxes. Reminder, these taxes are calculated from an employee’s taxable gross pay, not net pay. The following are the two mandatory payroll taxes to account for.
- Federal Insurance Contribution Act (FICA) taxes
- Federal income tax withholdings
More on FICA taxes
FICA payroll taxes are 15.3 percent of your employee’s gross pay after the pre-tax deductions are accounted for. This amount is split between the employer and employee to 7.65 percent each. For an employee, this percentage is then defined further into a Social Security tax (6.2 percent) and a Medicare tax (1.45 percent).
For Social Security Tax, there is a cap on the amount that can be taxed. In 2021, the SSA increased the earnings cap from 137,700 to 142,800. Any income after 142,800 is not subject to Social Security Tax. There is currently no cap on taxable Medicare income.
More on Federal income tax withholdings
Employees must also pay federal income taxes. The amount in which an employee owes per payroll period is available upon gathering available information from an employee’s W-4 filling form, completed upon hiring.
The W-4 includes their filing status, number of dependents, and any additional withholding amounts. With this information, you can calculate tax withholdings using the Wage Bracket Method available with instructions in Publication 15-A from the IRS. For additional support, use a tax withholding assistant.
Step 3: Account for wage garnishments
Finally, an employee’s payment may require wage garnishments. Currently, about 10 percent of employees in the U.S. owe wage garnishments, so it is not unusual to factor these in as an employer. These deductions are court mandated and deducted after all other mandatory deductions are made.
As an employer you will be notified of the amount to withhold per payment period. Examples of wage garnishments include child support, unpaid student loans, creditor garnishments, and tax debts.
