What is Gross Pay?

by Jennifer Kiesewetter in

TLDR

  • When learning how to administer payroll for a startup, founders must understand two foundational concepts: gross pay and net pay.
  • The primary difference between gross and net pay is the timing of payroll deductions. Payroll deductions are the amounts you withhold from your employees’ pay.
  • Gross pay is the amount of employee pay before withholding mandatory (e.g., taxes) and voluntary deductions. Net pay is what is left over and known as "take-home pay."
  • Expressed as an equation, net pay = gross pay – deductions.
  • When calculating gross pay, the startup must take into account whether the employee is salaried or hourly.
  • A salaried (exempt) employee is paid the same amount each pay period, whether they worked 40 hours a week or 60 hours a week. Salaried employees aren’t eligible for overtime.
  • Hourly employees, on the other hand, are paid a set amount for each hour worked. Most hourly employees are eligible for overtime, according to both state and federal law. 
  • To determine an hourly worker’s gross pay, multiple the employee’s hourly rates by the number of hours worked during the pay period.
  • To calculate gross pay for salaried employees, the startup will divide the employee’s annual salary by the number of pay periods.
  • All employees covered by the FLSA must receive overtime pay for hours worked in excess of 40 in a workweek, unless the employee is exempt. The minimum amount of overtime pay should equal no less than 1.5 times the employee’s regular pay rate.
  • According to the FLSA, employers must keep written documentation related to their employees’ gross and net pay. Payroll records must be maintained for at least three years, and any documentation about wage calculation must be maintained for at least two years. Wage calculation documentation includes timecards and records related to deductions, such as health or retirement plan participation and deduction amounts.
  • Under federal law, employers are not required to provide their employees with pay stubs. However, they may be required to do so under state law. Each pay stub reflects the pay period dates, the number of hours worked, gross earnings, deductions, net earnings, overtime, contributions to health and/or retirement plans, and year-to-date gross and net earnings.

Establishing and running payroll can often be time-consuming and confusing. In addition to gathering the correct information from employees, such as social security numbers and bank account information for direct deposit, startups must comply with numerous state and federal laws. Failing to comply with the payroll laws can potentially result in significant fines.

When learning how to administer payroll for a startup, founders must understand two foundational concepts: gross pay and net pay. This article will address the difference between gross and net pay and how each applies to salaried and hourly employees.

What is the Difference Between Gross Pay and Net Pay?

When running payroll, startups must understand the difference between gross pay and net pay, and the latter is what is left over after payroll deductions, also known as "take-home pay." Payroll deductions are the amounts the employer withholds from their employees’ pay.

Some deductions, such as federal and state taxes, are mandatory withholdings, where others are voluntary. Examples of voluntary deductions include those for health insurance and retirement plans.

Gross pay is the amount of employee pay before withholding mandatory and voluntary deductions. Founders attract and retain employees by focusing on their gross pay. For example, if a startup advertises a job with a salary of $95,000 annually, that reference is to gross pay. Net pay, on the other hand, is the employee’s take-home pay.   

What is Included in Gross Pay?

Gross pay is the total salary paid to the employee before deductions such as Medicare and Social Security taxes are withheld. Gross pay includes:

  • Wages for salaried or hourly employees
  • Vacation pay
  • Sick pay
  • Holiday pay
  • Sales commissions
  • Bonuses
  • Shift differentials

Gross pay is based on the salary your startup and the employee agree on before the employee’s first day of work. Expressed as an equation, gross pay = net pay + deductions.

What is Included in Net Pay?

As discussed above, net pay is gross pay minus all mandatory and voluntary deductions. Mandatory deductions include:

For Social Security taxes, the employer pays 6.2 percent of gross wages towards the tax, and the employee pays 6.2 percent as well, for a total of 12.4 percent. For Medicare taxes, the employer pays 1.45 percent of gross wages towards the tax, and the employee pays 1.45 percent as well, for a total of 2.90 percent. These taxes are all mandatory and must be deducted from an employee’s gross pay for each pay period.

Voluntary deductions can include deductions for the following examples:

  • Health insurance
  • Retirement plan
  • Group life insurance
  • Group disability insurance
  • Group dental and/or vision insurance
  • Flexible spending accounts

Once these deductions are subtracted from the employee’s gross pay, you get the employee’s “take-home” pay or net pay. Expressed as an equation, net pay = gross pay – all deductions.

