What Is Gross Pay and How To Calculate It

When you look at a paycheck, you’ll notice that the amount for gross pay is different from the final take-home amount. Gross pay refers to the total compensation an employee receives before any taxes or deductions are taken out.

Understanding gross pay is important for negotiating salary, managing your taxes, and planning a budget. In this article, we’ll go through the components of gross pay, common deductions from gross pay, and how to calculate gross pay for salaried and hourly wages so you can simplify your payroll process.

Key Takeaways

• Gross pay is the total amount an employee is paid before taxes and other deductions.
• Understanding gross pay is important for tax compliance, budgeting, and fair compensation.
• Gross pay includes regular wages, salaries, overtime, commissions, bonuses, tips, vacation, holiday, and sick pay.
• Federal and state income tax withholdings, Medicare and Social Security taxes, health insurance premiums, and contributions to retirement plans are deducted from gross pay.
• Net pay (take-home pay) is employee earnings after payroll taxes and other mandatory and non-mandatory deductions are subtracted from gross pay. 

Table of Contents

• What Is Gross Pay?
• Understanding Gross Wages as an Employer
• Understanding Gross Wages as an Employee
• Gross Pay Components
• What Can Be Taken Out From Gross Wages?
• How To Calculate Gross Pay
• Gross Pay vs. Net Pay
• Simplify Your Gross Payroll Process

What Is Gross Pay?

Gross pay is the total amount of wages an employee earns before any deductions are made. Payroll deductions, taxes, and health benefits are deducted from an employee’s gross wages.

When employers discuss salaries and wages, they usually discuss them in terms of gross pay. For example, $70,000 annual salary or $40 an hour wages are examples of gross pay.

Understanding Gross Wages as an Employer

As an employer, it’s important to understand gross wages so you can meet all your legal obligations and have fair and transparent compensation discussions with your employees. Some of the benefits of understanding gross wages as an employer include:

Transparent Compensation

Gross pay is the total amount of money that you pay to an employee, but it’s not the total amount they take home. Taxes, benefits, and other deductions are taken from gross pay, reducing the final sum that your employee receives. Ensuring that both you and your employees understand what gross pay means and how it affects your employees helps you negotiate clear compensation where both parties are satisfied.

Legal Compliance

Understanding gross pay ensures that you can properly make any deductions to employee paychecks. This includes mandatory deductions like taxes as well as voluntary deductions for other benefits like company savings plans.

Payroll Management

Knowing how gross wages work helps you streamline your payroll process so you can make all necessary deductions before you send out paychecks.

Planning Your Budget

Calculating total gross wages for all your employees allows you to create a clear budget for all your labor expenses. It also helps you to predict how much you’ll spend on labor in the future.

Understanding Gross Wages as an Employee

As an employee, gross wages represent your total earnings for tax purposes, but they’re not the amount you take home at the end of the day. Understanding what goes into gross wages can help you plan and budget for financial success.

Income Evaluation

When employers discuss your salary or wages, they’re usually speaking in terms of gross pay. Knowing this can help you decide whether a job is offering you fair compensation for your work and whether it will be enough to comfortably support your lifestyle. 

Budgeting & Financial Planning

Although you’ll see your gross pay on a paycheck, you’ll take home a smaller amount (called net pay) after taxes and other deductions. Understanding the difference between gross and net pay helps you plan an accurate budget. 

Loan & Credit Application

Most credit and loan applications ask for your gross annual or monthly income. It’s important to put your gross income, rather than your net income, so that you can provide accurate information on your application and increase your chances of approval.

Gross Pay Components

Several components come together to total your gross pay. These different components include the following:

Hourly Wages 

An hourly wage is a fixed amount earned per hour multiplied by the total number of hours worked in each pay period. Hourly wages are one type of gross pay that an employer can pay an employee.

Some employees like hourly wages because they can receive a greater overall sum if they work a large number of hours. However, the variability of hours worked means that paychecks can sometimes fluctuate.

Salaries

A salary is a fixed amount of pay an employee earns during a year. Salaried employees are usually exempt from overtime pay. Salaries are usually paid bi-weekly or monthly. A salary is another type of gross pay that an employer and employee can negotiate.

Some employees prefer salaries as the consistent paycheck makes it easier to create a regular budget.

Bonuses

In some cases, an employer may award an employee a bonus for good work. Bonuses are also sometimes given for special occasions like holidays. These bonus payments are included as a part of income in gross pay.

Overtime

If an employee works more than the agreed-upon number of hours (usually 40 hours per week), they may be paid overtime. Overtime is often paid at a higher hourly wage than standard hours, in most cases one and a half times the standard hourly wage. Overtime hours are included in gross pay.

Tips

In many service industry positions, customers will give an employee a tip as a form of direct compensation. These tips are in addition to the employee’s regular compensation from their employer. Tips must be declared as income and are included in gross pay.

Shift Differentials

Shift differentials refers to working at non-standard times, for example at night or on the weekends, at an elevated pay rate. Unlike overtime pay, there’s no required standard rate for these hours, but employers may offer an elevated rate to encourage employees to work these shifts. Some businesses with round-the-clock operating times may choose to offer shift differential payments.

