The Employer's Guide to Net Pay: Definition & Calculation
It's essential to have a firm understanding of gross and net pay definitions, as well as how to calculate each. Here is a rundown of everything you need to know.
We know — it’s not the most exciting of topics. But as an employer, calculating your employees’ net pay is an essential part of managing payroll. While larger companies have entire accounting departments that manage taxes and payroll, small business owners have historically had to muddle through it themselves — till now.
Roll by ADP offers business owners a personalized payroll service, without having to hire an internal team. Our innovative payroll app for small business makes payroll easy from any device, at any time. We calculate, deduct, and pay taxes for you so you never have to worry about complicated net pay calculations again!
While we’ll do all the heavy lifting, you may still be curious about gross and net pay definitions, as well as how to calculate each. That’s why we’ve created this handy guide that will define net pay and gross pay, how to calculate net pay, and other important factors to keep in mind.
Ready to get started? Here is a rundown of everything you need to know.
What is Net Pay?
If your small business is required to issue pay stubs under the Fair Labor Standards Act (FLSA), you’ll need to provide a clear breakdown of exactly how much each staff member takes home at the end of each pay period. But, precisely what does net pay mean on your paychecks?
Many net pay definitions simply state that gross pay is before taxes and net pay is after taxes, but there’s a bit more to it than that. The most widely accepted net compensation definition is as follows:
Gross pay - Payroll taxes - Other deductions = Net pay
You see, it’s not just federal and state income taxes that need to be subtracted, but all other relevant deductions, including:
- Medicare and Social Security taxes
- Health and dental insurance premiums
- Other insurance contributions (accident, life, etc.)
- Retirement contributions
- Flexible spending accounts (FSA) contributions
- Union dues
- Garnishments for unpaid taxes or loans
- Garnishments for child or spousal support
- Repayments for cash advances or goods/stock purchases
- Charitable donations
Let’s put this into practice with an example. Suppose an employee wants to know what is the net amount of pay on their salary of $4,000 per month. If deductions for all taxes and benefits total $800, $3,200 would be their remaining net pay, meaning that’s the amount they take home to spend.
Of course, employees might not necessarily use the term “net pay” in their discussions with you. It’s much more likely they’ll use a less technical description for the money they take home. So, what is another name for net pay? Yep, you guessed it, the most common alternative used by workers is simply “take-home pay.”
Net Pay vs Gross Pay
Having firmly established that a reliable net pay definition refers to the take-home salary after taxes and deductions, let’s take a more in-depth look at gross pay.
When hiring for a position, it’s standard practice to list the gross amount, which is also commonly referred to as a “base salary” as it excludes any additional incentives or benefits. But, why is this standard practice?
There are a couple of reasons. For one, the gross figure is higher and therefore likely to be more attractive to candidates. However, the main reason is that, unlike gross salaries, net figures can vary significantly even between workers on the same pay scale. If you only listed a net pay definition, economics-savvy applicants would be quick to point this out.
Ultimately, stating gross pay figures in salary descriptions and allowing employees to control their net earnings by making their own financial decisions about additional contributions and deductions is the best way to create transparency and trust in your payroll system.
Calculating Net Pay
Payroll and taxation are heavily regulated, so it’s a good idea to maintain up-to-date documentation that states clearly how much money you’ve paid, how often, and to whom.
Follow these steps to calculate net payments accurately for each of your employees.
To calculate an employee’s gross pay in any cycle, you’ll first need to establish the base amount of salaried compensation. For full-time staff, divide the gross annual salary by the number of pay cycles per annum. For hourly workers, multiply the number of hours worked by the hourly rate. Once you have a figure, add on any relevant commissions, bonuses, or overtime payments.
It is your duty as an employer to deduct the applicable federal and state income taxes, plus Social Security (6.2%) and Medicare (1.45%). These must be reported and submitted to the government in your Employer's Quarterly Income Tax Return using IRS Form 941.
As we highlighted earlier, there are several other possible deductions. Be sure to carefully calculate and double-check the exact deductions for each individual to avoid potential errors.
At this point, you should have an accurate total for payroll taxes and other deductions for each employee. Next, deduct that amount from each individual’s gross pay figure for that cycle to calculate the total net pay, meaning that’s how much you need to provide in their pay packet.
Run Payroll in Under a Minute
At Roll, we understand that wrapping your head around net pay definitions and payroll calculations can be time-consuming. But just because you’re not a corporate giant (yet!) doesn’t mean you shouldn’t have access to the expertise and reliability of the biggest name in payroll. That’s why we introduced Roll, the first-of-its-kind chat-based payroll app for small business.
With its familiar and intuitive interface, payroll becomes as quick and easy as sending a text, leaving you with more hours in your week to grow your business, take some “you time,” or literally do anything else but payroll.
Don’t roll the dice on your payroll app. Roll with ADP. Download the app and sign up for your free trial to reap the benefits of a seriously stress-free payroll experience.