For example, if an employee has gross pay of $95,000 annually, that employee may only take home $65,000 annually after all mandatory and voluntary deductions are subtracted. The net pay is directly indicative of the employee’s spending power.

How are Hourly and Salaried Gross Pay Calculated?

When calculating gross pay, the startup must take into account whether the employee is salaried or hourly. A salaried employee is paid the same amount each pay period, whether they worked 40 hours a week or 60 hours a week. Salaried employees aren’t eligible for overtime.

Hourly employees, on the other hand, are paid a set amount for each hour worked. Most hourly employees are eligible for overtime, according to state and federal law. To know if your hourly employees are eligible for overtime, you’ll need to check the federal rules in addition to those in the state where your startup operates. Startups must pay all hourly employees at least minimum wage.

Let’s look at how gross pay is calculated for both hourly and salaried employees.

Hourly Employees

To determine an hourly worker’s gross pay, multiple the employee’s hourly rates by the number of hours worked during the pay period. For example, if the employee receives a $10 hourly wage and worked eighty hours over the two-week pay period, that employee’s gross pay for the two-week pay period is $800 (80 hours x $10 per hour).

If the hourly employee worked overtime, you’d need to take these additional hours into account when calculating gross pay. We address over time in more detail below.

Salaried Employees

To calculate gross pay for salaried employees, you will divide the employee’s annual salary by the number of pay periods. For example, if the startup pays employees twice a month, and the employee’s gross annual salary is $95,000, then that employee’s gross pay per pay period is $3,958.33 ($95,000/24).

How are Hourly and Salaried Net Pay Calculated?

Now, let’s look at how net pay is calculated for both hourly and salaried employees.

Once you establish the gross pay for your startup employee, whether they are hourly or salaried, your net pay calculation is the same:

Net Pay = Gross Income – All Deductions

How is Overtime Calculated?

Overtime is governed by the Fair Labor Standards Act (FLSA), enforced by the U.S. Department of Labor. The FLSA requires that all employees covered by the Act receive overtime pay for hours worked over 40 in a workweek unless the employee is exempt. The minimum amount of overtime pay should equal no less than 1.5 times the employee’s regular pay rate.

The FLSA applies to all companies engaged in interstate commerce or those with annual sales of $500,000 or more. Although the FLSA applies to most businesses, including startups, it’s essential to understand your state laws related to overtime as well, as they may apply in addition to any federal laws.

How do You Record Gross Pay, Net Pay, and Overtime?

According to the FLSA, employers must keep written documentation related to their employees’ gross and net pay. For example, for non-exempt workers, the startup must keep the following documentation:

  • Employee’s full name
  • Employee’s current address
  • Employee’s Social Security number and birthdate (if younger than 19)
  • Each employee’s work schedule
  • Hours worked each day for each employee
  • Total number of hours worked each week for each employee
  • Employee’s regular pay rate and whether they are salaried or hourly
  • Any overtime pay
  • All deductions subtracted from each employee’s paycheck

Payroll records must be maintained for at least three years, and any documentation about wage calculation must be maintained for at least two years. Wage calculation documentation includes timecards and records related to deductions, such as health or retirement plan participation and deduction amounts.

Under federal law, employers are not required to provide their employees with pay stubs. However, they may be required to do so under state law. Each pay stub reflects the pay period dates, the number of hours worked, gross earnings, deductions, net earnings, overtime, contributions to health and/or retirement plans, and year-to-date gross and net earnings.

Some states have specific legislation regarding pay stubs, where others don’t. For example, in California, if employers don’t provide employees with accurate and complete pay stubs, the employee may seek damages from the employer for each paystub violation. On the other hand, nine states have no paystub laws, including Florida, Georgia, and Ohio.

The format of paystubs also varies by state; some states permit the employer to provide written, printed, or electronic pay stubs, such as Illinois, Michigan, New York, and Virginia, whereas other states require that the paystubs be written or printed as in California and Texas.

Because the FLSA requires that eligible employers maintain specific payroll documentation, if an employee requests payroll information, the employer should provide it. This best practice applies even if a state does not have specific laws about pay stubs.

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