Summary: Net pay is the amount that an employee is paid after deductions are taken off by the employer, such as income tax withheld and payroll taxes.
Think about a fisherman who goes out to sea for a day’s work. While “the one that got away” always makes a great story, the only thing that counts at the end of the day is what’s left in his net. Like this fisherman’s take, net pay is what an employee ends up with after paying taxes, contributions to benefits programs, and other deductions.
In this article, we’ll define net pay, examine its importance, and show you how you can calculate it for yourself or your employees.
What Is Net Pay?
While the fishing example above provides a good comparison, the terms ‘net pay’ and ‘net income’ don’t come from a maritime tradition. Instead, these words stem from an old French word net, which means ‘neat’ or ‘clean’. While this may not make sense at first, we can think of net pay as an employee’s total pay that has been cleaned and tidied up by removing deductions. This is the real reason that it’s called net pay.
One way to consider net pay is as a part of the following equation:
net pay = gross pay – deductions
This calculation shows us that net pay is related to gross pay and deductions in an important way. Net pay is what is left after all of an employee’s earnings for a pay period have been added u,p and all of their deductions have been subtracted from that total. This is why net pay is also often called ‘take-home pay’. It’s what an employee actually takes home on their paycheck or receives as a direct deposit in their bank account.
How much an employee nets depends on two main factors: how much they make from their work in all forms of earnings and how much is taken off from this gross pay for all kinds of deductions. This table summarizes many of the earning and deduction types that are common in employment situations:
| Net Pay | = | Gross Pay | − | Deductions |
|
Basic salary or wages Overtime pay Tips Commissions Bonuses Incentives Paid time off income Retroactive pay increases Allowances |
Federal income tax State income tax Local income tax Social Security Medicare Unemployment insurance Disability insurance Garnishments Insurance premiums (life, health, medical, dental, etc.) Retirement plan contributions Union dues |
Why Is Net Pay Important?
Net pay can be important for both employers and employees in a number of ways.
In contrast with gross pay, it represents what employees are actually paid. Employers are required to withhold taxes from their employees but they don’t necessarily need to remit these taxes immediately. However, come payday, the employer needs to have enough liquid funds to pay all of their employees so knowing the total of their net pay helps the employer know their cashflow requirements.
Employers also need to check their payroll calculations and make sure that each employee’s net pay is correct. Payroll accuracy is critical for employee satisfaction. If an employee receives less net pay than they’re entitled to, the employer should have a quick system in place to recheck their calculations and correct any net pay mistakes.
When employees look for jobs, they have to assess offers based on gross pay. While they need to think about their net pay, they won’t know it accurately without knowing how much they’ll earn and what their deductions will be.
However, they can start with the amount of money they want to receive for their personal spending and saving goals and call this their net pay estimation. Working backwards, they can also estimate their tax obligations and other deductions. Adding these to their net pay estimations, they can arrive at the rough gross pay they need to ask for to attain their financial goals.
Finally, the real net pay that employees receive is the amount they need to work with when managing their day-to-day and long-term finances. Rather than using estimations, the real net pay they take in sets their budgets. It dictates how much they can spend before their next paycheck, how much they should be able to save, and how much they may need to borrow to make ends meet.
What’s the Difference Between Net Pay vs Gross Pay?
As we saw in our calculation above, net pay and gross pay are related in an important way. Gross pay is what an employer provides for an employee in terms of salary or wages as well as the tips they earn on the job and other earnings like bonuses and allowances.
Once taxes and benefits contributions are taken away, the employee is left with their net pay. This is the actual amount that comes out of the employer’s bank account and into the employee’s, usually either by paycheck or direct deposit.
What’s the Difference Between Net Pay vs Net Income?
While these two terms sound similar and are often used interchangeably, they can mean different things from a legal and tax perspective.
Net pay is generally used to describe the final amount of money on an employee’s paycheck. It’s the amount they actually receive from their employer in any given pay period.
Net income, on the other hand, is often used in annual tax calculations. Taxpayers can have income from a lot of different sources outside of their jobs, and people who don’t work at all can still receive income. People earn income from things like inheritances, gifts, dividends, capital gains on investments, interest, royalties, rent, rewards, and even lottery winnings.
All money gained from these income streams needs to be reported on tax returns. Once adjustments and deductions are made to it and taxes taken away, taxpayers are left with their net income for the year, the actual amount of money they get to keep or use.
How to Calculate Net Pay
The general equation for calculating net pay (gross pay – deductions = net pay) is simple. However, things get more complicated the more types of earnings an employee has and as more types of deductions apply to them.
If you’re an employer, this is a good reason to carefully build each employee’s pay calculation and then automate your payroll to help save a lot of time and promote a high level of accuracy. If you’re an employee estimating what your net pay will be, though, it may take longer to calculate.
Let’s look at an example to give you an idea of how net pay is calculated. Let’s say that South Dakotan worker Employee A has been hired as a salaried worker, making $75,000 per year and being paid monthly. This would put them comfortably in the 22% federal income tax bracke,t while South Dakota doesn’t levy personal income tax.
They would also be liable for FICA (Federal Insurance Contributions Act) taxes of 6.2% for Social Security and 1.45% for Medicare. If Employee A has no other earnings and doesn’t contribute to any benefits schemes, how much would their net pay be for the month? Here’s the calculation:
Net pay = gross pay – deductions
Net pay = ($75,000/12) – ($75,000/12) x [22% + 6.2% + 1.45%])
Net pay = $6250 – ($6250 x 29.65%)
Net pay = $6250 – $1853.12
Net pay = $4,396.88
Employee A earns 1/12th of their salary in the month, which means a gross income of $6,250 for the month. In total, though, they’ll pay 29.65% in income and FICA taxe,s which equals a deduction of $1,853.12. This leaves them with a net pay of $4,396.88 on their paycheck.
Net Pay Summarized
Net pay, also known as take-home pay, is what the employer actually pays an employee. This figure represents the total of their gross earnings minus taxes and other deductions that are taken off their wages.
Net pay helps employers manage their cashflows while aiding employees in budgeting and estimating their ability to save. At the end of a pay period, net pay is the amount on an employee’s paycheck or deposited into their bank account and is theirs to do as they please.
FAQ
Yes, it’s possible for gross pay and net pay to be equal if an employee has no deductions to subtract. This can happen in countries that don’t levy personal income tax or that don’t require PAYE (pay as you ear) income taxes to be deducted by employers. Instead, employees would have to pay these taxes later. Volunteers who make no income would also have no deductions so their gross and net pay would both be zero.
No, net pay is usually already taxed and can be thought of as post-tax income. It’s what’s left behind once taxes and other deductions have been taken off.
This is theoretically possible, though many governments forbid employers from deducting the total of their employees’ salaries. However, if an employee takes pay advances, these will be deducted from their pay so they could receive a paycheck of zero.