What Is the Definition of Net Pay?

Net pay represents take-home pay, so it’s usually the amount employees are most concerned with when it comes to their paychecks. If you know the basics, you can help alleviate your employees’ concerns about net pay.

What is net pay?

As stated, net pay is take-home pay. Specifically, it’s the amount leftover from an employee’s wages after payroll deductions have been subtracted from their gross pay.

What is the difference between net pay and gross pay?

Gross pay is the employee’s total earnings before deductions are taken out. It includes:

• Regular hourly wages
• Overtime pay
• Salary
• Tips
• Bonuses
• Commissions
• Time-off pay, such as for vacation and sick leave
• Retroactive pay, such as for salary increases
• Reimbursements from the employer, such as for business expenses

Whereas gross pay comprises all remuneration for employment, prior to payroll deductions, net pay is remuneration after payroll deductions. So, to arrive at net pay you must first determine gross pay.

How do employee deductions impact net pay?

Employee deductions take 2 forms: mandatory and voluntary. To understand their effect on net pay, you’ll need to know which deductions fall under each category, and which ones are taxable.

Mandatory deductions are those required by law. They include:

• Federal payroll taxes
• State payroll taxes
• Local payroll taxes
• Wage garnishments

Voluntary deductions are those the employer offers at its discretion and the employee chooses to accept or decline. They include:

• Medical insurance
• Dental and vision insurance
• Retirement savings plan
• Life insurance
• Union dues
• Disability insurance (if not required by the state)
• Health savings accounts
• Flexible spending accounts

Employee deductions can be pretax or after-tax. If the deduction is pretax, it’s not subject to tax withholding, thereby lowering taxable wages and increasing net pay. If the deduction is after-tax, it is subject to tax withholding and therefore does not lower taxable wages or increase net pay.

In the next section, we provide a deeper understanding of how pretax and after-tax deductions influence net pay.

How to calculate net pay

Step 1

Determine the employee’s gross pay — that is, their entire compensation for the pay period.

Example: an hourly employee works 80 hours for the biweekly pay period and earns $16 per hour. Their gross hourly wages are $1,280 (Calculation: 80 x $16), assuming they have no other earnings for the pay period.

If the employee is salaried, divide their annual salary by the number of pay periods in the year to arrive at their gross salary.

Example: annual salary of $70,000 paid semi-monthly equals $2,917 (Calculation: $70,000 / 24 pay periods).

Step 2

Subtract pre-tax deductions and nontaxable wages from gross pay to arrive at taxable wages. 

Pre-tax deductions include contributions made to a traditional 401(k) plan and voluntary benefits offered under a Section 125 plan, such as health insurance, health savings account, and flexible spending account. Nontaxable wages include expense reimbursements made under an IRS-qualified accountable plan. If the employee has no pre-tax deductions or nontaxable wages, then their gross pay (from Step 1) is the taxable amount.

Important: Not all pretax deductions are exempt from the same taxes, so you’ll need to know the tax rules for the deduction in question. For example, Section 125 health insurance premiums are excluded from federal income tax, Social Security tax, and Medicare tax. However, contributions made to a traditional 401(k) plan are excluded from federal income tax withholding but not Social Security and Medicare taxes — the same goes for group-term life insurance exceeding $50,000 in coverage.

Whether pre-tax deductions are exempt from state and local taxes depends on the state and locality. Though they’re excluded by most states, there are exceptions — such as in New Jersey. The state may exempt certain payroll deductions from taxes while making others taxable.

Step 3

Withhold payroll taxes from taxable wages. Specifically, federal income tax, Social Security tax, Medicare tax, plus applicable state and local taxes — such as state income tax, state unemployment tax, state disability insurance tax, and city and county taxes.

For instructions on withholding federal payroll taxes, see IRS Publication 15-T. The state revenue agency can provide guidance on state and local tax withholding.

Step 4

Subtract after-tax payroll deductions to arrive at net pay. This includes wage garnishments, union dues, Roth 401(k) contributions, and other deductions that aren’t pre-tax or nontaxable. The remainder is the employee’s net (or take-home) pay. If the employee has no after-tax deductions, then the result from Step 3 is their net pay.

Formula for determining net pay:

Gross pay – pre-tax deductions and nontaxable wages – payroll taxes – after-tax deductions = net pay