Net pay, or take-home pay, is an employee’s earnings total after all deductions are subtracted from their gross pay. Examples of deductions include mandatory withholdings, such as Federal Insurance Contribution Act (FICA) taxes and income taxes, as well as voluntary contributions to benefits, like health insurance and retirement savings plans. These transactions, if done incorrectly, pose substantial risks to employers, which is why many choose to work with a payroll service provider.
Types of pay: An overview
Net pay is usually based on either an hourly wage or a salary. Hourly employees are largely non-exempt from the Fair Labor Standards Act (FLSA), which means they must be paid at least the federal minimum wage and are entitled to overtime if they work more than 40 hours in a workweek. Note that some states have their own minimum wage and overtime laws.
Salaried employees, on the other hand, are generally exempt from the FLSA if they perform certain job duties and their total salary meets minimum requirements. Such individuals are not paid a different rate for any overtime worked, but depending on their role and their employer, they may receive performance-based bonuses or other incentives for putting in extra time.
What is the difference between gross pay and net pay?
Gross pay is how much employees earn before taxes and other withholdings, whereas net pay is the amount of money employees actually take home after all payroll deductions. For example, if an employee makes $8,000 gross per month and has $1,700 deducted for taxes and benefits, that individual’s net pay would be $6,300. This difference between gross and net pay is a result of any of the following types of withholdings:
- State, federal or local income taxes
- Social Security tax
- Medicare tax
- Retirement savings plans
- Health benefits, including vision, dental, etc.
- Wage garnishments
- Union dues
- Insurance (life, accident, etc.)
How to calculate net pay
Calculating net pay is an essential part of managing payroll. Here are the basic steps:
- Calculate gross wages
- Deduct pretax contributions to certain types of health and retirement plans
- Withhold all federal, state and local taxes
- Garnish wages from disposable income, if applicable
- Deduct post-tax contributions to benefit plans or unions
- The result is net pay
Why employers need to know their employees’ net pay
Employers need to have accurate information about net pay readily available for any of the following reasons:
- Employee relations
New employees commonly have questions about why their net pay is significantly less than their gross pay or may feel like too much money is being deducted. Possessing the ability to explain how deductions work can effectively mitigate this conflict.
- Accounting practices
Net pay, employee withholdings and other payroll records can help guide many budget-related decisions. For example, based on their payroll expenses, employers may choose to alter their benefits packages.
- Payroll taxes
The process of converting gross pay to net pay requires accurate payroll tax calculations. If an employee’s take-home pay is incorrect, there’s a chance that a tax was deducted improperly, which could result in penalties.
- Legal defense
Sometimes employees will dispute their earnings and file a wage claim. Having a detailed history of gross and net pay is a valuable legal defense in these cases, especially if the records show that the employers fulfilled their payroll obligations.
Tools and services to assist with calculating net pay
While it’s possible for employers to calculate net pay manually, many choose to use payroll software, which automates the process, thereby saving time and improving accuracy. Another option is to outsource payroll to a full-service provider, who in addition to running payroll, will deposit and file taxes on the employer’s behalf and support regulatory compliance.
Frequently asked questions about net pay
What is the meaning of net pay?
Net pay means take-home pay or the amount employees earn after all payroll deductions are subtracted from their gross pay.
What is an example of net pay?
If an employee makes $1,000 gross per week and has $180 worth of taxes and benefit contributions withheld, that individual’s net pay would be $820.
Is basic salary net or gross pay?
A basic salary is the minimum amount an employee earns prior to taxes and other deductions, which makes it a form of gross pay. It does not include other forms of compensation, such as commission, bonuses or the monetary worth of benefits packages.
Is net pay what you get paid?
Yes, net pay is the value of an employee’s paycheck or the amount transferred electronically to a bank account or paycard.
This guide is intended to be used as a starting point in analyzing an employer’s payroll obligations and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services.