Gross pay vs. net pay: How to calculate the difference

Whether you’re a business owner or an employee, it  pays to know the difference between gross and net pay. It’ll help you explain the difference to your employees and give you insight into how to calculate employee paychecks. 

Gross pay, or gross wages, is the amount an employee would receive before payroll taxes and other deductions. By contrast, net pay is the amount left over after deductions from an employee’s gross pay. Let’s explore the differences between the two and how to calculate each:.

What is gross pay?

Gross pay is the total pay a worker earns before payroll taxes and deductions. It is the cumulative earnings amount, meaning it includes all of the following: 

• Salary
• Hourly wages
• Overtime pay
• Bonuses
• Commissions
• Tips

Gross pay for ‌salaried workers is their annual salary divided by the number of times they’ll receive a paycheck during a year. Gross pay for hourly employees is the number of hours they work during the pay period multiplied by their hourly pay rate. Then you add overtime, bonuses, or other pay to that base pay. 

For example, say a salaried employee makes $60,000 a year, and the company has one-week pay periods. Divide $60,000 by 52 weeks for a total of $1,153.85 per pay period. If the employee had also earned a $50 commission, their gross pay for the week would be $1,203,85. 

Understanding gross pay is important for employees as it represents the total amount they have earned. It serves as the starting point for calculating net pay. 

What is net pay? 

Net pay is a worker’s total take-home pay, or what’s left after payroll withholdings and deductions. The net pay formula is: 

Gross pay - deductions = Net pay 

Some common deductions include income taxes, Social Security taxes, health insurance, and retirement contributions. Calculating the difference between gross pay and net pay is crucial for employers and employees. Here’s a quick guide to doing so:

1. Find the gross pay: Start by identifying the employee's total earnings before any deductions. For salaried employees, it’s the annual salary divided by the number of pay periods. For hourly employees, multiply the hours worked by the hourly rate.
2. Subtract any pre-tax deductions: Subtract any voluntary deductions that are pre-tax, such as health insurance premiums and retirement contributions.
3. Deduct taxes and mandatory deductions: Subtract the amount of income tax, payroll taxes, and other required deductions from the gross pay. Various factors affect these deductions, such as income level, marital status, and number of dependents.
4. Calculate net pay: The resulting amount after deducting all taxes and deductions from the gross pay is the net pay. This is the actual amount the employee takes home, hence the term “take-home pay.”

Example of how to calculate gross pay

You can calculate gross wages two ways, one for salaried employees and another for hourly employees: 

Salaried employee gross pay

To calculate a salaried employee’s gross pay for a single pay period, divide their annual salary by the number of pay periods your company has in the year according to your payroll schedule. Here’s how to calculate the gross pay for employees: 

1. Determine the number of pay periods you have in a year. For example, if you pay your employees ‌every week, there are 52 pay periods. Here are the most common pay schedules a company will choose from:  

• Weekly = 52 pay periods 
• Every two weeks = 26 pay periods 
• Semimonthly = 24 pay periods 
• Monthly = 12 pay periods 

2. Divide your employee’s annual salary by the number of pay periods. If you have a salaried employee making $60,000 per year, here’s how gross pay would look, divided by each type of pay period: 

• Weekly: $60,000 / 52 = $1,153.85 per pay period
• Every two weeks: $60,000 / 26 = $2,307.69 per pay period
• Semimonthly: $60,000 / 24 = $2,500 per pay period
• Monthly: $60,000 / 12 = $5,000 per pay period

3. Add additional earnings for the pay period, including commissions, bonuses, or overtime pay (if the salaried employee is nonexempt). 

For example, say your pay schedule is set to weekly, and your salaried worker from above is set to receive a $100 commission this week. Their gross pay would be the $1,153.85 weekly salary plus the $100 commission for a total of $1,253.85. 

Hourly employee gross pay

Now say you have an hourly employee. To calculate an hourly employee’s gross wages for a pay period, multiply their hourly pay rate by the number of hours according to your time tracker. The gross pay formula for hourly employees is: 

Hourly employee gross pay = Hourly pay rate x number of hours worked 

You’ll then add any additional income they’ve earned during that pay period, including overtime pay, commissions, or bonuses. 

