As an employer, you are responsible for withholding taxes and other deductions from an employee’s gross wages. Knowing how to calculate net pay is essential for running an accurate and legal payroll.
Read on to learn the difference between gross and net pay, determine how to calculate net pay from gross pay, and see an example.
Gross pay vs. net pay
The sticker price of an employee’s salary is not what they take home. Your employee might ask, How much will my paycheck be after taxes? Understanding the difference between gross and net pay is the first step to learning how to find net pay.
What is gross pay?
You can find weekly gross pay for salaried employees by dividing their yearly salary by 52 weeks. For hourly workers, multiply the employee’s hourly pay by the number of hours worked.
What is net pay?
Net pay is the take-home pay an employee receives after you withhold payroll deductions. You can find net pay by subtracting deductions from the gross pay.
What are deductions?
To get from gross to net pay, you must withhold deductions. Payroll deductions are amounts you withhold from an employee’s paycheck each pay period. There are both mandatory and voluntary deductions.
Types of payroll deductions that are mandatory include payroll and income taxes. You must withhold Social Security, Medicare, and federal income taxes. Depending on where your employees work, you may also need to withhold state and local income taxes.
You may also have to withhold mandatory non-tax deductions, like garnishments and child support payments. You will be notified if you need to withhold these from an employee’s gross pay.
Voluntary deductions include health, disability, and life insurance, retirement plans, flexible spending accounts (FSAs), and health savings accounts (HSAs).
How to calculate net pay
Need help calculating net pay? Here is the net pay formula:
Net Pay = Gross Pay – Deductions
To help you calculate net pay for your employees, you need to know how much to withhold in taxes and deductions.
How much are taxes?
Social Security and Medicare taxes make up FICA tax. The FICA tax rate is a flat percentage of 7.65% that you hold from each employee’s wages. Of this 7.65%, 6.2% goes toward Social Security tax and 1.45% goes toward Medicare tax. Keep in mind that there is a Social Security wage base and additional Medicare tax you may need to apply for employees who reach a certain threshold.
The amount of federal income taxes varies based on factors like the employee’s pay, Form W-4 information, and filing status. When each employee began working for you, they should have filled out Form W-4, Employee’s Withholding Certificate. Use each employee’s Form W-4 and the federal income tax withholding tables in IRS Publication 15 to figure out how much the employee owes in federal income taxes.
State and local income taxes vary by state and locality. You will need to check with your state for more information.
How much are non-tax deductions?
Next, determine whether you must hold additional money for employee benefits and other non-tax deductions. Keep in mind that some of these deductions are pre-tax while others are post-tax.
If an employee has a pre-tax deduction, you will subtract the amount from their wages before you figure out some or all of their taxes. This lowers their taxable income. Examples of pre-tax deductions include health insurance premiums, some retirement plans, and life insurance premiums.
If an employee has a post-tax deduction, withhold the amount after you have figured out their taxable income. Examples of post-tax deductions include Roth retirement plans and wage garnishments.
Subtract the employee’s non-tax deduction from their wages depending on whether it is pre-tax or post-tax.
Example of gross to net calculation
Let’s say your employee is a single-filer living in Phoenix, Arizona with zero claims on their Form W-4.
The employee makes $15 per hour and works 40 hours per week. You pay the employee weekly, and their total gross is $600. The employee does not work overtime.
The employee’s health insurance premium is $50 per week. Health benefits are exempt from Social Security, Medicare, and income tax withholding.
You will withhold the following to determine the employee’s net pay:
Health insurance premium
Because health insurance premiums are pre-tax deductions, you will need to subtract the $50 from the employee’s gross wages first.
$600 – $50 = $550
Use the amount of $550, not $600, to calculate the employee’s taxes.
To determine how much of the employee’s paycheck goes toward FICA tax, you will need to multiply the employee’s wages after their pre-tax deduction ($550) by 7.65%.
$550 X 0.0765 = $42.08
Withhold $42.08 in FICA tax from the employee’s gross pay.
Federal income tax
Use the income tax withholding tables in Publication 15 to determine the employee’s federal income tax withholding. In this example, we used the wage bracket method for a single-filer with zero claims.
For a wage bracket of at least $550 but less than $560 weekly, you withhold $54 for federal income taxes each week.
State income tax
In Arizona, employees must fill out Form A-4, Employee’s Arizona Withholding Election. On this form, they can choose one of the listed percentages of their gross wages that goes toward state income tax. For this example, let’s say the employee chose to withhold 2.7% of their gross wages for their state income taxes.
Multiply $550 by 2.7% to determine the employee’s state income tax withholding.
$550 X 0.027 = $14.85
Withhold $14.85 from the employee’s gross wages for state income taxes.
Local income tax
Phoenix does not have local income taxes. You do not need to deduct anything from the employee’s gross pay for local income taxes.
Find the net pay
To calculate net pay, we will need to deduct FICA tax; federal, state, and local income taxes; and health insurance from the employee’s gross pay.
Using the formula to calculate net pay, determine the employee’s net pay.
Net Pay = Gross Pay – Deductions
Here is a rundown of the withholding amounts we calculated:
- Gross Pay = $600
- Health Insurance Premium = $50
- FICA Tax = $42.08
- Federal Income Tax = $54
- State Income Tax = $14.85
- Local Income Tax = $0
Net Pay = $600 – $50 – $42.08 – $54 – $14.85 – $0
Net Pay = $439.07
The employee’s net pay is $160.93 less than their gross pay.
Doing calculations by hand leaves room for simple mistakes. If you want to avoid this process, let Patriot’s online payroll software do the work for you. Enter your employees’ pay, hours worked, and benefits, and we will do the rest. Enjoy your free trial today!
This article has been updated from its original publication date of 10/19/2016.
This is not intended as legal advice; for more information, please click here.