As an employer, you’re required to deduct payroll taxes from employees’ paychecks. To do so correctly, you need to understand two key terms: gross pay and net pay. Gross pay is the total amount an employee earns before you deduct anything from their paychecks, namely payroll taxes. Once you’ve deducted payroll taxes (and made any other deductions, like health care premiums or IRA contributions), your employee goes home with the net pay, or the sum left over after deductions.
Gross Pay vs. Net Pay
How to calculate gross pay
To calculate an hourly employee’s gross pay over a given pay period, multiply their hours worked by their hourly rate. For instance, let’s say you pay an employee $20 an hour. They work 40 hours a week, and you pay them every Friday. To find their gross pay for one pay period, multiply their hours worked by their pay rate:
$20 x 40 hrs. = $800
Your employee’s gross wages for the period total $800.
To calculate a salaried employee’s gross salary over a given pay period, figure out how many pay periods you have this year. Then, divide the employee’s annual salary by the number of pay periods to find out how much they earned this pay period.
For example, let’s say a salaried employee earns $52,000 a year. You pay your employees every week, which means there are 52 pay periods in the year:
$52,000 / 52 pay periods = $1,000
Your salaried employee’s gross pay for the pay period is $1,000.
In general, employers can choose from one of four pay schedules:
- Monthly (12 paydays per year)
- Semimonthly (24 paydays per year)
- Biweekly (26 paydays per year or 27 paydays in a leap year)
- Weekly (52 paydays per year)
Different states have different rules about which pay schedules you’re allowed to use. Check out the Department of Labor’s list of state regulations to find yours.
Tips, bonuses, and overtime
If your employee earned any supplemental wages this pay period, such as tips or overtime pay, make sure to add that total to their gross pay calculation. And if your employee earned a bonus this pay period, you can either add the bonus’s total to your employee’s gross wage this pay period or pay out the bonus as a separate payment. If you choose the latter, you’ll deduct a 22% flat tax rate from the bonus before paying your employee. (You can calculate bonus taxes using our free calculator.)
How to calculate net pay
Once you’ve calculated your employee’s gross pay, it’s time to calculate their net pay. The net pay is what remains after you withhold money for taxes, childcare payments, or other key deductions. Each pay period, you’ll follow these steps to find your employee’s net salary.
1. Check for voluntary pre-tax deductions
Not every employee opts into voluntary deductions, but those who do might request pre-tax deductions like these:
- Retirement plans, such as 401(k)s
- Premiums for employee-sponsored health care plans
- Group life insurance contributions
Make these deductions from the employee’s gross pay before calculating and withholding their payroll taxes—income dedicated to the voluntary deductions listed above are not taxed.
2. Calculate and withhold payroll taxes
Payroll taxes are taxes employers are required to withhold from their employees’ paychecks and remit to the IRS. After you make any pre-tax deductions, you’ll need to deduct the following taxes from your employees’ gross pay:
- Federal income taxes (FIT)
- State income taxes
- Social Security tax and Medicare tax (collectively known as FICA taxes, or Federal Insurance Contribution Act taxes)
Federal and state income taxes
To calculate federal and state income tax contributions, you’ll need your employee’s W-4 form. This form lists the employee’s withholding allowances, which determine how much you’ll withhold in taxes based on the employee’s marital status, dependents, additional income sources, and more.
We recommend using payroll software or a free payroll calculator to accurately calculate federal income tax deductions. With both options, you’ll just enter your employee’s gross income, withholding allowances, and tax-filing status. The software or calculator will automatically perform the calculation for you.
If you’d rather not use software or a free calculator, you can use the tax deduction worksheets listed on IRS Publication 15-T—but we strongly recommend using a calculator or payroll software instead. It’s easier, faster, and has less room for human error. If you’re committed to calculating taxes by hand using the IRS’ worksheets, we advise you to check out tax-filing resources like our guide to paying payroll taxes first.
Calculators and software can also automatically calculate and deduct your state’s income tax amount from employee paychecks. You’ll just choose the state in which you’re paying taxes from a drop-down menu, and the calculator or software automatically inserts your state’s tax rate.
Some states, including Texas and Alaska, lack state income taxes. If you’re running payroll taxes by hand, visit the IRS’ list of state websites to look up your state’s income tax requirements.
Employees must contribute 6.2% of their gross pay towards Social Security and 1.45% towards Medicare. Employers are required to match these contributions to Medicare and Social Security. Together, the employee and employer contributions total 15.4% towards Social Security and 2.9% towards Medicare.
3. Make any other mandatory deductions
Apart from taxes, you could be legally obligated to make other deductions from an employee’s paycheck. For instance, if an employee has court-ordered child support or spousal support payments, you’ll have to deduct those payments from the employee’s pay (after you make pre-tax and tax deductions).
Some employees might request additional deductions, such as the following:
- Charitable contributions
- Additional insurance contributions
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Tools for calculating net pay
You have a few main options for calculating net pay:
- By hand, using the IRS’ tax deduction worksheets
- With a free paycheck calculator
- With payroll software, such as Gusto or ADP
- With the help of an accountant, HR team, or virtual bookkeeping team
Calculating net pay by hand or with a free paycheck calculator are the cheapest options. And since IRS penalties for miscalculating taxes run high, we strongly recommend using a paycheck calculator in combination with a free payroll template.
If you’d rather not spend money on payroll software or a part-time accountant, consider downloading a free payroll template. It’s an easy way to keep employee payment records, which are necessary for maintaining a balanced budget and protecting yourself in the event of an audit. Many payroll templates also include employee pay stubs and check-printing options to streamline the payroll process.
Payroll software can cost anywhere from $0 to several hundred dollars a month, depending on the provider you choose and the number of employees you’re paying. Free, trustworthy payroll service providers are few and far between, but there are some solid options for paying employees at no cost. (We particularly recommend Payroll4Free, which lets you pay up to 25 employees with no fee.)
Otherwise, full-service payroll providers like Gusto start at around $20 a month. Along with calculating payroll taxes, these full-service providers will automatically remit payroll taxes to the IRS with the correct forms on your behalf.
A full- or part-time accountant costs the most of these four options, but as on-site financial professionals, they can take the most payroll stress off your plate. If your company is big enough, you’ll likely use a full-time human resources team to ensure your payroll taxes are both accurate and remitted on time. If an on-site expert or team is too much for your company, a virtual accounting team can help you minimize costs by dealing with payroll and finances offsite.
Gross pay vs. net pay FAQ
What is the definition of gross pay?
Gross pay is the total amount an employee makes before any money is deducted from their paycheck for taxes.
Which is higher, gross pay or net pay?
Net pay is what remains after an employer makes deductions from an employee’s gross paycheck. Therefore, gross pay is always higher than net pay.
Is gross income before or after taxes?
Gross income refers to an employee’s income before taxes and other mandatory deductions are made from their paycheck. Net income refers to an employee’s paycheck after mandatory deductions like payroll taxes, wage garnishments, and health insurance premiums are taken out.
How can you calculate gross pay from net pay?
You can calculate an employee’s gross earnings based on their net earnings using a gross-up calculator. The calculator is pretty straightforward: along with the employee’s net pay, you’ll need their Form W-4 so you can fill in relevant tax information. You’ll also want info on additional deductions your employee makes, including to health insurance plans and 401(k)s.
Gross wages and net wages are just two of the many financial phrases small-business owners need to know. And while the concepts might seem a little tricky upfront, don’t worry—from free templates to payroll software, you have plenty of tools at your disposal to calculate both amounts correctly.
Getting ready to hire your first employee? Read through our ultimate guide to small-business payroll to make sure you’re all set legally and financially.
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