Running payroll can be confusing. Although it’s natural to have payroll questions when starting out, you can’t afford to get tripped up when it comes to gross vs. net pay. Knowing the difference between gross and net pay impacts employee wages, payroll withholdings, recordkeeping, and even employer laws.
Learn gross pay vs. net pay, how to find both types of wages, and where to record gross and net pay.
Gross and net pay
Both gross and net pay deal with what your employee earns for their work at your business. But, the difference between gross vs. net pay comes down to when you withhold deductions.
Payroll deductions include federal, state, and local income tax; Social Security tax; and Medicare tax. Non-tax deductions include health insurance premiums, retirement plan contributions, and wage garnishments.
Gross pay is the amount you owe employees before withholding taxes and other deductions. Gross pay is not the amount you pay your employee. You must use gross wages to calculate your employees’ net wages.
Net pay is what an employee takes home after deductions. Net pay is the amount you give to your employee. An employee’s net wages can be significantly less than their gross wages due to mandatory and voluntary payroll deductions.
Gross pay is the sticker price that attracts employees to your business, but net pay is what the employee receives and has to spend.
You must determine an employee’s gross pay, deductions, and net wages each pay period. Common pay frequencies include weekly, biweekly, semimonthly, and monthly. You can even calculate an employee’s annual gross and net wages.
Gross pay vs. net pay: Formulas
To find gross pay, calculate the employee’s wages before deductions. For net pay, calculate the employee’s wages after deductions. Use the following formulas to help.
How you calculate gross pay depends on whether the employee is an hourly or salary worker.
When you hire hourly workers, you pay them an hourly rate. To find an hourly employee’s gross wages, multiply their hourly rate by the number of hours worked during the pay period.
Gross Pay (Hourly) = Employee’s Hourly Rate X Hours Worked
For example, you pay a full-time employee an hourly rate of $12. To calculate the employee’s gross pay during a biweekly pay period, multiply their hourly rate by 80 hours worked. The employee’s biweekly gross wages are $960 ($12 X 80).
You may also need to determine a salaried employee’s gross wages during a pay period. To find their gross wages, divide the employee’s annual salary by the number of pay periods in the year.
Gross Pay (Salary) = Annual Salary / Number of Pay Periods
Let’s say you pay an employee a salary of $35,000 per year. You use the semimonthly pay period, which means you give the employee 24 paychecks per year. To find the employee’s gross pay, divided their annual salary by 24. The employee’s semimonthly gross wages are $1,458.33 ($35,000 / 24).
You need to know an employee’s gross pay to calculate net pay. And, you must know the employee’s gross wages to determine their tax liability. To find net pay, subtract deductions from the employee’s gross wages.
Net Pay = Gross Pay – Deductions
Using the hourly gross wages example above, let’s say an employee earns $960 biweekly. First, calculate their deductions. The employee does not have anything withheld from their pay except federal income, Social Security, and Medicare taxes.
The employee is single, so their federal income tax liability is $51, (per IRS Publication 15-T). The combined Social Security and Medicare tax rate, known as FICA tax, is 7.65% of their gross wages. The employee’s FICA tax liability is $73.44 ($960 X 0.0765).
The employee’s total deductions equal $124.44 ($73.44 + $51). Subtract $124.44 from $960 to get the employee’s net pay of $835.56. Pay the employee $835.56 and remit the deductions to the IRS.
Where to record gross and net pay
You are required to keep payroll documents containing gross and net pay information in your records for at least three years. Record gross and net wages on pay stubs and in your payroll register.
Pay stubs list details about each employee’s pay, including their gross wages, deductions, and net wages.
For each payroll you run, you should create and distribute pay stubs for each employee. Depending on where your business and employees are located, you might be required to give your employees a physical or digital pay stub.
Pay stubs also show the employee’s year-to-date payroll. You and your employee can reference year-to-date paycheck stubs to determine the total amount of gross wages, deductions, and net wages for the year.
Employees can consult pay stubs if they have concerns about the difference between gross and net pay. And, you can view pay stubs to verify payroll accuracy.
Like a pay stub, a payroll register lists gross pay, deductions, and net pay. However, a payroll register is a record of payroll details for all your employees. Payroll registers are for your records, not for distribution to employees.
Payroll registers include information about individual employees, similar to pay stubs. At the end, the payroll register adds up gross wages, deductions, and net wages to give you totals.
Payroll registers show you the total gross wages your business pays during a period. And, they show you how much you withheld for taxes and other deductions. The net pay listed on the payroll register shows you how much you paid employees through direct deposit, check, or cash.
Why understanding net vs. gross income matters
To run payroll correctly, you must know the difference between gross and net pay. If you don’t withhold taxes from gross wages, you are paying employees under the table.
Understanding gross vs. net pay is also critical for when employees have questions about their earnings. An employee who was offered a certain gross pay might be surprised when they receive their net pay. You can explain the difference between gross and net wages to the employee.
You must also understand gross pay vs. net pay if you promise an employee a certain take-home pay. You can gross up payroll so the employee’s take-home pay is the sticker price you offered. A gross-up is when you increase the employee’s gross wages to account for their tax liability.
Looking for an easy way to calculate your employees’ gross and net wages? Patriot’s online payroll software lets you run payroll in three easy steps. And, our payroll register report shows all payment details for each employee. Get your free trial today!
This article has been updated from its original publication date of September 24, 2018.
This is not intended as legal advice; for more information, please click here.