What Is Net Pay?
Net pay is the amount of money an employer issues to an employee or non-employee contractor after any deductions and withholdings have been taken out. 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's the amount they receive to spend at their discretion.
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What Can Reduce Net Pay?
An employee’s net pay is impacted by both voluntary and involuntary deductions and withholdings, such as:
- Federal income tax: Employers calculate federal income tax according to a set of wage brackets from the IRS.
- State income tax: These withholdings vary according to state law. Some use state tax brackets, some states have flat tax rates, and others have no state income tax at all.
- FICA taxes: Employers must withhold payroll taxes according to the Federal Insurance Contributions Act (FICA). This includes a Social Security tax (currently 6.2% for the employee) and a Medicare tax (currently 1.45% or more, depending on how much the employee makes).
- Wage garnishments: Employers must comply if they receive a notice from the court ordering them to withhold a percentage of an employee’s earnings to pay debts, such as back taxes, child support, or alimony.
- Benefits deductions: Healthcare 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- Charitable contributions: Donations to charitable organizations can be directly withdrawn from an employee's paycheck.
- Union dues: If your employee belongs to a union, they'll likely pay dues from their paycheck.
- Form W-4 information: Also known as the Employee’s Withholding 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 extra withholding adjustments, all of which affect net pay.
Employees can see an itemized breakdown of these deductions on a properly formatted pay stub, which is included with each paycheck.
What Is the Difference Between Gross Pay and Net Pay?
Gross pay is the total amount your employee has earned during a particular pay period before deductions. Net pay is the final amount the employee receives in their paycheck 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 makes $60,000 per year and gets paid monthly. Simply divide $60,000 by 12 to figure out the gross pay ($5,000 per paycheck).
For hourly employees paid 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 making $15 per hour and working 35 hours per week would make $525 in gross pay.
Gross pay vs. net pay is more complex because net pay varies based on the employee’s income, filing status, dependents, benefits elections, court-ordered garnishments, and a host of other factors.
Why Net Pay Matters
Net pay matters for several important reasons, including:
- Building trust within your organization: Having an accurate way to calculate net pay builds trust with employees, helping them feel confident in you and motivated to stay.
- Budgeting for each year: Keeping meticulous net pay records can help your executive team make better budget decisions.
- Keeping detailed records: Maintaining payroll records that include your employees' gross and net pay can act as a defense in the case of wage claims and audits.
- Ensuring compliance: Tracking net pay helps ensure your withholding calculations and tax payments to the IRS are accurate.
Not only are gross and net pay records required by law, but they can also save 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 complex because it’s unique to each employee’s situation. However, here's one five-step method for calculating net pay:
- Figure out how much the employee earned this pay period (gross income).
- Deduct pre-tax benefits contributions from the employee's gross pay.
- Determine taxable income after those contributions.
- Withhold federal, state, and local taxes from this amount.
- Make post-tax deductions, including court-ordered garnishments.
For example, say you have an employee in Georgia filing as a single person who makes $60,000 annually and gets paid monthly with no pre-tax benefits contributions. That works out to $5,000 in taxable income per paycheck.
To calculate their net pay, withhold roughly 22% in federal tax ($1,100), 7.65% in FICA taxes ($382.50), 4% in state income taxes ($200), and $165 for their Roth 401(k) after-tax contribution. The employee’s net pay would be $3,152.50 per paycheck.
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