Tips for Calculating Net Pay for Employees

Paper pay slip with tax and pension information
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One of your most important jobs as a business with employees is to make sure your employee pay is calculated correctly. That responsibility includes withholding correct amounts for taxes and making other deductions. Begin with the employee's gross pay (total pay for the period) and work through the process of withholding and deducting to get to net pay.

Net pay is the amount of an employee's pay (either salaried or hourly) after withholding for federal and state income taxes, and any additional paycheck deductions. Net pay is thus the amount actually received by the employee in their paycheck. 

This article on gross pay includes a discussion of the difference between gross pay, taxable wages, and Social Security wages.

How to Calculate Net Pay

1. Start with gross pay.

To begin the calculation of net pay, you must start with the employee's gross pay. Gross pay is the amount that is owed to the employee for the pay period (weekly, bi-weekly, semi-monthly, or monthly).

All withholdings and deductions are based on gross pay. Begin each calculation with the gross pay amount. The gross pay amount may change if an employee has taxable income in addition to the calculated pay for work, such as reimbursements.

Gross pay for hourly employees is the hours worked times hourly rate, with overtime premiums, if applicable.

Sam has worked 42 hours this week, at an hourly rate of $12. That's 40 hours at his regular rate and 2 hours at 1 1/2 times that rate. 40 x $12 = $480. 2 x $18 = $36. Total gross pay= $480 + $36 = $516.

Gross pay for salaried employees is their annual salary divided by the number of pay periods in the year. Some exempt salaried employees may be eligible for overtime if their pay level is below $684 a week. 

Carlotta has an annual salary of $36,000 and she is paid every other week (26 paydays each year). To get her gross pay for this pay period: $36,000 / 26 = $1,384.62.

2. Calculate and deduct federal income tax withholding.

Federal income taxes are withheld based on the information provided by the employee on Form W-4. Employees may submit a new W-4 form at any time, and as many times as they wish, but only once per pay period. This form changed beginning January 1, 2020, so any new employees or employees changing their withholding after this date must use the new form. 

This form is complicated, with more steps than the old form. This article on Information for Form W-4 for Employers has tips for using the form to calculate employee income tax withholding. The Employer's Tax Guide from the IRS has all of the withholding tables and you can also use IRS Publication 15-T, with detailed steps in the process.

It's illegal for an employer to help an employee complete a W-4 form. If the employee is unsure, direct him or her to this IRS withholding calculator.

3. Deduct any state and local withholding.

State withholding is a little trickier because each state has different rules and forms for payroll withholding; some states have no withholding because they do not tax income. Different towns and cities also have their own rules. The Bureau of Labor Statistics has a chart of forms used by each state for calculating state income tax withholding.

If an employee works in several states or different localities within a state, you may have to deduct state income tax from multiple states. If you have employees in multiple states, you may want to get the help of a payroll service to try to keep all of these deductions straight.

Some states have reciprocity agreements, meaning that they do not tax out-of-state income. For example, an employee who works in Iowa and who is a resident of Illinois does not have to pay Iowa income tax on his or her wages. Check this list of reciprocity agreements.

4. Withhold FICA taxes.

FICA tax is a combination of OASDI (Social Security) and Medicare tax.

To calculate the Social Security withholding you'll need to determine what pay and benefits are included in Social Security wages. The formula for calculating FICA tax is gross pay times the employee portion of the tax, which is 7.65% (6.2% for Social Security and 1.45%t for Medicare).

The gross pay for Sam this pay period is $516, so you must withhold $39.47 in FICA taxes.

The gross pay for Carlotta this pay period is $1,384.62, so the FICA tax you must withhold $105.92.

You'll need to make yourself two reminders during the year. Each payroll period: 

  • Check to be sure that the employee's total gross pay for the year does not exceed the Social Security maximum for that year. At the point where the employee's pay exceeds this maximum, you must stop withholding Social Security (the 6.2%). There is no maximum on the Medicare portion.
  • You must also note when an employee's wages reach the amount for the Additional Medicare tax.This amount of gross pay depends on the employee's marital status. At this point, you must begin withholding an additional 0.9% (in addition to the 1.45%.
  • The employer must pay share of FICA tax on all Social Security wages and Medicare wages (but not the additional 0.9% of Medicare wages).

5. Take any additional voluntary deductions.

A number of voluntary deductions are possible, including health plan premiums, garnishments, and charitable donations.

Be sure you have documentation in the employee's payroll file to show authorization for any deductions. The only exceptions are FICA taxes and garnishments or other court-ordered payments.

Sam's Net Pay Calculation
Gross Pay   $516.00  
 - Federal income Tax  - $64.78 (single, paid weekly, no allowances)
 - FICA Tax  - $39.47  
+ Net Pay = $411.75  
Carlotta's Net Pay Calculation
Gross Pay $1384.62  
- Federal Income Tax  - $90.95 (married, paid semi-monthly, no allowances)
- FICA Tax  -$105.92  
= Net Pay    $117.75  

Writing the Employee Paycheck

Now that you have calculated gross pay, taken withholding for income taxes and FICA taxes, and any other deductions, you have a net pay amount. It's time to write the employee's paycheck.

Be sure you have documentation in the employee's payroll file to show authorization for any deductions. The only exceptions are FICA taxes and garnishments or other court-ordered payments.

Federal law requires that on each paycheck you must provide each employee with information on year-to-date amounts for all calculations.

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Article Sources

  1. Department of Labor. "Overtime Final Rule," Accessed Nov. 5, 2020.

  2. IRS. "FAQs on the 2020 Form W-4 Q. 4." Accessed Nov. 5, 2020.