Commissions

Commissions are a type of performance-based compensation where an employee receives a certain amount when they complete a task. For example, many sales jobs like real estate include a commission for selling a property or meeting a certain sales quota. Commissions can be a motivating factor for employees to meet the company’s goals. 

Piece Rate Pay

Piece rate pay is a form of per-unit compensation. This can include a set amount for items made, picked, cleaned, etc. Piece rate pay replaces hourly or salaried pay and is sometimes used by employers who want to motivate employees to reach a set quota. Some employees also like piece rate pay because they make a greater amount when they deliver higher output.

Vacation Pay

Vacation pay is when an employer gives an employee a certain amount of paid time off for leisure. These vacation days are compensated at the employee’s standard pay rate. Vacation pay is an important way for employees to rest and recover without having to worry about financial challenges. 

Sick Pay

Sick pay is similar to vacation pay in that employees are able to take a few days off work without losing income. The advantage of sick pay is that it can also help encourage employees to stay home and recover from illness, keeping them and their coworkers safe.

Holiday Pay

If employees are required to work statutory holidays, they may receive a higher level of pay than their standard pay. In most cases, holiday pay is paid at double the employee’s standard hourly wage. 

What Can Be Taken Out From Gross Wages?

Several deductions are taken from gross wages to give the final net pay. Some of these common wage deductions include: 

Federal Income Tax

Federal income tax is a tax imposed on income by the federal government. It’s calculated using the tax bracket system based on your taxable income. As your income increases, you move up the tax brackets and pay more in federal income tax, which is deducted from your gross wages.

State Income Tax

Most states deduct a state and local income tax in addition to federal income tax. The amount of state income taxes varies by state, so it’s important to check the regulations in your area. You’ll also need to check regulations if you have employees in multiple states, or if you are employed in multiple states. All states deduct state income tax except Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Washington, and Wyoming. 

Social Security

Social Security is a federal retirement plan that helps provide retirement income to most workers in America. Employers and employees are both required to contribute to Social Security. They must each pay 6.2% of wages into the program, with a maximum of $168,600.

Medicare

For people aged 65 and older, Medicare offers federal health insurance with set coverage and rates. Medicare is also available for some people with specific conditions and disabilities. Like Social Security, both employers and employees contribute 1.45% of wages and an extra 0.9% for those whose wages exceed $200,000.

Retirement Plan Contributions

Retirement plans aren’t mandatory, but many employees choose to contribute to one. In many cases, employers will offer a retirement plan through the company and may also contribute to retirement contributions as an incentive to draw workers to the company. If an employee elects to pay into a plan like a 401(k), this will be deducted from gross wages.

How To Calculate Gross Pay

The 2 most common types of gross pay are salaried and hourly pay. The calculations for each are slightly different, so we’ll walk through the steps of how to calculate salaried gross pay and hourly gross pay.

Calculating Salaried Gross Pay

Step 1: Calculate gross pay per pay period

Salaries are typically measured annually, so the first step to calculating an employee’s gross pay is to divide the annual salary by the number of pay periods the employee works. For example, someone with an annual salary of $90,000 who gets paid monthly and works 12 months has a gross pay of $7,500 per pay period.

Step 2: Add any bonuses or extras

If your employee received any tips, commissions, bonuses, or other extras for a given pay period, add them to the paycheck amount. This gives the final gross pay for that pay period. 

Calculating Hourly Gross Pay

Step 1: Calculate standard hourly wages

The easiest way to calculate hourly wages is by the week since most overtime applies to working more than 40 hours in a given week. 

If an employee makes $20 per hour and worked 45 hours this week, start by multiplying 20 x $40 for $800.

Step 2: Calculate overtime and holiday pay

Next, add any hours that are worked at a higher pay rate. If they worked 45 hours in a week, that’s 5 hours of overtime at 1.5 hourly wage, so $20 x 1.5 = $30, and 5 x $30 = $150.

Adding the standard hourly wages and overtime pay together, they would receive $950. 

Step 3: Add bonuses and extras

Finally, add in any bonuses, commissions, or other additional payments. For example, if this employee met a sales quota and received a bonus of $100, they would now have a total gross pay of $1,050 for this pay period. 

Gross Pay vs. Net Pay

Gross pay is the total amount of an employee’s paycheck before taxes and deductions, while net pay is the amount an employee takes home after all deductions. 

When employers are negotiating hourly wages and salaries, those are talked about in terms of gross pay. It’s important for employers and employees to understand the difference between gross pay and net pay so they can negotiate fair compensation and plan an accurate budget based on the real amount employees receive after taxes and deductions.

Learn more about gross pay vs net pay and why they’re important at tax time.

Simplify Your Payroll Process

Gross pay is the total amount of wages an employer pays to an employee before any taxes or deductions. This is different from net pay, which is the final amount the employee receives after deductions. Understanding gross pay is essential for business budgeting and ensuring your payroll is legally compliant.

The right payroll programs can help business owners simplify gross and net pay calculations. FreshBooks payroll software offers automated tax calculations and unlimited payroll runs so you can deliver quick and accurate payroll to your employees. Try FreshBooks free and simplify your gross pay calculations today.

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