Gross Pay vs. Net Pay: Explanation and Examples

ByDanica Jovic
February 22,2022

If you run a company, you’ll almost certainly have come across the terms “gross pay” and “net pay” as part of your payroll operations. But what do these terms actually mean? 

Below, we discuss gross pay vs. net pay and how to calculate both for your employees. 

Gross vs. Net Pay

Gross pay is what you pay employees before taxes and deductions. It’s the salary you quote when you’re recruiting staff. For instance, a company might advertise for a marketing manager, paying $45,000 per year plus benefits. 

Gross pay and net income (also called “take-home pay”) are not the same. You’ll notice that net pay is, by definition, lower than gross pay. That’s because it’s calculated by subtracting taxes and deductions from gross pay (and then adding benefits or allowances). 

Employers typically highlight net pay in bold on pay stubs since this is the money the employee actually receives into their bank account. Employees in the systems of income tax withholding (“pay-as-you-earn” or PAYE) never receive their gross pay. If you have the right software, payroll sends taxes automatically to the IRS. 

Gross Income vs. Net Pay: Deductions

Gross monthly income is all of the pay an employee receives as compensation for their work. Net pay is the total income minus any deductions. 

As stated above, apart from some very unusual circumstances, net pay is lower than gross pay. Deductions from gross pay fall into two categories: voluntary and involuntary deductions. 

Involuntary deductions include: 

  • Payroll taxes (Social Security - or FICA - and Medicare taxes)
  • Federal taxes
  • State taxes
  • Local income taxes

Employers may also make voluntary deductions on the employee’s behalf. For instance, workers may see further reductions in their take-home pay due to: 

  • Union dues
  • Equipment and uniform costs
  • Pension contributions
  • 401(k) deductions
  • Health savings account deductions
  • Flexible savings account deductions

In most cases, you can opt out of these payments. For instance, employees don’t have to make pension contributions or put money into a health savings account. 

For most voluntary deductions, the money remains the worker’s, whereas for involuntary deductions, it doesn’t. For instance, an employee will eventually be able to access the funds in their 401(k) account whereas they can’t get back any taxes they owe (unless they’ve paid more than they should). 

In most cases, there is a penalty for accessing savings early. For instance, employees may have to pay a fee to their pensions provider for early release. HR departments can inform workers about the types of penalties they’re likely to face if they want to access their cash today. This information is something you, as an employer, can include in the employee handbook

How To Calculate Gross Pay

Now that we’ve discussed the gross pay definition, it’s time to find out how to calculate it. How calculations proceed depends on whether the employee gets paid hourly, weekly, or monthly. 

Gross annual income is simply the sum of weekly or monthly paychecks. For instance, if an employee receives a wage of $3,000 per month, then their gross annual income is just $3,000 multiplied by 12 – the number of calendar months in the year. If their weekly income is $1,000, then their annual pay is $52,000. 

Here is a table showing how many payrolls are necessary per year depending on the frequency of the payroll accounting period: 

Pay period Example Payrolls per year
Daily You pay employees at the end of the day, say at 5 p.m. 365
Weekly You pay employees every Friday evening 52
Biweekly You pay employees every fortnight, such as a Friday 26
Semimonthly You pay employees twice a month, for example, on the 1st and then the 15th 24
Monthly You pay employees once per month, say on the 27th 12

If employees receive pay by the hour, then calculating gross pay is a little more challenging. For instance, you might have an employee earning $15 per hour, working 40 hours per week, on average. This would imply a weekly pay of $600.

For payroll purposes, you’ll usually calculate their expected income and then pay taxes on their behalf based on this. Then, if they earn less than expected, they can apply for a tax rebate. 

Employers who pay bonuses also need to add these to their gross salary calculations. Bonus income is often taxed at a different rate from regular income. For instance, an employee might receive a base salary of $52,000 and then a bonus of $10,000 for good performance. Total income would be $62,000. The additional $10,000 is generally taxed at a different rate from the rest of the employee’s pay. 

How To Calculate Net Income

Because of the complexity of the net pay definition, the net income formula is quite complicated. Here’s what to do: 

Step 1: Calculate Gross Pay

First, to find annual net income, calculate gross income. 

Step 2: Calculate Voluntary Pre-Tax Deductions

Part of the difference between gross income vs. net income are voluntary deductions. 

Employers typically make deductions such as health benefits, commuter benefits, or pension contributions. 

Here’s an example: 

Gross income $2,500
Health insurance -$500
Pension contribution -$200
Uniform costs -$20
Taxable gross income $1,780

Step 2: Subtract Mandatory Payroll Taxes

Once you’ve deducted all voluntary contributions that reduce taxable gross income, the next step is to calculate mandatory payroll taxes. 

Generally speaking, employees pay both federal income tax withholdings and FICA payroll taxes. Local and state tax withholdings may also apply. 

Federal Income Tax

To calculate an employee’s federal income tax, you’ll need to know their:

  • Filing status (based on marital status and family situation)
  • Withholding allowance
  • Gross wages

Most employers use an IRS Income Tax Withholding Table for the current tax year – Publication 15-A – to find their employees’ tax bracket. 

For instance, suppose an employee has gross wages of $2,500 and a tax withholding allowance of $1,000. The federal government will then tax the remaining wages at 22%, implying a tax bill of: 

($2,500 - $1,000) x 0.22 = $330

Net pay will then be: 

$2,500 - $330 = $2,170

FICA Payroll Taxes

Employees may also have to pay payroll taxes. These are currently set at 15.3%, with the employer and employee sharing the tax burden equally (7.65% each). Payroll taxes include a Social Security tax or FICA charged at 6.2% on the first $147,000 in income and a Medicare tax at 1.45%. 

To calculate this, first find the taxable pay (after making all qualifying voluntary deductions). Then reduce the gross pay by the amount stipulated on the FICA tax to get the net pay. 

Here’s an example: 

Taxable gross pay $2,500
Medicare at 1.45% -$36.25
Social security at 6.2% -$155
Net pay  $2,308.75

Step 3: Apply Any Additional Mandatory Contributions

Employees may also have to pay local and state taxes, so any pay stub must include these, too. Furthermore, some workers may be subject to court-ordered wage garnishments for things like child support or bankruptcy payments. 

Wrapping Up

The difference between gross pay and net pay is easy to understand once you become aware of all the elements that comprise gross pay. Gross pay is the wages employers offer employees before deductions and taxes, while net pay is what they actually get at the end of the pay period. 

Frequently Asked Questions
How do you calculate net income?

You can use a gross pay vs. net pay calculator or do it yourself. To calculate net income, first make qualifying deductions to establish your taxable net income. Then subtract mandatory taxes and deductions from your pay. 

Why is my net pay higher than my gross pay?

Your net pay might be higher than gross pay if you’ve recently received a reimbursement or a tax refund. 

What is the difference between gross pay and net pay?

Gross pay is the pay employees receive before tax and deductions. Net pay is the pay they get after they make these subtractions. 

How do you calculate gross pay from net pay?

The definition of net pay is hidden in the meaning of gross earnings. To calculate gross pay from net pay, simply add back any voluntary deductions and taxes. 

About the author

Danica’s greatest passion is writing. From small businesses, tech, and digital marketing, to academic folklore analysis, movie reviews, and anthropology — she’s done it all. A literature major with a passion for business, software, and fun new gadgets, she has turned her writing craft into a profitable blogging business. When she’s not writing for SmallBizGenius, Danica enjoys hiking, trying to perfect her burger-making skills, and dreaming about vacations in Greece.

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