Gross Pay vs. Net Pay: What’s the Difference

When you look at your paycheck, you’ll notice two important numbers: gross pay and net pay. Gross pay is your total income before any deductions and net pay is the amount that you receive in your bank account after taxes and deductions have been applied.

Understanding the difference between gross earnings and net pay is key to financial planning. Wages and salary are discussed in terms of gross pay, so knowing the difference can help you negotiate fair compensation and create a budget. It’s also helpful for making decisions about voluntary deductions like your health insurance premiums and retirement savings.

In this article, we’ll explore your gross wages vs. net pay, their basic components, and how to calculate them. We’ll also examine the different deductions that make up net pay so you can create a financial plan that works for you.

Key Takeaways

• Gross pay refers to an employee’s total income before deductions.
• Net pay is the take-home amount after taxes and other deductions.
• Understanding net vs. gross pay helps you create a financial plan.
• Net pay deductions include federal, state, and local income taxes, FICA taxes, and voluntary and mandatory deductions.

Table of Contents

• What Is Gross Pay?
• How To Calculate Gross Pay?
• What Is Net Pay?
• How To Calculate Net Pay?
• Gross Pay vs. Net Pay Deductions
• Key Difference Between Gross Pay and Net Pay
• Conclusion

What Is Gross Pay?

Gross pay is the total amount of compensation an employee earns before any taxes or deductions. When employers and employees negotiate salaries and hourly wages, these are discussed in terms of gross pay.

Gross pay includes an employee’s base compensation, measured as a salary, hourly wages, or piece rate pay. It also includes additional compensation such as bonuses, tips, and commissions. 

If you have any work that’s paid at a higher rate, such as overtime pay or shift differentials, or any wages for holiday and sick pay, these are also included in gross pay.

How To Calculate Gross Pay?

Calculating gross pay depends on whether you receive a salary or hourly wages. We’ll explore the basics of calculating gross income for each type.

Salary Gross Pay

For salaried employees, gross pay is simply annual salary divided by the number of pay periods. For example, if an employee earns $60,000 annually and works 12 months, their monthly gross pay is $5,000.

If they’ve received any bonuses, tips, commissions, or other extras, this amount is added to get the total gross pay for that pay period.

Hourly Gross Pay

To calculate hourly gross pay, multiply the hourly wage by the number of hours worked in that pay period. Start with the standard hourly wage, then add any overtime hours afterward.

For example, if an employee makes $20 an hour and works 44 hours this week, we would multiply $20 by 40 (the standard number of hours before overtime is counted) to get $800. They also worked 4 hours of overtime (usually counted at 1.5 hourly rate), so $30 x 4 gives us $120. Together, their gross pay for the week was $920.

As with payroll taxes for salaried workers, any bonuses are added afterward.

Learn more about gross pay and how to calculate it with our in-depth guide.

What Is Net Pay?

Net pay is the amount of money an employee receives after all taxes and deductions. This is their ‘take-home’ pay, or the amount that will be deposited in their bank account. 

Net pay includes deductions for federal income taxes as well as state and local income taxes. It also includes Medicare and Social Security, as well as any voluntary deductions like insurance plans and retirement savings plans. 

How To Calculate Net Pay

You can calculate an employee’s net pay by subtracting taxes and deductions from gross pay:

Net Pay = Gross Pay – Taxes and Deductions

Calculating Gross Pay

Calculate gross pay according to whether an employee is paid a salary or hourly wage. Add any bonuses, tips, and commissions to get the total gross pay for that pay period. 

Calculating Taxes and Deductions

Next, add up federal income tax and state and local income taxes. Federal income taxes are taxed according to tax bracket and marital status, but remain consistent across the nation. State and local income taxes vary by region, so it’s important to check the regulations for your area.

Medicare and Social Security are taxed at 1.45% and 6.2% respectively for a total of 7.65%.

Finally, include any mandatory and voluntary deductions. Mandatory deductions include things like court-mandated wage garnishments, while voluntary deductions include medical and life insurance and retirement savings plans. Note that some deductions are pre-tax and some are post-tax so it’s always a good idea to check whether they should be deducted before or after taxes.

Learn more about net pay and how to calculate it.

Gross Pay vs. Net Pay Deductions

Gross pay is an employee’s total income before deductions, while net pay is the amount an employee receives after deductions. The following deductions are included in calculations for net pay:

Federal, State, and Local Income Taxes

Income taxes are a mandatory deduction that typically includes three levels—federal, state, and local. Federal income taxes depend on your tax bracket and marital status and are consistent across the United States.

State income tax rates vary by state, and not all states have income taxes. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Washington, and Wyoming do not have state-level income tax.

Local income taxes also vary depending on your municipality.

Medicare and Social Security Taxes

Medicare and Social Security taxes make up the Federal Insurance Contributions Act (FICA) taxes, which total 7.65%. Employers match these contributions so the federal government receives a total of 15.3%. 

Like income taxes, these tax deductions are mandatory.

Voluntary Deductions

Employees may have the option to opt into certain programs like retirement savings, medical insurance, life insurance, and other benefits. If you pay a health insurance premium or contribute to a retirement plan, these voluntary contributions are deducted from gross pay.

Mandatory Deductions

In some cases, an employee may also have non-tax mandatory deductions. These can include court-ordered deductions like wage garnishments for child support or debt payments.

Key Difference Between Gross Pay and Net Pay

The key difference between gross pay and net pay is that gross pay includes no taxes or deductions, while net pay is the take-home amount after taxes and deductions have been applied.

Salaries and wages are discussed in gross pay, whereas net pay is the amount deposited into an employee’s bank account. Since net pay includes taxes and deductions, it’s a smaller total amount than gross pay.

Net pay is calculated by subtracting taxes and deductions from gross pay. These taxes and deductions include income taxes at federal, state, and local levels, as well as payroll deductions like Medicare and Social Security taxes. Mandatory and voluntary deductions such as wage garnishments, insurance premiums, and retirement plans also make up net pay.

Conclusion

Gross pay refers to an employee’s total income before any deductions, while net pay is the amount an employee receives after taxes and deductions. Understanding the difference between net and gross pay helps you negotiate fair compensation, plan your budget, and ensure you meet all your tax obligations.

The right payroll system makes it easy to calculate your employee’s gross and net pay. FreshBooks payroll software offers unlimited runs and automatic tax calculations so you can deliver quick and accurate paychecks. Try FreshBooks free to streamline your gross and net pay calculations today.

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