Net vs Gross Income: Key Considerations for HR and Employees

The difference between gross vs. net pay is just one of the many essentials that HR department leaders need to know. In this guide, we've outlined the key differences.

What Is Gross Pay?

Gross pay is the wages that are earned before payroll deductions are made. This means that it is what employees will earn before taxes, 401k contributions, garnishments, child support payments, and other kinds of payroll deductions are made.

Gross pay is essentially the number that you would use to advertise a job position.

How Is Gross Pay Calculated?

Gross pay is calculated mostly based on how your company pays its employees. It is essentially just the salary or hourly rate you pay your employees before any withholdings and deductions.

On top of base salary, gross pay will include overtime, commissions, bonuses, sick pay, and holiday pay. For the most part, calculating gross income is straightforward because gross income is earnings before taxes. There are other fringe benefits that may be included in gross income, but some do not count as taxable income. Depending on where your business operates, what counts as taxable income can vary.

Salary Worker Gross Pay

If an employee is salaried, then their gross pay will be equal to their annual salary divided by the number of pay periods each year. Depending on the payment schedule you use, the salary will be divided accordingly:

Hourly Worker Gross Pay

When it comes to calculating gross pay for hourly workers, you have to multiply your hourly pay rate by the hours worked during each pay period. If applicable, you need to account for overtime rates as well.

What Is Net Pay?

Net pay is the amount of money that employees end up taking home once all payroll deductions have been calculated. This means that all the necessary payroll deductions need to be made from the gross pay in order to get the actual amount for net pay. Net pay numbers are lower than gross pay because of certain mandatory deductions that cannot be avoided (at risk of penalties).

For organizations paying their employees either hourly or salaried, it is important for HR professionals and leaders to know the distinction between gross pay and net pay. It can help you meet labor compliance laws and foster more communication and trust between employees and employers.

How Is Net Pay Calculated?

Some payroll deductions are mandatory, but others are optional. Thus, each worker’s net pay can vary significantly within the same company and job position.

When calculating net pay, you have to make deductions from the gross pay based on applicable (and potentially mandatory) deductions. Here are the payroll deductions that HR professionals will typically factor into their net pay calculations:

• 401(k) and other retirement saving plans

• Health insurance premiums

• Pre-tax contributions

• All taxes that need to be withheld, such as FICA taxes, local and state taxes, and federal income taxes

• Court-ordered payments that result in the garnishment of wages (such as child support)

All of these factors have a part to play in how to calculate net income.

Are There Differences In Gross and Net Pay For Hourly vs. Salaried Employees?

Some employees must be paid hourly, whereas others can be paid a salary. Salaried employees receive a fixed wage, even if they have to work extra hours to meet their expected responsibilities. Salary workers on your payroll do not need to be paid overtime wages. This means that salaried workers can expect their gross pay to not include bonus overtime pay.

On the other hand, hourly employees need to be paid for any overtime hours that they work. This means that their gross pay may include additional compensation for the extra hours that they work.

In terms of net pay, both hourly and salaried workers will have their gross pay deducted by the necessary payroll deductions.

How Do Gross Pay and Net Pay Affect Employer Taxes?

Employers have numerous responsibilities when it comes to paying taxes, including the responsibility of withholding FICA taxes from employee paychecks. Since employers are responsible for paying half of each employee’s FICA taxes, the taxable income that employers pay their employees can affect their employer taxes.

Employers should be aware of and clear on what their employees’ net pay is because it helps with accounting practices, payroll taxes, and even potential legal defense if an employee files for a wage dispute.

What Are Income Deductions?

Income deductions may refer to either income tax deductions or payroll deductions from someone’s income.

Tax deductions help organizations and individuals reduce the amount of income that will be subject to income tax (AKA taxable income). Payroll deductions refer to the numerous kinds of taxes and deductions that need to be subtracted from the gross pay.

What Is FICA Payroll Tax?

The Federal Insurance Contributions Act (FICA) payroll tax is deducted from each paycheck that an employee receives. Even for those who are self-employed, FICA taxes need to be paid. The FICA payroll tax is meant to fund the Social Security and Medicare systems, and you cannot receive exemptions for this particular tax.

Federal Income Tax vs. State Income Tax

Federal income tax withholdings are a kind of tax that affects the net pay that employees will receive. This income tax is calculated using a bracket system and increases progressively based on income so that those with higher incomes will pay at a higher rate.

Meanwhile, whether state income taxes are a part of payroll deductions will depend on what location the business operates in. Some states have chosen not to have an income tax at all. On the other hand, some cities may impose their own income tax. It is a good idea to be aware of what state/city income tax your business needs to use to calculate net income.

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