How to Calculate Retro Pay for Hourly & Salaried Employees

Retro pay represents compensation for a past period during which an employee received less pay than they were due. This often arises from circumstances like a delayed salary increase, payroll errors, or miscalculated overtime hours. Retro pay ensures employees receive the full compensation they earned.

Identifying Retro Pay Elements

Gathering necessary information is important. Identify the specific types of compensation or adjustments that were underpaid, such as regular hourly wages, fixed salary adjustments, overtime pay, commissions, bonuses, or other supplemental payments.

Pinpoint the exact period for which retro pay is owed, establishing clear start and end dates. This period defines the underpaid timeframe. Compare the incorrect pay rate with the correct pay rate that should have applied during this period. Accurate record-keeping, such as pay stubs and time sheets, is helpful in identifying these elements and dates.

Calculating Gross Retro Pay

Gross retro pay is the total amount owed before deductions. Calculate it by finding the difference between what the employee was paid and what they should have been paid for the affected period.

For hourly employees, subtract the old hourly rate from the new, correct hourly rate to find the per-hour difference. This hourly difference is then multiplied by the total number of hours worked during the retroactive period.

For salaried employees, the calculation typically involves determining the difference in pay per pay period (e.g., weekly, bi-weekly, or monthly) and then multiplying this difference by the number of pay periods affected. For example, if a salaried employee’s annual salary increased by $3,000 and they are paid bi-weekly, the difference per period is $115.38 ($3,000 / 26). If this raise was delayed for four periods, gross retro pay is $461.52 ($115.38 x 4).

When overtime is involved, calculate the difference between old and new regular rates for all hours worked. Then, add the difference in the overtime premium (1.5 times the regular rate difference) for all overtime hours. This ensures full compensation for all underpaid hours.

Applying Deductions and Withholdings

After determining gross retro pay, various deductions and withholdings must be applied. Retro pay is generally considered supplemental wages for tax purposes, meaning it is subject to federal income tax, state income tax (if applicable), and Federal Insurance Contributions Act (FICA) taxes. FICA taxes include Social Security and Medicare.

For 2025, the Social Security tax rate is 6.2% for both the employee and employer, applied to wages up to an annual limit of $176,100. The Medicare tax rate is 1.45% for both employee and employer, with no wage limit. An additional Medicare tax of 0.9% applies to employee wages exceeding $200,000, which employers must withhold.

Federal income tax withholding for supplemental wages follows two methods: the percentage method or the aggregate method. If the supplemental wages, including retro pay, are $1 million or less for the year, employers can use an optional flat rate of 22% for withholding. If the total supplemental wages exceed $1 million, the amount over $1 million is subject to a mandatory flat rate of 37%. Alternatively, employers can use the aggregate method, where the supplemental wages are combined with regular wages for the current or most recent pay period, and the standard withholding rules apply to the total amount.

State income tax withholding on supplemental wages varies by jurisdiction. Some states may require withholding at a flat rate, others may treat supplemental wages the same as regular wages, or they might have specific rules if the supplemental pay is issued separately from regular wages. It is important to consult current state tax guidelines for specific requirements. Employers can refer to IRS Publication 15 and Publication 15-T for detailed guidance on these withholding rules.

Determining Net Retro Pay

The final step is calculating net retro pay, the amount an employee receives after all applicable deductions and withholdings are subtracted from gross retro pay. This is achieved by taking the calculated gross retro pay and reducing it by the total amount of federal income tax, state income tax, FICA taxes, and any other pre-tax or post-tax deductions that apply. The calculation is straightforward: Gross Retro Pay minus Total Deductions equals Net Retro Pay.