What is net pay?

Net pay is the amount an employer issues to an employee or non-employee contractor after any deductions and withholdings. In other words, net pay  is the sum of gross pay  or wages minus deductions. On the recipient's side, net pay is also known as ""net income"" or ""take-home"" pay, because it is the amount they receive to spend at their discretion.

What can reduce net pay?

An employee's net pay is affected by both voluntary and involuntary deductions and withholdings, such as:

• Federal Income Tax:  Employers   calculate federal income tax according to the pay brackets obtained from the IRS.
• State income taxes:  These deductions vary according to state law. Some states use tax brackets, some states have flat tax rates, and others have no state income tax.
• FICA taxes: Employers   must withhold payroll taxes in accordance with  the Federal Insurance Contributions Act (FICA). This includes Social Security taxes (currently 6.2% for the employee) and Medicare taxes (currently 1.45% or more, depending on how much the employee earns).
• Salary deduction:  If an employer receives a notice from the court ordering them to withhold a percentage of the employee’s income to pay debts such as unpaid taxes, child support or alimony, the employer must comply.
• Benefit deductions:  Health care premiums, certain retirement plan contributions, HSA/  FSA  savings, and other payments  are pre-tax deductions taken from gross pay  .
• Charitable Contributions:  Donations to charitable organizations can be deducted directly from the employee's pay.
• Union dues:  If your employee belongs to a union, they will likely pay dues out of their pay.
• Form W-4 information:  Also known as the Employee's Deductions Certificate,  the IRS Form W-4  lists information about the employee's filing status (single, married, etc.), number of jobs, total income, number of dependents, and additional deduction adjustments, all of which affect net pay.

 Employees can view a detailed breakdown of these deductions on a properly formatted  pay slip , which is included with each paycheck.

What is the difference between gross pay and net pay?

Gross pay is the total amount your employee   earned during a particular pay period  before deductions. Net pay is the final amount the employee receives in his or her pay after deductions  .

You can calculate gross pay for salaried employees by dividing the annual salary by the number of pay periods. For example, let's say an employee earns $60,000 per year and receives a monthly salary. Simply divide $60,000 by 12 to find the gross pay ($5,000 per paycheck).

For employees who are paid hourly each week, you can calculate their gross pay by multiplying the employee's hourly rate by the number of hours worked. For example, an employee who earns $15 per hour and works 35 hours per week would receive a gross pay of $525.

Gross pay vs. net pay  is more complicated because net pay varies based on an employee’s income, filing status, dependents, benefit elections, court-ordered deductions, and a variety of other factors.

Why Net Salary Matters

Net pay matters for several important reasons, including:

• Build trust within your organization:  Having an accurate way to calculate net pay builds trust among employees, helping them trust you and feel motivated to stay with you.
• Creating a budget for each year:  Keeping careful records of net pay can help your executive team make better budget decisions.
• Keep detailed records:  Maintaining payroll records, including your employees' gross and net wages, can act as a defense in case of wage claims and audits.
• Ensuring compliance:  Tracking net pay helps ensure that your deduction calculations and tax payments to the IRS are accurate.

 Not only are gross and net pay records required  by law , but they can also protect your business from costly lawsuits and penalties that affect company profits, reputation and more.

How to Calculate Net Pay Each Pay Period

Calculating take-home pay based on the standard net pay definition is complicated because it is unique to each employee's situation. However, here is a five-step method for calculating net pay:

1. Find out how much the employee earned this pay period (gross income).
2. Deduct pre-tax benefit contributions from the employee's gross pay.
3. Determine taxable income after those contributions.
4. Deduct federal, state and local taxes from this amount.
5. Make after-tax deductions, including court-ordered deductions.

For example, let's say you have an employee in Georgia who files as a single individual, earns $60,000 annually and is  paid monthly with  no pre-tax benefit contributions.   This equates to $5,000 in taxable income per paycheck.

To calculate their net pay, withhold approximately 22% in federal taxes ($1,100), 7.65% in FICA taxes ($382.50), 4% in state income taxes ($200), and $165 for their Roth 401(k) after-tax contributions. The employee's net pay would be $3,152.50 per paycheck.