Net Pay vs. Gross Pay: What's the Difference?

Net pay refers to how much an employee earns after employers take deductions out of their paycheck. There are several required deductions employee incomes are subjected to, including Medicare and Social Security tax, as well as voluntary deductions an employee can opt-in for. These deductions are automatically withheld from a paycheck, and the remaining pay leftover is considered the employee’s net income. Net pay can also be referred to as an employee’s take-home pay, or the amount of money that actually goes into their pocket.

Gross pay is the total sum of money an employee makes before any deductions or taxes are removed from their income. For example, if you sign a contract to make $45,000 a year, this means you’ll be making $45,000 in gross pay on an annual basis. But, because of the various withholdings employers are required to take from your gross income, you won’t actually bring home $45,000 in pay each year.

Your gross pay, or the amount of money your employer agrees to pay you on an annual basis, will always be more than your net pay, or the amount of money you actually take home each year. This is due to both voluntary and mandatory deductions your employer is required to withhold from your paycheck.

There are three types of mandatory payroll taxes your gross pay is subjected to:

• Federal income tax withholdings: How much is withheld for income tax is dependent on several factors, including your filing status, gross wages, withholding allowance, payroll schedule, and the IRS Income Tax Withholding table for the present year.
• Local and/or state income tax withholdings depending on where you live: Local or state income tax may be withheld from your paycheck based on the state you live in. For example, California has a 12.3% income tax rate, which means 12.3% of a California resident’s pay will be withheld. Some states, like Florida, do not have personal income taxes, so Florida residents won’t see this deduction on their paychecks.
• Federal Insurance Contributions Act (FICA) payroll tax withholdings: This withholding is equal to 15.3% of your gross pay after pre-tax deductions. It goes towards your Medicare and Social Security.

In addition to mandatory payroll taxes, there are also voluntary withholdings you can choose to have taken out of your pay that will affect how much you take home each paycheck. These voluntary pre-tax deductions include:

• Health insurance: Most companies that have salaried employees offer the option of healthcare. How much you pay for healthcare insurance will depend on how much your employee contributes to your healthcare plan. For example, you may pay $100 per paycheck for health insurance, which would be deducted from your gross pay.
• Retirement contributions: Some employers offer retirement benefits for employees, such as the opportunity to contribute to a traditional 401(k). Retirement contributions are withheld from your gross pay and will impact how much money you bring home each paycheck. For example, you could choose to have $100 withheld each paycheck to put towards your 401(k), which would mean that you’d be taking home $100 less in income.

How to calculate your gross pay will depend on if you’re an hourly employee or a salaried employee.

If you’re paid on an hourly basis, you can calculate your gross pay with the following steps:

1. Determine which period of time you’re going to calculate your gross pay for. For example, if you’re paid bi-weekly, you’ll want to total up all of the hours you worked during the two weeks you’re being paid for.
2. Multiply your hourly rate by how many hours you worked for that time period. For example, if you worked 80 hours in two weeks and are paid $20 an hour, your gross pay would be $1,600.
3. Add this number to any additional sources of income. For example, if you worked overtime or earned tips or commissions, you’ll want to include this in your gross pay total to get an accurate idea of your total pay for that period. So, if your base gross pay is $1,600, but you earned $400 in commissions for that pay period, your new gross pay would be $2,000.

If you’re a salaried employee, use the following steps to calculate your gross pay:

1. Determine how many pay periods you’ll receive a paycheck for each year. Typical pay periods include weekly, bi-weekly, semi-monthly, and monthly.
2. Divide your annual salary by the number of payroll periods in which you receive a paycheck. For example, if you make a salary of $40,000 a year and are paid bi-weekly, you’ll divide $40,000 by 26 to get $1,538.46. This is your gross pay for each payroll period.

Once you know your gross pay, you can calculate your net pay using the following steps:

1. Subtract any voluntary pre-tax deductions from your gross pay. If you’ve opted for voluntary deductions like health insurance or retirement contributions, you’ll need to subtract these from your gross pay. For example, if your health benefits cost $100 per paycheck and you choose to contribute $100 to your retirement plan, you’ll need to subtract $200 from your gross pay.
2. Subtract mandatory taxes from your gross pay. You’ll also need to subtract all mandatory taxes that are withheld from your paycheck. These include FICA payroll taxes, federal income tax, and any local and state tax withholdings.

An example of calculating net pay is as follows: You make $40,000 per year at your job and are paid bi-weekly for a gross pay per paycheck of $1,538.46. You’ve opted for health benefits and retirement contributions that total $200 each paycheck, and your mandatory deductions and withholdings total $300. This means that your net pay each paycheck will equal $1,038.46 ($1,538.46 – $500 = $1,038.46).