How to Calculate Retro Pay for Hourly Employees

Retro pay is compensation an employee is owed for work performed but for which they were underpaid in a previous pay period. This adjustment ensures employees receive the correct amount they should have earned. Situations requiring retro pay can arise from a delayed pay raise or a payroll error that resulted in an incorrect hourly rate. Providing accurate retro pay is important for employers to maintain compliance with labor laws and for employees to receive their full earned compensation.

Gathering Necessary Information

Calculating retro pay accurately begins with collecting specific and detailed information. Employers need to identify the original, incorrect hourly pay rate and the new, correct hourly pay rate. The effective date of the pay rate change is also necessary to determine the start of the retroactive period, which defines the timeframe the employee was underpaid.

Accessing comprehensive payroll records is also important for this process. This includes previous pay stubs and timekeeping data to confirm the total number of regular and overtime hours worked in each affected pay period. The accuracy of this data is important, as it directly influences the retro pay calculation.

Calculating Retro Pay for Regular Hours

The first step in calculating retro pay for regular hours involves determining the difference between the old and new hourly rates. This rate difference is the additional amount per hour an employee should have received. Next, identify the total number of regular hours worked during the retroactive period, from the effective date of the pay change up to the correction date.

To calculate the gross retro pay for regular hours, multiply the hourly rate difference by the total regular hours worked. For example, if an employee’s rate increased from $15 to $17 per hour, the difference is $2 per hour. If they worked 160 regular hours during the retroactive period, the gross retro pay for regular hours would be $320 ($2 per hour multiplied by 160 hours).

Adjusting for Overtime and Other Pay Types

Calculating retro pay becomes more involved when overtime hours are present. Overtime pay is calculated at 1.5 times an employee’s regular rate for hours worked over 40 in a workweek. If the regular hourly rate changed, the overtime rate for those past hours also needs adjustment based on the new, higher regular rate. This requires recalculating the overtime premium for all affected overtime hours.

The new regular rate must be applied to the overtime hours worked to determine the correct overtime compensation. If the regular rate increased, the original overtime payment was likely too low. Other forms of compensation, such as shift differentials or non-discretionary bonuses, may also require retroactive adjustment if their calculation is directly tied to the hourly rate. These adjustments ensure all components of an employee’s earnings reflect the correct rates for the retroactive period.

Withholding Taxes and Deductions

Once the gross retro pay is calculated, employers must withhold applicable taxes and deductions. Retro pay is considered supplemental wages by the Internal Revenue Service (IRS) and is subject to federal income tax withholding. Employers can choose to withhold federal income tax at a flat 22% rate if the retro pay is issued separately, or they can combine it with regular wages and use the employee’s W-4 withholding information.

Social Security and Medicare taxes, known as FICA taxes, must also be withheld from retro pay. For 2025, the employee’s portion of Social Security tax is 6.2% on wages up to $176,100, and the Medicare tax is 1.45% on all wages, with an additional 0.9% Medicare tax on wages exceeding $200,000 for single filers. State and local income taxes must also be withheld. Any percentage-based deductions, such as 401(k) contributions, may need adjustment or application to the retro payment, though employee elective deferrals to a 401(k) generally cannot be made retroactively.