What is Net Pay and How to Calculate It
What is Net Pay?
Net pay or take-home pays is the employee’s total earnings after subtracting all deductions from their gross salary. Some examples of deductions are mandatory withholdings such as income taxes and Federal Insurance Contribution Act taxes (FICA), as well as voluntary contributions for benefits like retirement savings and health insurance. Employers are exposed to significant risks if these transactions are done incorrectly. This is why many prefer to work with a payroll provider.
Types of Pay
The hourly wage and the salary are usually used to calculate net pay. Hourly workers are generally not exempt from the Fair Labor Standards Act. This means that they must be paid at minimum federal minimum wage. They also have overtime rights if they work over 40 hours per week. Some states may have their own overtime and minimum wage laws.
Salaried employees are exempted from the FLSA, provided they fulfill certain job duties and their total income meets minimum requirements. These individuals are not paid a different rate for any overtime worked, but it depends on their job and employer. They may be eligible for performance-based bonuses and other incentives to put in more time.
What is the difference between gross pay and net pay?
Gross pay refers to how much employees earn before taxes, while net pay is what employees take home after any payroll deductions. If an employee earns $8,000 per month but has $1,700 taken out for taxes and benefits, then the net pay of that person would be $6,300. The difference in gross and net pay can be attributed to any one of the following types of withholdings:
- Income taxes: State, federal, or local
- Social Security Tax
- Medicare tax
- Retirement savings plans
- Health benefits, including vision, dental, etc.
- Wage garnishments
- Union dues
- Insurance (life, accident, etc.)
Also read: What Is Holiday Pay and How to Create a Holiday Pay Policy
How to calculate net pay
managing your payroll is not complete without the ability to calculate net pay. These are the basics:
- Calculate the gross wages
- Pretax contributions can be deducted from certain types health of and retirement plans
- All federal, state and local taxes must be withheld
- If applicable, garnish wages from disposable income
- Take post-tax contributions to benefit programs or unions
- The result is net pay
Why employers should know their employees’ net pay
Employers must have access to accurate information regarding net pay for the following reasons:
New employees commonly have questions about their net pay may be significantly lower than their gross pay or feeling like too much money is being deducted. Possessing the ability to explain how deductions work is a great way to mitigate conflict.
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Many budget-related decisions can be guided by net pay, employee withholdings, and other payroll records. Employers may decide to change their benefits packages based on payroll expenses.
Correct payroll tax calculations are required to convert gross pay into net pay. Incorrect take-home pay can lead to penalties if a tax is deducted incorrectly.
Sometimes employees will file a wage claim and dispute their earnings. A detailed history of gross pay and net pay can be a valuable tool in legal defense, particularly if it shows that employers have fulfilled their payroll obligations.
Services and tools to help you calculate net pay
Employers can manually calculate net pay, but many prefer to use payroll software. This automates the process and saves time. A third option is to outsource payroll to a full-service provider. This provider will not only run payroll but also deposit and file taxes for the employer and ensure compliance with regulations.