person using a calculator and laptop to determine an employee's net pay

What is Net Pay and How is it Calculated?

Before employees start their first day on the job, it’s important they understand their compensation completely. They agreed to an hourly or salaried amount when you offered them the position. But, do they know precisely how much money will show up in their bank account each payday? If the answer is “no,” it may not be long before you hear a complaint. That’s why it might be wise to give them an idea about their net pay amount when they accept the job.

What is net pay?

Net pay is the amount that actually appears on an employee’s paycheck. It is the leftover number after withholding taxes and factoring in deductions during the payroll process.  

Net pay vs. gross pay

Confusion over income likely stems from a misunderstanding between net pay and gross pay. While net pay is the post-tax and post-deduction amount an employee brings home, gross pay is the pre-tax and pre-deduction amount that was likely agreed upon during salary negotiations. Consider it this way: if you take the employee’s salary and divide it by the number of times you’ll pay them in a year, you get their gross pay per pay period.

That’s the amount you worker sees at the top of their pay stub. However, that’s NOT the amount they’ll take home on payday.

How to calculate net pay

Net pay = gross pay – taxes withheld – deductions withheld

Now that you have a grasp on gross pay, let’s talk taxes and deductions you might withhold from an employee’s check. Taxes withheld include state and federal income taxes, as well as Social Security and Medicare. You’ll need to have all employees complete Form W-4, which specifies how much federal income tax to withhold from their paychecks. If you operate in a state with state income tax, you’ll need to provide the state version of that form.

Deductions can include 401(k) contributions, health insurance premiums, charitable donations, etc. Some deductions are pre-tax while some are post-tax. You’ll make deductions based on what benefits your company offers. Even if you offer these benefits, workers can opt-out and not partake so they can receive more take-home money in their paycheck.

Example

Let’s use a staff member who makes $50,000 a year for a salary, is paid semi-monthly, and contributes 5% of their pay to a retirement fund. The individual’s gross pay per paycheck is $2,083.33 ($50,000/24 yearly paychecks). The deduction for the 401(k) contribution is $104.15 ($2,083 x 0.05). Per the IRS, the current Federal Insurance Contributions Act (FICA) tax rate is 7.65%, which combines the rates for Social Security (6.2%) and Medicare taxes (1.45%).

Therefore, this employee would owe $159.35 ($2,083 x 0.0765) in FICA taxes per paycheck. Removing $104.15 and $159.35 from the gross pay yields $1,819.83. That’s before income taxes are taken out. This percentage depends on W-4 allowances, claiming status, and tax bracket. Each of these varies, so we will not include an income tax amount in this example. Just know that it must be factored in to determine an employee’s net pay. So, while the worker may expect a paycheck of $2,083.33 each pay period, they will bring home less than $1,800 each time.

Simplify payroll with Workful

If you’re not one for crunching numbers, or if you’d like to free up your time to focus on other aspects of your business, Workful can help. Our payroll platform will automatically calculate income tax, Social Security tax, and Medicare tax for each team member, as well as unemployment insurance liability for your business.

It will also store essential forms, including W-2s, Form 941,  and Form 940 (FUTA tax). Our solution will make your life easier by ensuring that your employees get paid accurately and on time.