Gross pay vs. net pay — Definition, calculation, key differences

Are you frustrated with the uncertainty about how much money you’ll see in your bank account each month? There is an easy way to better understand your salary and it has to do with the difference between gross and net pay. 

Knowing the meaning and the difference between these terms will help you grasp your borrowing capacity, learn how much you actually earn, and manage your savings. 

This blog post will help you comprehend the topic better, by covering:

• What gross pay is and how to calculate it,
• What net pay is and how to determine your net earnings, and finally
• The difference between gross pay and net pay.

What is gross salary? 

Gross pay (gross salary) refers to employees’ earnings prior to deductions from their wages. So, it presents the salary you receive from your employer. 

Bear in mind that gross pay is not the amount of money you take home, as it includes taxes and other deductions that have to be taken out of your pay before it reaches your bank account.

Gross pay is different from gross income, as gross income refers to all of your earnings before taxes, not only the ones you receive from your employer. According to IRS, gross income includes:

• Wages,
• Dividends,
• Capital gains,
• Business income, and similar items.

To make sure that you get a good understanding of gross pay, I decided to contact different experts and ask them how they would define parts of an employee’s gross salary. 

One of these experts is a certified public accountant (CPA) at Oak View Law Group, Levon Galstyan. Here’s how Levon explained the meaning of gross pay:

“Gross pay includes salary, hourly wage, reimbursements, bonuses, commissions, and overtime pay. To calculate gross pay, any commission, reimbursement, or bonuses owed to the employee should be added to their wages.”

Moreover, an accountant at Keirstone Limited, Francis Fabrizi, provided an example of gross salary: “If an employee earns a salary of £50,000 per year, their gross pay would be £50,000.”

Therefore, gross pay presents the salary you agreed to with your employer, and it includes your wages, overtime, bonuses, and reimbursements.  

How to calculate gross pay

Calculating your gross pay is quite straightforward, as it presents the salary you agreed with your employer. 

Gross pay includes:

• Your hourly wage or salary,
• Overtime,
• Bonuses, and
• Additional reimbursements for work-related expenses such as travel and uniform allowance.

The exact steps to calculate your gross pay will depend on whether you are a salaried or hourly employee. 

Calculating gross wages for hourly workers  

I brought some reinforcements when it comes to calculating your gross pay if you’re an hourly worker as well! Levon Galstyan provided steps to calculating gross wage per hour:

1. Multiply the hourly wage by the number of regular hours worked within a pay period, and
2. Include the overtime pay rate for the extra hours (this applies to nonexempt employees).

Pay periods present how often you get paid. They depend on the agreement you have with your employer and are usually part of your employment contract. 

Let’s say that you’re a software engineer in the United States and you want to calculate your weekly gross pay. The average hourly wage for a software engineer in the US equals $36. Let’s also assume that you get paid weekly. 

You tracked 40 regular hours and 2 hours of overtime for the previous week. 

We’ll first calculate your regular earnings. You should multiply your regular rate ($36) by the number of regular workweek hours (40 in this case) to get your earnings for regular hours worked:

$36 x 40 = $1,440

Since you are a non-exempt employee — the FLSA rules for overtime will apply. Thus, your hourly overtime rate will be one and a half (1.5) times your regular rate of pay: 

$36 x 1.5 = $54

Next, since you worked 2 overtime hours, you have to multiply your overtime rate ($54) by the number of overtime hours (2 hours) you worked to get your weekly overtime earnings:

$54 x 2 = $108

Once you calculate both regular and overtime earnings, the calculation will go like this:

$1,440 + $108 = $1,548

So, your weekly gross pay is $1,548.

Calculating gross earnings for salaried workers  

Levon Galstyan provided us with a process of calculating gross earnings based on your yearly salary as well. To get your gross earnings as a salaried worker, you should:

Divide the annual salary by the number of pay periods in a year

There are four common payment frequency schemes: weekly, biweekly, semi-monthly, and monthly. Out of these four schemes, 45.7% of US employees are paid biweekly. 

If you receive your salary once a week, you’ll have 52 pay periods. Therefore, to calculate your weekly earnings, you should divide your annual earnings by 52. 

In case you’re paid biweekly, you’ll have 26 pay periods. 

Moreover, employees that receive a salary twice a month will have 24 pay periods, while those who are paid monthly should divide their annual earnings by 12. 

Let’s assume that your annual salary sits at $72,000, and you’re paid semi-monthly (twice a month). Your semi-monthly gross salary will be:

$72,000 / 24 = $3,000

What is net pay?

Net pay is the salary workers actually receive. It’s also called take-home pay, and it presents your total earnings after all the deductions.

For the principal accountant of Willmot Accounting, Brett Willmot, net pay is: “The amount of money that an employee takes home after all deductions have been made. It is the total amount of money that an employee earns after all taxes, benefits, and other deductions have been subtracted from the gross pay.”

According to Sallie Mullins Thompson, Principal & Managing Member at Sallie Mullins Thompson, CPA, some of these deductions may include:

• Income taxes withheld for federal, state, and city (if applicable), 
• FICA (Social security and Medicare),
• Healthcare insurance premiums that are paid out-of-pocket by the worker, 
• State-mandated disability and medical/family leave payments,
• Retirement plan contributions, 
• Worker’s FSA, Section 125 benefits, and HSA contributions, and
• Union dues. 

