Even though employers offer hourly rates or annual salaries to employees, the sum of these numbers does not accurately reflect the amount of money that the employee gets to take home in cash.
The difference between the rate someone is paid versus how much money they actually receive is described using two terms: gross pay and net pay.
What is Gross Pay?
Gross pay is the amount of money that an employee is paid before any deductions are taken off. For example, if a business offers a new employee a salary of $40,000.00 per year, that will be their gross pay.
What is Net Pay?
Net pay is the amount of money that an employee gets to take home after their employer has taken off all of the necessary deductions. Deductions may include:
- Income taxes.
- Union dues.
- Benefit fees.
How It Works:
Let's consider an example to illustrate the difference between gross and net pay.
Say that Joe is hired by ABC Corporation in New York and is given a starting salary of $50,000.00 per year. ABC Corporation pays Joe's salary on a monthly basis, meaning that his gross monthly earnings are $4,166.66. However, ABC must deduct income taxes by law, so Joe will not receive a paycheck for the exact amount of $4,166.66.
Several factors will determine Joe's actual net pay, but for the sake of this example, let's say that Joe's employer deducts 5% for income taxes and 2% for his pension contribution. This means that 7% of his gross income is withheld before it reaches him, netting him 93% of his gross annual salary. That works out to $3,874.99 per month or $46,499.88 per year.
We can see that Joe's gross pay is $50,000.00 per year, but his net pay is only $46,499.88 per year.
The Bottom Line:
It's important for employers and employees alike to understand the difference between gross and net pay. Employees should remember that the amount they are offered does not necessarily reflect the amount that they will receive. In the same way, employers may find that they need to offer a larger gross salary to satisfy the earning requirements of their staff.
Other Payroll Resources:
What is the difference between gross and net pay?
What is net pay?
Net pay is the amount of pay that employees take home after all necessary deductions have been done.
Why is it important to know the difference between gross pay and net pay?
It is important the know the difference because employees should know that the amount they are offered does not necessarily reflect the amount that they will receive. Employers may also find that they need to offer a larger gross salary to satisfy the earning requirements of their staff.
How do you calculate gross pay from net pay?
You can use a net to gross pay calculator from a payroll software service, such as Quickbooks.