Are You Calculating Gross Wages Correctly?

Inaccurate gross wages may trigger a domino effect. Depending on the severity of the error, this chain reaction can be costly — impacting numerous payroll processes and employees’ take-home pay. It’s therefore critical that you accurately compute gross wages.

What are gross wages?

Gross wages are an employee’s total remuneration before mandatory and voluntary payroll deductions. Mandatory deductions are those required by law, such as payroll taxes, state disability insurance, and wage garnishment.

In contrast, voluntary deductions are established at the company level. Unlike mandatory deductions, you must have the employee’s consent to make voluntary deductions. Examples of voluntary deductions include employee payments or contributions for health insurance, 401(k), life insurance, flexible spending accounts, and short-term disability insurance.

Gross wages are an employee’s total remuneration before mandatory and voluntary payroll deductions.

What counts as gross wages?

Gross pay includes:

• Hourly wages
• Salaries
• Piece rate pay
• Bonuses
• Commissions
• Overtime pay
• Premium pay
• Holiday pay
• Vacation pay
• Paid sick leave
• Reimbursements for business expenses

What happens when gross wages are incorrect?

Errors in gross wages can adversely impact:

• Net (or take-home) pay. To arrive at net pay, you must subtract the employee’s payroll deductions from their gross wages. This process is called “gross-to-net.” If the gross wages are wrong, so are the net wages.
• Taxable gross wages. This is the amount of gross wages that is subject to tax withholding. If the gross wages are incorrect, the tax withholdings may be off as well.
• Employer payroll taxes. This is the amount an employer must contribute for payroll taxes (e.g., SUTA tax) that are based on employees’ taxable gross wages. If the taxable gross wages are wrong, the employer’s payroll taxes might be off, too.
• Paystubs and Form W-2s. If the gross wages on these forms are wrong, the employee may run into problems when filing their taxes.
• Employer tax filings. Employers must report gross wages in their employment tax filings. If the gross wages are wrong, the same likely goes for the employer’s tax filings.
• Recordkeeping. Employers are legally required to keep certain payroll records, including gross wages. If the gross wages are wrong, so are the payroll records.
• Financial statements. Employers must record gross wages in their financial statements. If the gross wages are wrong, so are the financial statements.

Moreover, gross pay mistakes can lead to:

• Disgruntled employees filing wage-and-hour complaints or lawsuits
• Investigations by the administering agency, such as the Internal Revenue Service or the United States Department of Labor
• Penalties for noncompliance, from the administering agency

Gross wages vs. taxable gross wages

Whereas gross wages represent an employee’s total remuneration, taxable gross wages are wages that are subject to taxation. Often, an employee’s gross wages and taxable gross wages will not be the same, due to pretax benefits — such as a Section 125 health plan.

With a Section 125 health plan, the employee’s payments are excluded from federal income tax, Social Security tax, and Medicare tax. You would, therefore, deduct these payments from the employee’s gross wages before withholding federal taxes. The remainder is the employee’s taxable gross wages, provided the employee has no other pretax deductions and no nontaxable wages. Ultimately, this employee’s Section 125 payments lower their taxable gross wages.

Compare this with an employee who doesn’t have any pretax deductions or nontaxable wages. This employee’s gross wages and taxable gross wages will be the same amount because they have no pretax deductions and no nontaxable wages to lower their taxable amount. Everything this employee earns is subject to taxation.

Determining taxable gross wages can be tricky because not all pretax benefits are subject to the same tax exclusion rules. For example, traditional 401(k) contributions are excluded from federal income tax withholding, but not Social Security or Medicare tax withholdings. On top of that, the definition for taxable gross wages varies by federal, state, and local taxation agencies.

Therefore, it can be difficult to decipher gross wages, taxable gross wages, and gross-to-net wages without the right tools. In fact, determining wage payment and gross-to-net is a top reason why employers outsource payroll. It is also why many employers use payroll software.

How payroll software helps with gross pay calculations

Considering the many issues that can stem from gross pay mistakes, it’s best to keep manual calculations to a minimum.

Considering the many issues that can stem from gross pay mistakes, it’s best to keep manual calculations to a minimum. (Manual calculations significantly elevate the risk of errors.)

You can vastly reduce manual computations by using payroll software, which automatically calculates:

• Gross hourly wages, based on employees’ timecard information
• Gross salaries
• Other compensation, such as bonuses, commissions, and overtime pay
• Voluntary deductions, such as health insurance premiums and 401(k) contributions
• Taxable gross wages. The software identifies which wages are subject to federal, state, and local tax withholding.
• Payroll taxes. The software withholds payroll taxes from employees’ taxable gross wages plus calculates employer payroll tax liabilities.
• Other mandatory deductions, such as child support and state disability insurance
• Net pay. The software figures take-home pay according to the employees’ gross wages and payroll deductions.

Payroll software also:

• Generates paystubs and Form W-2s
• Enables automated payroll tax filings
• Simplifies internal payroll audits
• Promotes accurate payroll recordkeeping and financial statements

Above all, the software helps keep you in compliance and out of legal crosshairs.

Check out our People Ops Podcast episode “How and Why Small Business Can Close the Gender Pay Gap.”