Gross pay vs net pay is one of the most common topics that employees, self-employed individuals, and sometimes freelancers need to understand on their paystub. Learning more about them could help you better comprehend your compensation, potential tax liabilities, and buying power.
What Is Gross Pay?
The gross pay on paystub is the total amount of money owed to an employee for the pay period before taking out any taxes or deductions, such as FICA taxes and retirement contributions. It is the start of any computation in an income statement, from overtime pay and withholding taxes to year-to-date (YTD) amounts and net pay. The gross pay impacts everything written on a check stub.
There are several alternative names that you might encounter when trying to determine what gross pay is. It could be called pre-tax income, before-tax income, or taxable income.
How Gross Pay Works?
Gross pay is the base and starting point of all calculations in your payroll stub. It also influences how much money you could loan for a home or a car and determines your state and federal taxes. So how does gross pay or gross income on a check stub work?
For starters, an hourly worker's gross earnings is their hourly salary rate multiplied by the total numbers they have worked. In some instances, the pay rate could be negotiated by a union contract. Meanwhile, for salaried employees, the employment contract or pay letter dictates a fixed amount for your gross income, typically for a year's worth.
In each case, the gross wage rate or salary should be agreed upon and signed by both the employer and employee before starting to work.
Gross pay includes wages (based on an hourly rate) and salaries (based on an annual rate), bonuses, shift differentials, commissions, piece-rate pay, vacation pay, sick pay, and holiday pay.
On the other hand, self-employed individuals' gross pay could come from different sources aside from a W-2 job. It could be from freelancing, consulting, side jobs, self-employment, tips, alimony, royalties, selling goods, rental property, interest, capital gains, dividends from investments, gambling or lottery winnings, and Oil, gas, or mineral rights.
Adjusted Gross Income (AGI)
After identifying all your sources of earnings to calculate your gross income on a check stub, several expenses and deductions could reduce it, ultimately reducing your tax burden. The income derived from these adjustments is what you would call "adjusted gross income," or AGI for short. This would serve as the basis for your income taxes.
Here are some of the deductions that would decrease your gross pay:
- Health savings account (HAS) deductions
- Student loan interest (with some qualifications)
- Jury duty pay directly sent to the employer of the juror
- Deduction for half the self-employment tax
- Educator expenses
- Certain business expenses such as materials, gas mileage, or equipment rental fees
- Alimony paid
- SEP-IRA, SIMPLE IRA, and 401(k) deductions for the self-employed2
- Contributions to certain retirement accounts
- Fine for early withdrawal of savings from financial institutions
What Is Net Pay?
After gross pay, you should be able to understand what is net pay or net earnings on a paystub. Net pay is the take-home pay of an employee or a self-employed individual. It is the money left over after removing obligatory deductions such as federal and state taxes, Social Security, and Medicare FICA taxes are automatically withheld from someone's earnings.
Some deductions are also voluntary, such as those in the form of benefits. Health, vision, dental, and life insurance or retirement funds are optional and may be offered through the employer. All of this would cost the employee in the form of deductions subtracted from their gross taxable income.
For example, an employee receiving a gross monthly income of $5,000 could only bring home $3,000 after accounting for taxes and contributions. Net income is a good indicator of the spending power of an individual.
Now, what does net pay mean for employers? In a broader definition, it includes implications, such as the obligation to match a worker's retirement or savings fund. As said earlier, net pay refers to the money an employee takes home. However, it is not the amount it costs and employer to employ them.
What Is The Difference Between Gross Pay and Net Pay?
As an employee or a self-employed person, two of the most important items to learn on a check stub are gross pay and net pay. If you make an annual salary of $50,000 year-to-date, it does not mean that you get to take home all of that money. This is when you should know when to differentiate between gross pay vs net pay.
Again, gross pay on paystub is the total money an employee or self-employed individual earns before any deduction and taxes are subtracted. Meanwhile, net earnings on paystub is the total amount of money left a worker takes home. It is the spending power of employees that they would need to budget.
When you look at your paystub, the amount listed in a larger font would be your net pay most of the time. However, the most evident difference between gross pay and net pay is that gross pay would always have a larger amount on your paystub than net pay.
Additionally, calculating your gross income requires you to add up your gross pay for all pay periods within a fiscal year. On the other hand, net income is also calculated by adding all net pay for all periods within a fiscal year.
Gross Pay Deductions
The most common deduction from the gross pay you would encounter throughout your working career is federal taxes. The government would always deduct a portion of money from your paycheck every pay period for as long as you are working.
