Gross Pay and Net Pay

Understand the Various Terms on Your Paycheck

Woman is paying bills using her net pay, what is left after deductions are made by her employer.
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What Is Gross Pay?

Gross pay is the total amount of money that the employer pays in wages to an employee. Gross pay is computed based on how an employee is classified by his or her organization.

An hourly or nonexempt employee is paid by multiplying the total number of hours worked by his or her hourly rate of pay. The nonexempt employee's paycheck may also include payments for overtime time, bonuses, reimbursements, and so forth.

The exempt or salaried employee is paid gross pay based on the amount of his or her annual salary divided by the number of pay periods in a year, usually 26. For example, a salaried employee who makes $40,000 per year is paid by dividing that $40,000 by the number of pay periods in a year. In the example, the employee would receive 26 paychecks that each total $1538.46. Any reimbursements, bonuses or other payments would also be added to gross pay.

In addition to the required payroll deductions for taxes, Medicare and Social Security, the employer also subtracts voluntary deductions from an employee's gross pay.

Voluntary deductions to gross pay can include such items as charitable contributions and the employee's required contribution to the employer's healthcare insurance coverage. Any court ordered garnishment whether voluntary or required by law, is also subtracted from an employee's gross pay.

The resulting paycheck, after all of the required and voluntary deductions, are subtracted, is called net pay.

Because the US tax laws are confusing, you might also want to talk with your state Department of Labor and / or an employment law attorney when you venture down the road of hiring employees.

Your business accounting firm is also another expert in matters relating to payroll taxes and deductions.

What Is Net Pay?

Net pay is the total amount of money that the employer pays in a paycheck to an employee after all required and voluntary deductions are made. To determine net pay, gross pay is computed based on how an employee is classified by his or her organization.

An hourly or nonexempt employee is paid by the hours worked x the agreed upon hourly rate of pay. The nonexempt employee's paycheck may also include payment for overtime, bonuses, reimbursements, and so forth.

The salaried or exempt employee is paid an annual, agreed-upon salary, usually in bi-weekly payments. The amount of the paycheck is determined by the total annual salary divided by the number of pay periods in a year, normally 26.

From this total pay which is known as gross pay, the employer is required by law to withhold certain percentages of an employee's paycheck to pay required tax withholdings. After voluntary payroll deductions are subtracted and legally required payroll deductions are subtracted, the pay that the employee receives is called net pay.

In all cases, to calculate the employee's net pay, the amount to subtract from gross pay is determined by using the number of deductions declared by the employee on the W-4 form.

These are used in conjunction with the tax charts provided by the Internal Revenue Service (IRS). The employee's total number of deductions are determined by the number of immediate family members.

A single employee can take one deduction. A married employee with two children can take four deductions. The key is to pay enough in taxes without overpaying. When an employee overpays, the government is able to freely use the employee's money until the employee fills out an income tax return to get his refund from the IRS.

See Taxes 101 for additional information about taxes. This site, written by William Perez, is an outstanding resource for taxpayers.

In addition to the required payroll deductions for taxes, Medicare and Social Security, the employer also subtracts voluntary deductions from an employee's gross pay.

Voluntary deductions from gross pay include items such as charitable contributions (for example, United Way), disability insurance, extra life insurance, and the employee's required contribution to healthcare insurance coverage.

Any court ordered garnishment is also subtracted from an employee's gross pay.

Simply put, net pay is whatever is left over from an employee's pay after all legally required and voluntary deductions are subtracted.

Because the US tax laws are confusing, you might also want to talk with your state Department of Labor and / or an employment law attorney when you venture down the road of hiring employees. Your business accounting firm is also another expert in matters relating to payroll taxes and deductions.