Net Pay

Net pay is the amount of money an employee receives on payday after all required and voluntary deductions have been taken from gross pay. It is what is paid into the employee's bank account by direct deposit or by check, and is often called take-home pay. Gross wages, by contrast, are total earnings before any deductions, including salary, hourly pay, overtime, commissions and bonuses.

For employers, calculating net pay correctly is a core payroll task. The difference between gross and net pay is not a saving for the business: each amount withheld is owed to someone else, such as the government, a retirement plan or an insurer, and is recorded as a liability until it is paid over.

In the United States, deductions fall into three broad groups:

• Taxes: federal income tax withholding based on the employee's Form W-4; state and sometimes local income taxes; and the employee's share of Social Security and Medicare taxes under FICA.
• Pre-tax benefit deductions: contributions to a 401(k) or similar retirement plan, and health, dental and vision premiums or flexible spending contributions paid through a cafeteria plan. These reduce taxable wages for income tax, and cafeteria plan deductions also reduce wages subject to FICA.
• Post-tax deductions: Roth retirement contributions, union dues, charitable gifts through payroll, repayments of employee advances and court-ordered garnishments such as child support.

The basic calculation is:

Here $\text{Gross pay}$ is total earnings for the period, $\text{Taxes withheld}$ are income and payroll taxes deducted, and $\text{Other deductions}$ are benefit contributions and other amounts the employee has authorized or a court has ordered.

An employee earns $3,000 every two weeks. She contributes 6 percent, or $180, to a traditional 401(k), and pays $120 for health insurance through a cafeteria plan. Wages subject to Social Security and Medicare are $3,000 minus the $120 health premium, or $2,880; the 401(k) contribution does not reduce these wages. Social Security tax at 6.2 percent is $178.56 and Medicare tax at 1.45 percent is $41.76. Federal income tax withholding is $260 and state withholding is $110.

Total deductions are $180 plus $120 plus $178.56 plus $41.76 plus $260 plus $110, which is $890.32. Net pay is $3,000 minus $890.32, or $2,109.68, about 70 percent of gross pay.

When payroll is recorded, the employer debits salaries or wages expense for the full gross amount of $3,000. It credits separate liabilities for each deduction, such as FICA taxes payable, federal income tax withholdings payable, state withholding payable, 401(k) payable and health insurance payable, and credits cash or wages payable for the net pay of $2,109.68. When the withheld amounts are paid to the government and benefit providers, the liabilities are debited and cash is credited. The employer's own costs, such as its matching FICA, unemployment taxes and its share of health premiums, are recorded separately as employer payroll taxes and benefits expense; they do not reduce the employee's net pay. If payday falls after the period end, unpaid wages are recorded as accrued payroll.

Errors in net pay usually come from out-of-date W-4 forms, misclassifying benefits as pre-tax or post-tax, applying FICA to the wrong wage base, or missing a garnishment order. Federal law limits how much of an employee's disposable earnings can be garnished, and the Fair Labor Standards Act prohibits deductions that would reduce pay below the minimum wage for certain items such as uniforms. Employees see their gross pay, each deduction and net pay on their pay stub, and the year's totals on Form W-2. Employers that pay through a payroll provider still remain responsible for depositing the withheld amounts on time.