What is Gross Pay? Definition, Calculation, and Examples in 2025

Gross pay compliance

Gross pay is governed by labor and tax regulations. Employers are responsible for calculating and reporting it correctly to comply with federal, state, and local laws.

If you have employees, here’s what’s expected of you to remain compliant:

Classify employees and calculate pay correctly

Correctly identify whether each worker is an employee or an independent contractor, and determine their exempt or non-exempt status under the Fair Labor Standards Act (FLSA). Gross pay must reflect all earnings owed to the employee, including base pay, overtime, bonuses, and commissions. Misclassifying workers can lead to serious consequences, including back wages, legal penalties, and potential lawsuits.

Follow all applicable wage and recordkeeping laws

Stay current with federal, state, and local regulations, including minimum wage standards, overtime rules, and required payroll recordkeeping. Maintain payroll records for at least three years (FLSA requirement). Some records, like wage computations, should be kept for two years.

Provide clear pay stubs 

Pay stubs should clearly outline gross pay, deductions, and net pay to help employees understand how their earnings are calculated. While it’s a best practice to provide pay stubs in all states, some require them by law, while others leave it up to the employer. Regardless of location, offering clear and consistent pay documentation supports transparency and fosters trust. 

Use consistent payroll processes

Apply reliable, standardized payroll procedures across the organization. This reduces the risk of errors and supports ongoing compliance with wage and labor regulations.

Report earnings and withholdings accurately

Employers must provide each employee with IRS Form W-2 at the end of the year, showing total wages and all taxes withheld. These figures are used by employees when filing their tax returns.

Withheld amounts for income tax, Social Security, and Medicare are considered part of gross income and must be reported in the year they’re withheld.

Employers are also required to submit W-2 forms and other payroll-related filings to the IRS and the Social Security Administration to remain in compliance.

Conduct payroll audits

Conducting regular payroll audits helps ensure accurate wage calculations, proper handling of deductions, and alignment with current labor laws. Audits can catch errors early, prevent costly compliance issues, and confirm that your payroll processes are running efficiently.

Factors that affect gross pay

Gross pay includes more than just an employee’s base wages or salary. Various factors can increase the total amount an employee earns before deductions are applied. 

Here are some of the most common items that can impact gross pay:

• Overtime pay. Hours worked beyond 40 in a workweek (under FLSA guidelines) are typically paid at 1.5× the regular hourly rate.
• Bonuses. Performance, signing, or holiday bonuses are considered part of gross earnings.
• Commissions. Sales-based compensation is added to gross income and varies based on performance.
• Tips. Tips received directly or reported by employers are included in gross pay.
• Shift differentials. Higher pay for night shifts or less desirable hours may be added to regular wages.
• Piece-rate pay. Compensation based on units produced or tasks completed adds to total earnings.
• Retroactive pay. Back pay from a previous period (e.g., retroactive raises) increases gross pay.
• Paid time off (PTO). Paid time off (PTO), like vacation or sick days, is included in gross pay when it’s paid out. This includes regular paid time off during employment and any unused PTO paid at termination, both of which are subject to tax withholdings.
• Taxable fringe benefits. Some cash or non-cash perks must be included in gross pay unless specifically exempt under IRS rules. Examples include the personal use of a company car or housing allowances. 

How benefits affect gross pay

Most benefits do not increase or reduce gross pay. Pre-tax and post-tax deductions—like health insurance or retirement contributions—are taken out after gross pay is calculated. Employer-paid benefits, like 401(k) matches or insurance premiums, also don’t count toward gross pay. In short, benefits affect what gets withheld, but not the gross pay amount itself.

However, certain taxable fringe benefits, such as personal use of a company car or housing allowances, must be included in gross pay and reported for payroll tax purposes. Review IRS guidelines to identify fringe benefits that may require tax reporting.

What is the deduction order of precedence in payroll?

Sometimes, an employee’s gross pay isn’t enough to cover every deduction in a single pay period. When that happens, there’s a set order, called the order of precedence, that tells employers which deductions to take out first.

This order ensures that required taxes and legal obligations are taken out before any optional deductions. Here's how it typically works:

1. Retirement contributions, including federal pensions.
2. Mandatory taxes like Social Security, Medicare, federal, state, and local income tax.
3. Basic insurance premiums, such as employer-sponsored health or life insurance.
4. Government debts, including unpaid taxes, salary overpayments, or advances.
5. Court-ordered payments, for example, child support, alimony, or bankruptcy-related garnishments.
6. Optional benefits, such as dental, vision, flexible spending accounts, or retirement savings (e.g., 401(k)).
7. Other voluntary deductions, which may include union dues, charity donations, or personal account transfers.

If the paycheck can’t cover everything, deductions lower on the list may be skipped or reduced until the next pay period.

How to use gross pay for financial planning

From planning long-term savings to designing thoughtful compensation strategies, understanding how to use gross pay can help both employees and employers make informed, strategic choices.

For employees:

Gross pay gives you a full picture of your earnings before deductions. It’s useful for setting a budget, planning for large expenses, and evaluating job offers. Understanding your gross pay helps you estimate taxes and compare benefits across jobs more clearly.

For employers:

Employers use gross pay to estimate payroll costs, stay compliant with wage laws, and structure compensation fairly. It also helps them evaluate the financial impact of raises, bonuses, and benefits when planning budgets.

Accurate payroll starts with accurate gross pay

Accurate gross pay calculations support fair pay, regulatory compliance, and employee confidence. It forms the cornerstone of a payroll system that guides smart planning, protects your business, and fosters long-term trust.