Gross Pay vs. Net Pay: Definition and Differences

Trying to figure out how to handle payroll for your small business can quickly become a nightmare. Different types of pay, deductions, and labor rules need to all be addressed and appropriately managed. Wondering, “What is gross pay?” is completely normal. 

You only need to start handling the essentials one by one to stay on top of legal standards and payroll rules. Getting a handle on the difference between gross and net pay is likely the first hurdle to overcome. You should be aware of the various deductions and exemptions in addition to distinguishing between the two types of payment terms. 

You can learn both how gross and net pay relate to one another and how to determine them for your business’s payroll in the sections below.

Gross Pay vs. Net Pay: The Key Differences

When you give a potential hire a contractual agreement, it usually contains the gross salary they would receive if hired. Their gross pay is their total wage before taxes and other withholdings are taken out of it. 

After all deductions, an employee’s net pay is the amount of money they will get. This is the total amount of money they have available to them, often known as their take-home pay. 

You’ll need to include both net and gross compensation on your team’s pay stubs when completing payroll. The gross pay is normally listed first, followed by information on the employee’s numerous withholdings. After that, you can calculate what the net amount should be.

Deductions From Your Gross Pay 

Payroll deductions are withdrawn from employee paychecks to guarantee that taxes, garnishments, and benefits are completed correctly. As an employer, you should guarantee that both hourly and salaried employees’ partial wages from their paychecks are withheld. Withholding salaries from independent contractors, on the other hand, is not essential. 

Although calculating and keeping track of these deductions might seem like a  a hassle, there are certain advantages to doing so. For example, certain deductions, such as health insurance, are fully voluntary. 

Maintaining track of payments, particularly your payroll, can help you decide which additional deductions you should make in order to benefit most at tax time. 

How to Calculate Gross Income

Multiply the employee’s gross salary by the number of pay periods to calculate gross income. For example, if someone is paid $800 a week and works every week for a year, their annual gross income is $41,600 because there are 52 weeks in a year. 800 multiplied by 52 is $41,600.

How To Calculate Gross Income For Salaried Employees

The method for determining gross pay is largely determined by the way theemployee is compensated. Gross pay for employees with salaries is found by taking their yearly income and dividing it by the number of pay periods in a year. So, if a person earns $41,600 per year and is paid monthly, the gross compensation is $3,466 each month.

Calculating Gross Income for Wage Employees

Take the hourly rate and multiply it by the amount of hours that are worked during a pay period to get the gross pay for hourly workers. A part-time employee who works 35 hours at $12 per hour, for instance, will earn $420 in gross salary. If relevant, overtime costs must also be factored in.

How to Calculate Net Income

How to Calculate Net Income for Salaried Employees

While the details might get intricate, the basic formula for calculating gross vs. net compensation is rather simple. In theory, you can find out how to determine gross or net pay by manipulating a simple equation: 

Gross pay – (deductions + taxes) = Net Pay. 

That’s all there is to it. 

All you have to do is take your gross salary and add it to your total deductions and taxes, then subtract the latter from the former. Your net pay is the consequence, and it tells you all you need to know about your gross vs. net wage. 

Calculating Net Income for Wage Employees 

We must deduct FICA tax, federal, state, and local income taxes, and health insurance from the employee’s gross compensation in order to compute net pay. 

Determine the employee’s net compensation using the formula for calculating net pay. 

Gross pay – deductions = net pay. 

Let’s imagine your employee is a single-filer from Phoenix, Arizona, who has filed no Form W-4 claims. 

The employee’s hourly wage is $12, and she works 40 hours per week. The employee is paid weekly, and their total earnings are $480. 

The employee’s weekly health insurance premium is $50. Social Security, Medicare, and income tax withholding are not applied to health benefits. 

To calculate the employee’s net compensation, you will withhold the following:

• Health Insurance Premium
• FICA Tax
• Federal Income Tax
• State Income Tax
• Local Income Tax

Here’s an overview of the amounts we determined for withholding: 

What Are Deductions?

You must withhold deductions to get from gross to net compensation. Payroll deductions are sums deducted from an employee’s paycheck on a regular basis. Deductions are both necessary for all types of businesses.

Payroll and income taxes are examples of obligatory payroll deductions. Social Security, Medicare, and federal income taxes must all be withheld. You might also need to withhold state and local income taxes, depending on where your employees work. 

Garnishments and child support payments are examples of obligatory non-tax deductions that you may have to withhold. If you need to deduct these from an employee’s gross salary, you’ll be told. Health, disability, and life insurance, retirement plans, flexible spending accounts (FSAs), and health savings accounts are all examples of voluntary deductions (HSAs).

Conclusion

Depending on the situation, gross and net income might have distinct meanings. These words can be found in a variety of locations, including loan applications. 

Using a basic rule of thumb is an easy approach to keep these terms straight. The larger amount is usually gross income, whereas the lower number is net income. Look at the directions or contact someone for help if you’re not sure which number is being required on a form.

Free insights to help you take control of business finances.

Discover the best tips, tricks, and tools for better money management.

Email *

Subscribe