Take note that the amount deducted and withheld from your check stub depends on which federal tax bracket you are classified into. This means that the amount taken would always fluctuate depending on your gross pay – the more you make, the larger the tax rate and deduction would be. Each bracket dictates a range of gross income that is important to know, as this would tell you how much federal tax you expect to be subtracted from every payroll payment.
Next, if you live in any of the 41 states that require state income tax, you would probably see it listed in your paystub. Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming are the only few lucky enough states to do away with state income tax.
Lastly, the Federal Contributions Act or better known as the FICA (you can read more about FICA in our article). This tax consists of the Social Security and Medicare tax, which every working individual in the U.S. needs to contribute to from his or her salary. With a wage base limit of $137,700, the employer and the employee both pay 6.2 percent of gross compensation for the Social Security portion of the FICA on a paystub, totaling 12.4 percent.
For example, if Joe earns $1,920 per payroll period, his employer then withholds $119.04 for Joe's share and makes a payment of an additional $119.04 for the employer's share. This makes a total of $238.08 paid into Social Security.
Medicare is another common tax that you are required to pay. However, Medicare tax on paystub does not have a wage base, unlike Social Security. This means that no matter how much Joe makes, his employer would deduct a total of 2.9 percent for the Medicare tax. Joe and his employer would both pay 1.45 percent of his gross income on a check stub.
Like the first example, if Joe earns $1,920 per payroll period, the employer withholds $27.84 for the employee's share and then matches it with the same amount equivalent to 1.45 percent. Therefore, the employee would have a total of $55.68 paid into the Medicare fund.
Gross Pay Calculation
Let us now answer the question of how to calculate gross pay for both hourly and salaried employees.
Gross pay calculations for hourly employees are simple as multiplying the total number of hours an employee worked in a pay period by their agreed-upon hourly rate. For most workers, the most common pay period is on a bi-weekly basis. This means, to compute for gross pay, the employer should add up the payments for two weeks then add them up during payroll.
For example, if Joe works for a total of 40 hours per week and earns a wage rate of $24 per hour, a simple multiplication results in a $960 gross pay for a week. Double that, and the gross earnings on paystub for him in a bi-weekly pay period is $1920. Additionally, if Joe worked three hours of overtime for $30 per hour, he would receive an additional $90 in his gross pay.
Gross pay for salaried employees works a little bit more complicated than for hourly employees.
Firstly, identify the pay period for that employee, whether weekly, bi-weekly, or monthly. Then take their annual income based on their contract and divide it by the number of pay periods for one year.
For example, Jane makes $120,000 per year and paid bi-weekly. Her gross earnings on paystub would turn out in a $5,000 gross pay for each pay period.
Net Pay Calculation
The easiest way to differentiate between gross pay vs net pay is through identifying deductions. First, to calculate net pay, subtract all of the employee's voluntary deductions and contributions from their gross income. This would determine their taxable income. Next, take away what the worker owes in the federal, state (if applicable), and local taxes from the taxable income to come up with the net pay.
Using the previous example of Joe with $1,920 as gross pay, subtract the voluntary deductions. In this case, we would deduct $150 and $100 for retirement and healthcare benefits, respectively. Joe's taxable income would yield $1,670. As for the salaried worker Jane, the same process of removing voluntary contributions would also determine her taxable income.
The next step to calculating net pay would be to compute and subtract from the taxable income the mandatory deductions required for each working individual to pay from their paycheck.
As discussed previously, Social Security and Medicare consume 6.2 percent and 1.45 percent of Joe's taxable income, respectively. Using $1,670 as a basis, the Social Security would equal $103.54 while Medicare would equal $24.22. This brings Joe's net income to $1,542.24 for the pay period after removing both taxes. Again, the same process would apply to Jane for her net pay.
After all the calculations, Joe and Jane's net earnings on paystub are what they would take home to spend or budget freely.
Gross pay vs net pay may seem like a big undertaking when learning about it. As complicated as it may look, the concept of these two terms is quite simple and easy to grasp. Gross pay, also known as pre-tax income, is what an employee would earn each pay period before taxes and deductions. Meanwhile, net pay is what the employee takes home after all taxes and deductions are subtracted from the gross pay.
The process of making payroll and computing gross and net pay could be even more straightforward and faster using Real Check Stubs' paystub generator with automatic calculations and templates. You would also not need to worry about the correct rates for taxes, as the online check maker is up-to-date with the latest information.