How Do You Calculate Net Pay? - A Full Guide

Overview

Employers are responsible for ensuring that deductions and taxes are taken out and considered from their employees gross pay. Understanding the way in which net pay works is extremely important for running a smooth and efficient business - whilst also adhering to legal requirements and accuracy. 

It’s therefore essential that we understand the differences between gross pay and net pay before we dive in any further. 

Net Pay vs Gross Pay 

The figure of your employees salary is not what they will be taking home - so we need to find out what these pay differences are. 

Also read: How To Prepare Your Accounts For New Hires

Gross Pay Explained 

Gross pay is the figure that the employee's wage will be before deductions. If you want to calculate how much the gross pay will be weekly, simply divide their annual pay by 52 (52 weeks). If you want to calculate the hourly pay, just multiply the hours the employee has worked with their hourly pay figure. 

What About Net Pay?

Net pay is the take-home pay that an employee will have. This is their pay after deductions have been withdrawn from the gross pay. 

What Exactly Are Deductions?

To go from gross pay to net pay, you must take out deductions. A deduction from the payroll is the money that you withhold from an employee's take-home pay which can either be voluntary, mandatory or both. 

Examples of mandatory deductions include things like federal tax, social security, medicare, local and state taxation (which could also be garnished salary demand from court due to a judgement) or payroll deductions. Whereas examples of voluntary deductions might include disability, HSA and FSA, retirement plan, health or life insurance. 

So, How Do You Calculate Net Pay?

Effectively, net pay is the gross pay minus deductions. Understanding the deductions is the critical part of the process, because getting these figures wrong will wildly change the final figure. 

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Taxes - How Much Is Deducted?

Medicare and social security is in the bracket of FICA tax - which is a flat rate of 7.65% which must be withheld from the employees pay. Out of this percentage, 6.2% is used for social security taxation and medicare receives 1.45%. If applicable, an employee might reach a specific threshold which would incur an additional medicare tax and social security wage base. 

Federal taxes that are withheld from an employee’s income will vary depending on circumstances such as the amount of pay the employee receives. Any local or state income taxes will vary depending on where you are. 

What About Deductions That Aren’t Tax?

The next step is to determine exactly the deductions that must be withheld that aren’t taxes. It’s important to note that some of these deductions will be before tax and some will be after tax. 

If the deduction is before tax, you have to deduct this amount before considering the tax deduction which will overall lower their income that can be taxed. These deductions before tax can be things like for retirement or a plan for life insurance. 

If the deduction is after tax, you have to withhold the amount after you determine their taxable deduction. Some retirement plans fall into this category like Roth and another example is garnished salary through a judgement or for child support payments. 

What Is An Example Calculation Of Gross To Net 

Consider for example an employee that is making 15 bucks an hour for working 40 hours a week. If you’re paying weekly a gross sum of 600 dollars. 

Their health insurance is 50 dollars a week which are exempt from medicare or income tax - they’re pre-tax deductions. So deduct 50 dollars from 600 dollars equating to $550. This is the figure you will use to determine the tax for the employee. 

Also read: Why Pay Stubs Are Important At Tax Time 

FICA Taxation 

You must determine this by multiplying the wage of the employee after any before tax deductions by the figure of 7.65%. In this example, it will be $550 x 7.65% which equates to $42.08. 

This final figure of $42.08 must now be withheld from the employee’s gross payment. 

Federal Taxation 

These figures will differ as we said, but if we use this example $550, then the amount to be withheld is $54. On the subject of difference, the same will apply for local and state taxations. 

Determining The Net Payment 

We must now detract the federal, state, local and FICA taxes along with the health insurance or anything else from the gross pay of the employee. 

Remember, net pay is gross pay minus deductions! 

In our example, we would see:

Gross pay = $600 

DEDUCT 

Health insurance = $50
FICA = $42. 08
Federal tax = $54 

Total = $146.08 

NET TOTAL

$600 - $146.08 

= $453.92

What Happens If I Botch The Payments?

Generally, your employee will notice the discrepancy and contact you as soon as possible in order for you to rectify the situation. If however, you choose not to or do not believe this to be the case - the employee can contact the IRS who will then begin a formal process. 

Naturally, you wouldn’t want to get these things wrong - so it’s best that, if you’re struggling, you hire an experienced accountant or payroll professional. 

Also read: How to Review Your Paychecks Before Filing Income Taxes

Important Things To Know About Deductions And Payments 

There are many important things to know about payments and deductions, which we will do our best to cover here! 

• It is against the law to withhold any portion of an employee's wages without their explicit consent, apart from legal taxations such as federal or FICA. Non-required deduction of pay must be recorded in the event of an IRS audit. 

• An employer cannot withhold any portion of an employee’s pay out of spite or in the form of protest or punishment. Even if an employee has breached the terms of their employment contract, you can’t refuse to pay them.

• You can’t make deductions of an employee’s wage if it reduces the amount of pay below minimum wage. 

• Even if your company goes bankrupt, you cannot refuse to pay an employee(s). You have a duty to continue payments through a priority debt classification in court .

• Tipped employees are still legally entitled to minimum wage.

If an employee is disgruntled or suspects something isn’t right with their pay, they might make a formal complaint to the Department of Labor. Remember, it is your responsibility to ensure your employees net pay is entirely accurate and any failure to adhere to this, will result in action taken against you! 

Also read: Why do Jobs Hold Your First Paycheck?

Summing Up

Calculating net pay from gross pay can often be a very confusing process, particularly when it comes to deductions that are different through state to state, pre and post deductions, among other things that may come into account. 

However, it’s important that you fully understand this process of how to calculate the net pay from the gross pay and if you find it difficult to keep up, contact a professional. All these mentioned deductions will also be shown on your pay stubs. Our pay stub maker is a simple way to generate pay stubs online and it is very user friendly.