Gross pay is the total amount an employee earns before taxes and deductions; net pay is the amount the employee takes home after those deductions.
Whether you’re a business owner or an employee, it pays to know the difference between gross and net pay. It’ll help you explain the difference to your employees and give you insight into how to calculate employee paychecks.
Gross pay, or gross wages, is the amount an employee would receive before payroll taxes and other deductions. By contrast, net pay is the amount left over after deductions from an employee’s gross pay. Let’s explore the differences between the two and how to calculate each:
Gross pay is the total pay a worker earns before payroll taxes and deductions. It is the cumulative earnings amount, meaning it includes all of the following:
Gross pay for salaried workers is their annual salary divided by the number of times they’ll receive a paycheck during a year. Gross pay for hourly employees is the number of hours they work during the pay period multiplied by their hourly pay rate. Then you add overtime, bonuses, or other pay to that base pay.
For example, say a salaried employee makes $60,000 a year, and the company has one-week pay periods. Divide $60,000 by 52 weeks for a total of $1,153.85 per pay period. If the employee had also earned a $50 commission, their gross pay for the week would be $1,203,85.
Understanding gross pay is important for employees as it represents the total amount they have earned. It serves as the starting point for calculating net pay.
Payroll withholding and deductions play a crucial role in determining an employee's net pay. Deductions can include various taxes and employee benefits. Note that some deductions are pre-tax, meaning they lower your taxable income.
For example, voluntary deductions like health insurance premiums and retirement contributions will lower your taxable income. Taxable income is the amount of an employee's earnings that is subject to income tax.
When calculating gross pay, you need to consider several deductions to arrive at your net pay. The most common payroll deductions include:
Net pay is a worker’s total take-home pay, or what’s left after payroll withholdings and deductions. The net pay formula is:
Gross pay - deductions = Net pay
Some common deductions include income taxes, Social Security taxes, health insurance, and retirement contributions. Calculating the difference between gross pay and net pay is crucial for employers and employees. Here’s a quick guide to doing so:
You can calculate gross wages two ways, one for salaried employees and another for hourly employees:
To calculate a salaried employee’s gross pay for a single pay period, divide their annual salary by the number of pay periods your company has in the year according to your payroll schedule. Here’s how to calculate the gross pay for employees:
1. Determine the number of pay periods you have in a year. For example, if you pay your employees every week, there are 52 pay periods. Here are the most common pay schedules a company will choose from:
2. Divide your employee’s annual salary by the number of pay periods. If you have a salaried employee making $60,000 per year, here’s how gross pay would look, divided by each type of pay period:
3. Add additional earnings for the pay period, including commissions, bonuses, or overtime pay (if the salaried employee is nonexempt).
For example, say your pay schedule is set to weekly, and your salaried worker from above is set to receive a $100 commission this week. Their gross pay would be the $1,153.85 weekly salary plus the $100 commission for a total of $1,253.85.
Now say you have an hourly employee. To calculate an hourly employee’s gross wages for a pay period, multiply their hourly pay rate by the number of hours according to your time tracker. The gross pay formula for hourly employees is:
Hourly employee gross pay = Hourly pay rate x number of hours worked
You’ll then add any additional income they’ve earned during that pay period, including overtime pay, commissions, or bonuses.
Here’s an example of gross pay using a one-week pay period:
1. Multiply the hourly rate by the number of hours worked, up to 40 hours per week. Let’s say you have an hourly employee that makes $15 per hour. If the employee works 40 hours, their gross pay is:
2. Account for overtime, tips, and commissions. Remember that, typically, overtime is 1.5 times the employee’s hourly rate. Say your hourly employee works two overtime hours and earns a $50 commission. The employee’s overtime pay rate is $22.50, so they make $45 plus their commission. This puts their gross pay at:
The net pay formula subtracts an employee’s paycheck deductions from their gross pay. The net pay formula is:
Gross pay - deductions = Net pay
Post-tax deductions, such as voluntary deductions for additional life insurance or student loan payments, do not reduce taxable income. Two employees can have the same gross pay but different net pay. Employees may have different tax withholdings based on their W-4s and different retirement or health insurance deductions. Employees can also have wage garnishments or live in another state and pay different tax rates.
In the example below, we’ve broken deductions into three parts: pre-tax deductions, taxes, and additional deductions.
1. Start with the employee’s gross pay. In this case, we’ll use the hourly employee from above whose gross pay for the week was $695. If this employee had zero deductions, their gross pay and net pay would be the same. This is rarely the case, however.
2. Now account for pre-tax deductions. Start by subtracting any pre-tax deductions the business offers, such as health insurance premiums or retirement contributions. Let’s say an employee deducts 6% of their gross pay each week ($41.70, or $695 x 6%) to put toward their 401(k) and pays $62 per week for health insurance. Their taxable income comes out to:
3. Subtract payroll taxes. This includes federal and state income taxes, FICA payroll taxes (which include Social Security and Medicare), and any additional state payroll taxes. Our salaried employee has the following payroll taxes:
Their updated net pay is now:
4. Finally, check for any remaining deductions, such as uniform cleaning fees or wage garnishments for unpaid child support or taxes. For example, if our hourly employee from above also had a $10 uniform cleaning fee per week, their final net pay would be $406.48 ($416.48 - $10).
Gross pay and net pay sound interchangeable, but as you can see, they can be very different. The difference between a person’s initial gross pay and take-home pay can be vast, depending on their deductions and withholdings.
Going step-by-step from gross pay to net pay can be a lengthy manual process. But if you have a payroll service like QuickBooks Payroll, most of these calculations are automatic, including paying and filing state and federal taxes.
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