It’s absolutely vital for business owners, executives, and employees to understand the difference between gross pay vs net pay. Business owners need to be able to easily calculate how much they are paying employees as a total package as well as their take-home pay to gain a complete grasp of payroll costs.

Workers also need to understand the difference between gross pay and net pay so that they can better understand their total earnings before and after deductions, especially when negotiating pay with an employer. Don’t worry if you don’t fully understand the terms yet. In this article, we will break down the differences between gross pay and net pay and will walk you through how to calculate both in a matter of seconds.

Gross Pay vs Net Pay: What Is Gross Pay?

Gross pay or gross income is the total earnings without considering any deductions and it is usually found on the employee’s pay stub like the example below. Typically, most job openings specify the gross pay and not the net pay – which can vary between different individuals based on their tax status and voluntary contributions.

pay stub with gross earnings
Example Pay Stub

In a nutshell, gross income is the compensation that the employee earns during a pay period before any deductions are considered. Gross income includes additions like commissions, bonuses, reimbursements, and overtime. Before paying you, your employer (unless you are an independent contractor) will take that figure and remove payroll deductions – which include income tax, Social Security taxes, and Medicare taxes.

How to Calculate Gross Pay

The methods used to calculate gross pay in any given pay period are somewhat different for hourly and salaried employees.

How to Calculate Gross Pay for Hourly Workers

While the gross pay for salaried employees is usually similar across pay periods, it can vary significantly for hourly-wage employees. The gross pay for an hourly employee would be:

Total number of hours worked x hourly rate = gross pay

Unless the total hours worked don’t change from day to day or week to week, the gross pay for hourly workers will fluctuate. This is unlike salaried employees whose gross pay is usually similar across all pay periods unless they are given other compensation like bonuses or commissions.

Also, both types of employees should also be eligible for overtime pay if they work in excess of the normal 40-hour workweek. According to the US Department of Labor, unless exempt, employees must receive overtime pay for any hours that they work beyond 40 hours in a week and the overtime pay rate during that period should not be less than 1.5x their normal pay.

For instance, if an hourly employee works for 50 hours in a week and the hourly wage is $20 and an overtime rate of $30 then the gross wages for the week would be $1,100. Calculated as follows

  • 40 x $20 = $800 for the first 40 hours
  • 10 x $30 = $300 for the next 10 hours (assuming a 50% higher hourly rate.)
  • Total = Normal wages + premium overtime pay = $1,100

How to Calculate Gross Pay for Salaried Workers

The salaried employee’s gross pay is specified at the time of hiring only and is generally specified as the annual salary. The job offer letter (like the sample attached below) mentions the employee’s gross pay as well as the various benefits that are part of the employee’s annual salary.

sample offer letter mentioning gross pay and benefits
Example Offer Letter

The general formula for calculating salaried gross pay is:

Gross pay per pay period = annual salary / (number of days in a pay period / 365)

This can be simplified for common lengths of pay periods such as 1 month:

Gross pay per monthly pay period = annual salary / 12

For example, if the annual gross pay for the employee is $120,000, the monthly gross income would be $10,000.

Similarly, if the employee is paid twice a month there would be 24 pay periods during the year so the annual gross salary would need to be divided by 24, equaling $5,000 in this case.

Gross Pay vs Net Pay: What Is Net Pay?

Employers are responsible for deducting taxes from their employee’s pay. Net pay, also known as take-home pay is the final amount that the employee is paid after these deductions. Mandatory deductions include:

  • Federal Insurance Contributions Act (FICA taxes or payroll taxes) which are split into Social Security tax (currently at 6.2%) and Medicare taxes (currently at 1.45%).
  • Federal income tax is the same across the US and varies between 10%-37% depending on the taxable income and the filing status.
  • State and local income taxes if applicable
2023 tax brackets
2023 Income Tax Brackets

The amount of taxes deducted depends on your gross income and marital status, just like normal income taxes.

Note that these deductions are not mandatory for independent contractors but they have to pay the same taxes by tax day. They also have to pay twice the amount of payroll taxes as their clients don’t have to pay their half for them.

Employers may also deduct:

  • Health insurance premiums
  • retirement account contributions (like a 401(k))
  • Wage garnishments

It is the employee’s take home pay which is available after deduction of all the legally mandated and voluntary deductions and is the money that the employee receives in their bank account.

How to Calculate Net Pay

To calculate an employee’s net pay, we first need to arrive at the gross wages for the pay period. Then we need to deduct the following from the gross pay

  1. FICA taxes
  2. Federal income tax
  3. State and local income tax
  4. Any other non-mandatory deductions including health insurance premiums, 401(k) contributions, and wage garnishments.

Check out Mr. de la Garza’s video on calculating net pay for an even more in-depth guide if you want to see a full walkthrough:

Employer Payroll Tax Obligations

While the above-mentioned deductions are deducted from employee’s gross wages, the employer also pays their share of the Social Security and Medicare taxes which is equal to the payroll taxes (FICA) deducted from the gross pay of the employees.

The FICA tax rate is 15.3%, split into 12.4% for Social Security tax and 2.9% for the Medicare tax.

The Bottom Line

Now that you fully understand the difference between gross pay and net pay you can more effectively negotiate your compensation with your current and prospective employers. When joining a new job or negotiating the hikes in an existing role, the figure discussed is usually gross pay. This isn’t ideal as it isn’t the figure that you will be taking home but as long as you know the difference between gross and net pay you can negotiate more effectively.