If you’re new to the world of employment, you may come across terms on your pay stubs or in conversations that may leave you confused. One of those terms is the difference between gross pay and net pay. This is an important term that you must understand as it will allow you to understand precisely how much you’re getting paid, where your money is going, and how much you’re left with.
This article will discuss the key difference between gross and net pay and how you can calculate them. So let’s get started.
Gross pay vs. Net pay: Definitions and examples
Please find below a definition and example of what gross pay and net pay mean,
What is gross pay?
Gross Pay: Gross pay is the total amount of money that an employee gets paid from employment BEFORE any deductions are taken.
Example of Gross Pay: Fred has just secured a new job in California, and his employment contract indicates that he will earn $120,000 a year. The value of $120,000 is Freds’ gross pay. Therefore, his monthly gross pay would be $10,000.
What is net pay?
Net Pay: Net pay is the total amount of money an employee receives AFTER any taxes and deductions have been deducted.
Example of Net Pay: Following the example above, Fred has just received his wage in his bank account. Instead of $10,000, he receives $6,790 due to taxes and deductions. This is his net pay. Over a year, he will receive $81.485 in actual take-home pay rather than $!20,000.
This is the basics of what gross pay and net pay are. Gross pay is the total money an employee has earned before taxes and deductions, whereas net pay is what the employee receives once deductions have been accounted for.
How to calculate gross vs. net pay?
Next, we will look at calculating gross pay and net pay.
How to calculate gross pay for salaried employees?
An annual salary is usually agreed upon within an employment contract for salaried employees. Both the employee and employer will be aware of this, as it is often the most important aspect during the hiring/applying process. The annual salary that is agreed upon also makes up the annual gross pay for an employee.
To calculate monthly gross pay for a salaried employee, you would take the total amount of money the employee earns annually and divide it by the number of pay periods.
So, for example, if Fred earns $120,000 a year and gets paid on the 1st of every month. $120,000 is divided by 12 months, leaving $10,000 as the monthly gross pay.
An employee’s gross pay can also increase with bonuses, tips, or commissions.
How to calculate gross pay for an hourly employee?
When calculating gross pay for an hourly employee, the total amount will vary depending on how many hours are worked during the pay period. The hourly wage is multiplied by hours worked to determine the gross income.
For a gross pay example, Fred works 20 hours a week, and the hourly rate is set at $20. The hourly rate multiplied by hours worked is the total gross pay. In this example, Fred earns $400 as gross pay.
How to calculate net pay for a salaried employee?
The total sum for net pay will depend on the value of taxes and deductions. This would usually include, at the very least, Federal Income Tax, State Income Tax, Social Security, Medicare, and State Disability Insurance. The total value of all of these deductions can also vary by state. Therefore, when calculating net pay, it is important to know the total cost of these deductions.
For example, if Fred lives in California and has a monthly gross salary of $12,000. He will receive a net pay of $6,790, as $3,210 will be taken for taxes and deductions.
How to calculate net pay for an hourly employee?
Net pay for hourly employees can be calculated by taking the gross income for the pay period and then deducting the total for taxes and deductions.
For example, Fred earns $1600 in gross pay over a month. After taxes and deductions, Fred receives $1390.This is his net pay as an hourly employee.
Deductions from gross pay
Here are some examples of the standard payroll deductions that you may see:
- Federal income tax /Social Security taxes/Fica taxes
- Retirement contributions and investments or 401(k)
- Health insurance premiums
- Medicare taxes
- State/local income tax
As you can see, you need to be aware of a few different payroll taxes and deductions. Adding to this, when you factor in differences in tax amounts by the state, it can get even more confusing. Additionally, if you work and receive additional overtime pay, bonuses, tips, or commissions, this is also taxable income. This may result in a more significant difference between your gross income and net income.
How to calculate net pay from gross pay?
To work out the difference between net and gross pay, simply calculate the total amount you pay in taxes and deductions. Then subtract that from gross pay. This is your net pay. If you feel you are paying too much, then it may be worth seeking a qualified accountant for some tax advice.
The difference between net pay vs. gross pay is essential to understand. It will help you realize just how much money you have left over so you can better forecast budgets and savings.
We hope you enjoyed this article and were able to better understand the difference between net pay and gross pay and how it affects you. If you are looking for a new career or just want to know how much you could be making, then make sure you check out our salary comparisons and compensation information.