When it comes to a paycheck, the less miscommunication the better. Here's how to calculate gross to net pay-- and why it matters.
Understanding the differences between gross pay and net pay are essential for employers and employees. Both parties must understand gross to net pay when establishing salary requirements, making hiring decisions, and negotiating an offer.
What’s the difference between gross pay and net pay?
When an employee accepts a new job offer, the negotiated salary is typically a figure determined before tax, which is known as the gross pay. The first paycheck received includes the net pay amount after tax. Gross wages equal the amount before tax whereas net pay is the sum after tax. Net pay is also commonly referred to as “take-home” pay.
It’s common practice for a new employee to accept an offer based on gross pay. It’s harder for an employer to make an offer based on net pay because each employee’s tax withholdings may differ. In this scenario, the individual might be surprised by the total amount on their first check if it doesn’t match up to the gross pay figure. If the employer does not discuss the differences between gross to net pay before the offer is made, it can cause frustration on both sides.
How do you calculate each?
It’s essential for employers and job candidates to calculate gross and net pay before pursuing an offer. There are several payroll calculators out there that help determine gross and net pay. However, it’s important to understand what each formula takes into account.
To calculate an employee’s gross pay, start by identifying the amount owed each pay period. Hourly employees multiply the total hours worked by the hourly rate plus overtime and premiums dispersed.
Salary employees divide the annual salary by the number of pay periods each year. This number is the gross pay.
All withholdings and deductions are calculated from the gross pay. The first step is to determine the Federal Income Tax requirements, which are based on the individual’s W4.
Second, calculate state deductions. The Bureau of Labor Statistics has a helpful chart that breaks down each state’s requirements. Third, find out FICA Tax requirements. FICA tax combines social security and Medicare withholdings. Find out what you owe by multiplying gross pay by 7.65%. For example, an employee who earns $3,000 per month will owe $229.50 in FICA tax.
Fourth, add up any additional deductions, such as health premiums, charity deductions, etc. Once you’ve added up all of the deductions above, subtract the sum from the gross pay to reach your total net pay.
Bill is an electrician who wants to calculate his take-home net pay. He currently makes a gross annual salary of $50,000. Bill lives in Colorado with his wife and daughter.
Annual Salary $50,000
Federal Income Tax – $4,233
FICA Tax – $3,825
CO State Tax – $1,915
Net Pay = $40,027
Why should employers communicate both net and gross pay to job candidates and new employees?
As you can see from the example above, there is typically a big difference between gross to net pay. Bill’s take-home pay is almost $10,000 less than his gross pay. The scenario shows how miscommunication between gross and net pay can make a significant impact on the employee and the employer.
If an employee receives their first paycheck under the impression they will be receiving the number presented in the gross pay offer, they may be disappointed with a lower number. If the employee and employer are not on the same page from the beginning, it can create friction.
The employee may ultimately decide to leave the company if their compensation does not meet their needs after tax is withheld. On the other hand, if the employer increases the gross pay offer to account for taxes, they may overextend the budget for the position.
Both parties must communicate gross pay and net pay before an offer is extended. When an agreement is reached, the employment process can move forward. It’s much harder to re-negotiate salary and make payroll changes after an offer is accepted.