Net Pay and Payroll Software
What is the difference between net pay and gross pay, and how can payroll software help make calculations easier? Knowing this information will help you figure out your business’s budget and process payroll more accurately. Read on to learn about the ins and outs of the numbers that make up a paycheck.
Net Pay vs Gross Pay
There are two key figures in payroll that financial departments and employees need to know. This information impacts paychecks and withholdings, record keeping, and employment laws.
Gross pay and net pay are wages that your employees earn. Gross pay is the amount employees earn before payroll deductions are calculated and withheld from their wages. It is an agreed upon salary or wage between the employer and employee when the worker accepts employment.
When deductions are in place — which happens with every employee — the figures change. Once all withholdings are calculated and deducted from the gross pay, the amount remaining becomes net pay or take-home pay.
Payroll deductions cover the wide variety of amounts taken off an employee’s paycheck. They can include tax and can also be pre-tax or post-tax additional deductions. There are mandatory payroll deductions and voluntary deductions.
Mandatory Payroll Deductions
Certain amounts of money must be withheld from employee wages and submitted to tax agencies. If employers do not do this, they are subject to penalties.
Federal Insurance Contributions Act (FICA) tax and federal income tax are federally mandated.
FICA tax includes social security and Medicare taxes, and the employees and employers contribute to it equally. The total amount deducted from an employee’s paycheckque is 7.65%, and as an employer you must also pay a 7.65% contribution.
Federal income tax is based on W-4 information and gross pay. The IRS has information that can help you calculate the amount to withhold.
There are also state and local taxes, which need to be calculated based on information from those entities.
Voluntary Payroll Deductions
Voluntary payroll deductions are amounts taken from gross pay with an employee’s consent. In other words, they need to opt into these deductions.
This can include health insurance premiums based on what your company offers for insurance coverage. The same applies to retirement plans, disability coverage and life insurance premiums, again depending on what you offer.
Employees may also deduct job-related expenses, including union dues, meals, or uniforms.
A wage garnishment is a mandatory payroll deduction, but it only applies when an employee has unpaid debt. This can include taxes, alimony, child support, and defaulted loans. You will learn about this as an employer, through court orders or government agencies. Garnishments can range from 15 percent to 70 percent of a paycheck.
Calculating Gross Pay and Net Pay
Employers must calculate gross pay every pay period, whether weekly, biweekly, semimonthly or monthly. That is simply the amount of money they have before deductions, but it is the starting point for net pay. Gross pay also impacts the employee’s tax liability.
Gross pay for hourly workers is calculated by outplaying their hourly rate by the number of hours worked in a pay period. For salaried workers, gross income is calculated by dividing their annual salary by the number of pay periods in a year.
Net pay is gross pay minus deductions, and it also has to be calculated each pay period.
For small businesses and those just starting out, manually managing payroll, including gross and net pay, might seem appealing and affordable. To do this, your company needs to decide on a pay period and implement a way to track hours worked, vacation, and other factors that impact how much pay is earned each period.
Then, you need to designate someone who will manually calculate hours worked multiplied by the pay rate for each employee. They will also need to calculate appropriate deductions and remove them from gross pay. All of this needs to be recorded.
The next step is to actually run payroll, which means paying the employees what they are owed in wages and ensuring they have a pay stub. You will then need to remit the taxes you have withheld to the government monthly or quarterly.
Using Payroll Software
Payroll software offers many advantages in calculating gross and net pay, recording payroll, and ensuring financial compliance is met.
Businesses of all types and sizes can use payroll software. Some may opt for online bookkeeping, which adds an extra element of management from real accountants. With managed payroll software or even do-it-yourself software, information is automatically updated from other sources to ensure that payroll is accurate.
For example, if you hire a new employee, their tax information can be loaded into the system, ensuring that the appropriate deductions are taken. Their time worked, input manually or by integration with timesheet software is also automatically processed. The software calculates their gross pay, deductions, and net pay, records it, and can even print checks or ensure that direct deposit is complete.
Payroll software is fast and less prone to error because the information is automatically processed. It requires minimal effort and ensures that needed forms and returns are prepared for employees. Other tasks can be automated, like year-end reporting, and compliance is easy to meet.
While payroll software costs more than manually calculating what is owed to employees, there are also cost savings regarding how much time it takes to manually manage all aspects of employee wages. What you make back in time is worth a lot of money, and accuracy and compliance ensure that there is less of a risk of a costly error.
Recording Gross and Net Pay
Payroll documentation has to include both gross and net pay. This documentation must be in a business’s records for a prescribed period. The payroll register records all individual payroll information and calculates a business’s overall gross wages during any period, as well as tax withholdings.
Pay stubs are also a record of gross and net pay. Stubs typically show employees their gross wages, deductions as line items, and net wages. Every employee needs a pay stub during each payroll run. Stubs can be digital or physical and can be accessed by the employee.
Pay stubs also show year-to-date payroll, including gross wages, deductions and net wages for the whole year. This information is important to verify payroll accuracy and is helpful for employees if they have any concerns.