Here’s an example of gross pay using a one-week pay period:

1. Multiply the hourly rate by the number of hours worked, up to 40 hours per week. Let’s say you have an hourly employee that makes $15 per hour. If the employee works 40 hours, their gross pay is:

• Gross pay = Hourly rate x hours worked
• $600 = 40 hours x $15 per hour

2. Account for overtime, tips, and commissions. Remember that, typically, overtime is 1.5 times the employee’s hourly rate. Say your hourly employee works two overtime hours and earns a $50 commission. The employee’s overtime pay rate is $22.50, so they make $45 plus their commission. This puts their gross pay at:

• Gross pay = Total hourly pay + overtime + commissions 
• $695 = $600 + ($22.50)2 + $50 

How to calculate net pay

The net pay formula subtracts an employee’s paycheck deductions from their gross pay. The net pay formula is: 

Gross pay - deductions = Net pay

Post-tax deductions, such as voluntary deductions for additional life insurance or student loan payments, do not reduce taxable income. Two employees can have the same gross pay but different net pay. Employees may have different tax withholdings based on their W-4s and different retirement or health insurance deductions. Employees can also have wage garnishments or live in another state and pay different tax rates. 

In the example below, we’ve broken deductions into three parts: pre-tax deductions, taxes, and additional deductions. 

1. Start with the employee’s gross pay. In this case, we’ll use the hourly employee from above whose gross pay for the week was $695. If this employee had zero deductions, their gross pay and net pay would be the same. This is rarely the case, however. 

2. Now account for pre-tax deductions. Start by subtracting any pre-tax deductions the business offers, such as health insurance premiums or retirement contributions. Let’s say an employee deducts 6% of their gross pay each week ($41.70, or $695 x 6%) to put toward their 401(k) and pays $62 per week for health insurance. Their taxable income comes out to: 

• Gross pay - 401(k) contribution - health insurance premium = Taxable income
• $695 - $41.70 - 62 = $591.30

3. Subtract payroll taxes. This includes federal and state income taxes, FICA payroll taxes (which include Social Security and Medicare), and any additional state payroll taxes. Our salaried employee has the following payroll taxes: 

• Federal tax of $83 
• State tax of $39
• FICA of $52.82 

Their updated net pay is now: 

• Net pay = taxable income - taxes 
• $416.48 = $591.30 - $83 - $39 - $52.82 

4. Finally, check for any remaining deductions, such as uniform cleaning fees or wage garnishments for unpaid child support or taxes. For example, if our hourly employee from above also had a $10 uniform cleaning fee per week, their final net pay would be $406.48 ($416.48 - $10). 

What affects gross and net pay

Payroll withholding and deductions play a crucial role in determining an employee's net pay. Deductions can include various taxes and employee benefits. Note that some deductions are pre-tax, meaning they lower your taxable income. 

For example, voluntary deductions like health insurance premiums and retirement contributions will lower your taxable income. Taxable income is the amount of an employee's earnings that is subject to income tax.

The most common deductions include:

• Federal and state income taxes: Specific amounts vary based on income, filing status, and the dependents you claim.
• FICA taxes: The FICA (or Federal Insurance Contributions Act) taxes include Social Security and Medicare taxes.
• Retirement savings: Contributions to certain plans, such as 401(k)s, reduce your taxable income.
• Health insurance premiums: Some employers allow you to deduct the cost of your health insurance premiums as a pre-tax deduction.
• Wage garnishments: These are court orders that require the employer to withhold part of your income to pay a debt.
• Other deductions: There are other less common deductions that can reduce your net pay, such as life insurance premiums, charitable contributions, or union dues.

Next steps for streamlining your payroll process

Gross pay and net pay sound interchangeable, but as you can see, they can be very different. The difference between a person’s initial gross pay and take-home pay can be vast, depending on their deductions and withholdings.

Going step-by-step from gross pay to net pay can be a lengthy manual process. But if you have a payroll service like QuickBooks Payroll, most of these calculations are automatic, including paying and filing state and federal taxes. 

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