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The Difference Between Net Pay and Gross Pay: A Basic Guide for Your Business

Understanding how to handle payroll for your small business can easily turn into a nightmarish quest. Different kinds of pay, deductions and labor laws all need to be considered and handled properly. 

To stay on top of legal requirements and payroll rules, you just have to start tackling the essentials one by one. Grasping the difference between gross and net pay is probably the first one to conquer. Besides differentiating between the two types of pay terms, you should also stay on top of the different deductions and exemptions. 

In the sections below, you can find out not only how gross and net pay relate to each other, but also how to calculate them for your company’s payroll. 

What Is the Difference Between Gross Pay and Net Pay?

When you offer a contractual agreement to a potential hire, that typically includes the gross amount they would receive if employed. The gross pay is their total salary before any taxes and other withholdings are deducted from their paycheck. 

The net pay is the income that an employee would receive after all possible deductions have been made. This represents the actual total amount of money they can use, or their take-home pay. 

When preparing payroll for your team, you would need to include both net and gross pay on the pay stubs. The gross pay usually appears first, followed by details about the various withholdings that apply for the employee. Afterwards, the net pay amount should also be included.  

Calculating Gross Pay

The definitions of gross and net pay are easy to grasp. However, the payroll battle gets tough when it comes to calculating payments for different types of workers. 

Salaried Employees

Employees who receive a fixed remuneration per year are called salaried employees. They are considered exempt employees under the U.S. Fair Labor Standards Act (FLSA). 

Gross income signifies the total yearly amount that an employee earns. In order to calculate the gross amount for a weekly, biweekly or monthly term of a salaried worker, you can use the following formula:

Gross pay = annual gross salary / number of payroll periods

For example, if the annual gross pay of a team member is $33,000 and you want to calculate the monthly pay, you can divide $33,000 by 12 months. The result is $2,750. You can adjust the calculation to a weekly or bi-weekly payroll period, if you need to obtain even more granular information. 

Hourly Employees

Many types of businesses with a mobile workforce – from construction to delivery services – hire workers on an hourly basis. They are considered non-exempt employees under the FLSA’s definition. 

The calculation for the gross pay of an hourly worker is different than that of a salaried employee. 

The formula is the following:

Gross pay = gross hourly rate x number of hours worked for a pay period

You can thus easily calculate the gross wage of an hourly worker according to the number of pay periods. The period can be a week, month, or even year, but in all cases, you must use the gross hourly wages that you have set when hiring the employee. 

To get the calculation right, you also have to keep in mind the hours per week that the person has agreed to work. In many cases, it’s 40 hours per week, but hours can vary for part-time employees. 

Let’s say that you pay the minimum wage – $12 per hour (gross) to one of the couriers working for your delivery company with less than 25 employees in California. 

The person works 40 hours per week, so the standard full-time work week. You want to determine the employee’s gross wage for a month. 

The calculation will be the following: 

$12 x 40 hours x 52 weeks /12 months = $2,080 

The gross pay of an hourly employee may also span other types of payments, such as overtime pay and bonuses. Keep in mind that the overtime pay rate is 1.5 times the regular hourly rate of a worker. 

Formula for Calculating Net Pay

In order to calculate an employee’s net pay, you have to first determine the gross pay, following the formulas in the previous section. 

Then, you can make the following subtraction:

Net pay = gross pay – all types of deductions

This formula also appears quite straightforward. The catch is that you need to determine all the various tax rates and other obligatory and voluntary deductions that apply to this particular person. 

Basics about Payroll Deductions and Tax Withholdings

What types of deductions and withholdings do you have to keep in mind in order to calculate your payroll correctly, and more specifically – the net pay? 

The main income tax withholdings from an employee’s paycheck include local, state and federal income taxes. All staff members have to fill out a W-4, the Employee’s Withholding Certificate. In it, they have to declare their tax deductions, with special consideration to the number of people in their family. You have to cross-check with the IRS tax charts in order to determine the deductions that apply. That’s how you will get the amount of payroll taxes that have to be withheld. 

The other major obligatory withholdings for employees include Medicare tax (1.45%) and Social Security tax (6.2%), which is often referred to as FICA tax (7.65% altogether). You have to direct all tax deductions to the IRS and pay the rest of the sum to the employee. 

In some cases, there may be additional deductions, called wage garnishments. They may include unpaid child support, student loans, taxes, and credit card loans, among others. 

There are also voluntary deductions that you may need to take out from an employee’s gross pay to calculate their net pay. Some of the typical ones include health insurance premiums, retirement contributions, additional life insurance, donations to charities, and others.

Keep in mind that health benefits and retirement contributions are considered pre-tax deductions. They have to be subtracted before the tax withholdings are applied. Post-tax deductions include garnishments, for example, which have to be deducted after taxation. 

Need Help with Handling the Payroll for Your Business?

Are you prepared to take care of all payroll requirements – beyond net and gross pay? If you want to operate a successful business, you need to be. You have to comply with a number of laws, such as having a payroll register, issuing the right pay stubs, and keeping your payroll records for at least three years. And that’s not all, of course.

How can you stay on top of payroll laws and practical aspects? Hourly is here to help. It offers a platform that combines time tracking, payroll and workers’ compensation insurance tools for your business. With Hourly, you can record and report each and every item for your payroll – without the hassle. 

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