Summary: Gross pay is the total amount that an employee receives before the deduction of income tax and employee contributions.
Whether you’re managing payroll for a small business or you’re an employee trying to figure out your paycheck, understanding different financial terms can be challenging. With a little experience and knowledge behind you, however, finances quickly become a great deal easier to manage. Knowing what gross pay is, how it’s calculated, and what this figure is used for can be key to your understanding.
What is Gross Pay?
There’s nothing disgusting about gross pay. While it may sound like this kind of pay is vulgar, the word gross actually comes from an old French word gros, meaning ‘large’. This makes sense because gross pay is almost always larger than net pay if it’s not the same.
One way to look at gross pay is to think of it as part of this calculation:
gross pay – deductions = net pay
In this equation, we can see that gross pay is what an employee starts off with after working for a set pay period. Their deductions like taxes and benefits contributions are subtracted from this; then net pay is what the employee gets on their paycheck.
Another way to think about gross pay is that it represents everything that the employee earns during a pay period. If the employee is on a salary, their gross pay is mostly composed of the portion of their salary that the pay period represents (for example, on a monthly pay period, 1/12 of their annual salary). If the employee earns an hourly wage, their gross pay is mostly made up of their hourly rate multiplied by the hours they worked.
However, gross pay also includes any other earnings they may receive, including:
- Overtime pay (often paid at least 1.5 times the employee’s normal rate)
- Tips (personal tips and those allocated to the employee)
- Commissions (rewards based on percentage of sales)
- Bonuses (reward payments for hitting or exceeding performance targets)
- Incentives (pre-arranged reward payments for attaining goals)
- Paid time off income (vacation pay, sick leave pay, maternity leave pay)
- Retroactive pay increases paid on a current paycheck
- Allowances (housing, car, travel, utilities, etc.)
- Other compensation
What’s the Difference Between Gross Pay vs Net Pay?
As we saw from the calculation above, gross pay and net pay are intimately related. Net pay is normally calculated by subtracting deductions from gross pay. However, you can also figure out gross pay by calculating backwards – if you know an employee’s net pay and their deduction amounts, you can add these together to find their gross pay.
The important relationship here is that gross pay is the total of everything an employee earns, but net pay is what they actually get paid after taxes and other deductions are taken off their pay.
Here’s an example calculation to illustrate how gross pay and net pay are related:
Imagine Employee X is paid $2,500 twice a month and pays income taxes in the 22% federal tax bracket. The basic calculation for one pay period would be:
$2,500 (gross pay) – $550 [2500 x 0.22] (deductions) = $1,950 (net pay)
So, if Employee X only receives income from their salary and is only deducted federal income tax, they’d take home $1,950 twice a month.
While this calculation is greatly simplified, you can still see how gross pay and net pay are linked, with gross pay almost always being more than net pay.
Why is Gross Pay Important?
Once you know what gross pay is and how it relates to both deductions and net pay, you can start to see why it’s such an important figure to understand.
For employers, gross pay is what they offer workers. There’s no way for employers to accurately calculate net pay for any position without first knowing the tax obligations of the people who might will it. Therefore, they can only offer gross pay in job advertisements and on employment contracts.
Gross pay is also used to set legal standards like minimum wages or prevailing wages. When governments decree that workers must be paid minimum wages or contracts indicate that salaries should follow prevailing wages, these always refer to gross pay.
This is because, once again, no one can calculate net pay until knowing who will be working and what their specific deductions are. This means that employers legally can and do pay workers less than the minimum wage because they provide net pay after deductions are taken off gross pay.
For employees, gross pay represents the rate of pay they need to consider when looking for jobs or thinking about job offers. They, too, don’t know their deductions perfectly so they need to depend on gross pay rates to determine if jobs will compensate them adequately.
Gross pay is also used in the financial world for calculating loans and credit card limits. Many financial institutions set their lending limits and rates based on peoples’ gross income simply because it’s easier to access and manage these numbers. Likewise, landlords often look at gross pay to determine whether or not they’ll agree to let an applicant rent their property as it gives them a reasonable estimate of the person’s ability to pay.
Finally, gross pay or gross income is used as the basis for calculating income taxes. In the US, for example, the Internal Revenue Service (IRS) requires taxpayers to declare their gross income and then subtract some adjustments to end up with their adjusted gross income (AGI). This is the basis for calculating their tax obligations.
How Do You Calculate Gross Pay?
The task of calculating gross pay is different depending on how an employee is paid and how often. Here we’ll look at how to calculate gross pay for a salaried employee, an hourly wage worker, and a salesperson paid on commission only.
Gross Pay for a Salaried Employee
To calculate the gross pay for a salaried employee, we need to know their annual salary and the length of their pay period. Their gross pay will generally be calculated by dividing their salary by the number of pay periods in the year and then adding any extra earnings like bonuses or allowances.
For example, let’s return to Employee X. Imagine this employee is on a salary of $60,000 per year. If they’re paid semi-monthly (twice a month), this means there are two pay periods a month and 24 pay periods in the year. The basis for their gross pay calculation would then be:
$60,000/year ÷ 24 pay periods/year = $2,500/pay period (plus other earnings)
Employee X would be paid a gross pay of $2,500 plus other earnings in each pay period.
Gross Pay for an Hourly Worker
Calculating the gross pay of an hourly worker involves multiplying their hourly wage by the number of hours worked during a pay period. Like the salaried employee, we also need to add other earnings to this calculation. Let’s calculate the gross pay for hourly worker Employee Y.
Imagine Employee Y is paid weekly and gets $22/hour for regular working hours. When they work overtime, they’re paid time-and-a-half or $33/hour. If Employee Y works a 40-hour week and does an extra 6 hours of overtime, their gross pay calculation would be as follows:
(40 hours x $22/hour) + (6 hours x $33/hour) = $880 + $198 = $1078 (plus other earnings)
Employee Y’s gross pay for the week would be $1,078 plus any other earnings like tips or allowances.
Gross Pay for a Commissioned Salesperson
In many parts of the world, commissioned employees can be paid solely on the basis of their sales as long as their pay meets or exceeds the minimum wage set out in law. Their gross pay is usually simple to calculate by multiplying their total sales by their commission percentage.
Imagine Employee Z sells cars, receives a flat 20% on all successful sales, and is paid monthly. In one month, their total sales equal $80,400. Here’s how their gross pay would look:
$80,400 x 0.2 = $16,080 (plus other earnings)
Employee Z’s gross pay would be $16,080 for the month plus any other earnings.
Gross Pay Summarized
The best way to think of gross pay is the total of everything an employee earns during a pay period before any deductions are subtracted. Gross pay is useful in contract negotiations, loans and rental agreements, and in budgeting for staff. While the bulk of gross pay is composed of wages, salary, or commissions, it’s important to also include any other earnings that the employee receives during a pay period.
FAQ
In some locations in the world, like Monaco and Kuwait, employees are not subject to income tax. They might therefore have no deductions to pay so their gross pay and net pay would be the same. Volunteers receiving no compensation would have a gross pay of zero and with zero deductions, their net pay would also be zero.
No. Even if an employee owes more than they’re supposed to be paid for a pay period, their gross pay represents their earnings and has to be positive or, at worst, zero.