Moreover, the founder of the accounting firm AgileCPA Professional Corporation, Wendy Ha, helped us understand the importance of knowing our net pay:

“The reason why there is a net pay is that there are different types of deductions that are taken off from the paycheck and remitted to different parties (i.e., government, unions…etc). At times, the government/unions rather have the business owner deduct these taxes/fees and remit to them directly, as opposed to each individual themselves.”

Based on the information we received from experts, it’s safe to conclude that the net pay presents the amount of money you see on your paycheck. You won’t have to deduct anything from this amount.  

How to calculate net pay

You’ll get your net pay by subtracting taxes and deductions from your gross pay. The formula is: 

Gross pay – taxes – deductions = NET PAY

Employees in the United States may notice two types of deductions in their paychecks:

• Mandatory deductions, and
• Voluntary deductions. 

Mandatory (involuntary) deductions are made in accordance with the law. For US citizens, involuntary deductions include:

• Withholding of federal, state, and local income taxes (certain states do not impose state or/and local income taxes),
• Deduction for US social security taxes, Foreign Service retirement, Civil Service retirement, Federal Employees’ Group Basic Life Insurance (FEGLI), Federal Employees Health Benefits (FEHB), and
• Court-ordered garnishments and bankruptcy payments.

Garnishments present additional deductions and they differ from employee to employee. They usually include student loans, credit card loans, and unpaid child support. 

On the other side, voluntary deductions are the ones employees have the freedom to opt out of. For US workers, voluntary deductions include:

• Dental insurance,
• Retirement plan,
• Savings plan,
• Optional life insurance,
• Loan repayment, 
• Long-term care program, or
• Other optional programs.

Some deductions are pre-tax, while others are subtracted after taxes. It’s useful to know the difference between these two types of deductions. 

Pre-tax deductions apply to the full amount of your gross pay. Pre-tax deductions include certain health insurance premiums and 401(k). Simply put, 401(k) is a savings and retirement plan that workers contribute to from their wages. 

On the other hand, post-tax deductions are the ones you take out from the amount that remains after pre-tax deductions and taxes. Post-tax deductions typically consist of disability insurance or garnishments.

Essential elements to include in your net pay calculation 

Calculating net pay can be a pretty complicated process as it depends on various factors including: 

• The tax regulations in your state (state and local income taxes), 
• The filing status (single, married filing jointly, married filing separately, head of household, and qualifying widow(er) with dependent child), 
• Voluntary payments you’ve signed up for (e.g., retirement contributions), and other factors.

In general, there are a few initial steps in the net pay calculation you’ll have to go through: 

1. Subtract pre-tax deductions from your gross pay first (non-taxable items such as retirement plans, health insurance, etc),
2. Subtract federal income taxes (federal withholding — depends on the information you provide on Form W–4 — and FICA withholding — Social Security taxes 6.2% of your gross wages and Medicare taxes 1.45% of your gross wages), 
3. Subtract state income taxes (different in each state — some states don’t even impose state income taxes — and depend on your income and filing status), and
4. Local income taxes (not applicable to all states). 

Then, you’ll need to subtract post-tax deductions from the amount you receive to get your final net pay.

For further reference, Varsha Subramanian, a CPA at FlyFin.tax, came up with three employee examples and provided a table to illustrate the process of calculating net pay. In her example, paycheck deductions include 401(k), health insurance, and federal and state income taxes. 

Gross vs. net pay: key differences

Both gross and net pay determine an employee’s salary. The main difference between these two terms is that net pay is a worker’s take-home pay while gross salary is the amount employees earn before any deductions. 

Brett Willmot highlighted the significance of knowing the difference between net and gross pay: “It’s important to understand the difference between gross and net pay, as it can affect budgeting and financial planning. Gross pay is often used to determine an employee’s base salary or wages, while net pay is used to determine the actual amount of money that an employee will receive in their paycheck.”

Furthermore, Levon Galstan reminds us that:

“Employers are responsible for deducting the necessary expenses from an employee’s paycheck and making payments to the appropriate accounts before issuing the check or depositing the net pay into the employee’s bank account.”

As an employee, knowing your gross pay is essential as it’s part of your gross income. 

Gross income determines your borrowing capacity (how big of a loan you can take from a financial institution) as that’s the amount that lenders look at. Moreover, it determines a person’s federal income tax bracket. It’s the first step of filing tax returns.

On the other hand, net pay is the amount you actually receive on your paycheck. It’s extremely useful to know as it presents your disposable income. 

So, it’s safe to assume that using net pay when planning your expenses is a wiser choice. However, if you want to work with gross pay instead, Sallie Mullins Thompson warns:

“Remember: When making your budget for the year, if gross wages is the starting point, be sure to subtract the total of the taxes and other deductions listed above to compute how much is actually left to spend from each paycheck received.”

Conclusion: Learn the difference between gross and net pay to understand your earnings

Both gross and net pay are crucial terms to understand once you’re part of the workforce. As the amount usually written in your employment contract, gross pay will help you determine your tax bracket and understand your borrowing capacity.

Net pay is the money you can use however you want. Knowing it is useful as it can make saving and planning your future expenses much easier!

✉️ Did you manage to calculate your gross and net pay using this article? Did the final numbers surprise you? Feel free to share your thoughts with us at blogfeedback@clockify.me. Also, if you liked this article, be sure to spread the word to your friends and colleagues!