How to Calculate Retro Pay for Salary Employees

Retroactive pay is a payment an employee receives for work performed in a past pay period, where they were underpaid. For salaried employees, this typically involves a back payment to cover the difference between what they were paid and what they should have been paid over a specific duration.

Situations Requiring Retroactive Pay

Salaried employees may become eligible for retroactive pay in various circumstances. One common scenario involves a delayed salary increase or promotion where the effective date of the new compensation precedes its processing in the payroll system. This means an employee performed duties at a higher pay grade before their salary officially reflected it.

Another frequent reason for retroactive pay is the correction of payroll errors. Mistakes like incorrect salary entry, miscalculation of pay periods, or overlooked pay adjustments can lead to underpayment. Rectifying these errors necessitates a retroactive payment to cover the shortfall. New compensation policies or collective bargaining agreements applied retroactively can also trigger back pay, ensuring employees receive correct earnings from the agreement’s effective date.

Information Needed for Calculation

Before calculating retroactive pay, several data points must be gathered. These include the original annual salary, which is the amount the employee was earning before the change. The new annual salary, representing the increased or corrected amount the employee should have been earning, is also needed. These two figures form the basis for determining the per-period difference.

The effective date of the salary change is also needed, as this marks when the new salary should have been applied. Understanding the employee’s pay period frequency (weekly, bi-weekly, semi-monthly, or monthly) is important for converting annual salaries into per-period amounts. Finally, identify the number of affected pay periods. This is the total count of pay cycles between the effective date and the actual implementation date of the new salary.

Performing the Retroactive Pay Calculation

Calculating gross retroactive pay for a salaried employee involves a step-by-step process. First, determine the difference in the employee’s per-period salary. Divide both the new and original annual salaries by the number of pay periods in a year based on the employee’s pay frequency. For example, if an employee is paid bi-weekly, the annual salary is divided by 26.

Next, identify the total number of pay periods impacted by the salary change. This duration spans from the effective date of the salary adjustment to the date the new salary was reflected in the employee’s regular payroll. For instance, if a salary increase was effective January 1st but not implemented until March 1st, and the employee is paid bi-weekly, approximately four pay periods would be affected.

The final step involves multiplying the per-period salary difference by the total number of affected pay periods. For example, if an employee’s per-period salary difference is $100, and there are four affected pay periods, the total gross retroactive pay would be $400. This calculation yields the full amount owed to the employee before any deductions or withholdings.

Withholding Taxes from Retro Pay

Retroactive pay is considered taxable income and is subject to withholdings, just like regular wages. For federal income tax purposes, the Internal Revenue Service (IRS) often treats retroactive pay as “supplemental wages.” Employers typically withhold taxes using a flat percentage method (currently 22% for amounts up to $1 million in a calendar year). Alternatively, they may aggregate supplemental wages with regular wages for the current pay period based on the employee’s Form W-4.

State income tax may also be withheld, depending on the state where the employee resides and works. Retroactive pay is also subject to Federal Insurance Contributions Act (FICA) taxes, which include Social Security and Medicare taxes.

Social Security tax is withheld at 6.2% on earnings up to an annual limit, while Medicare tax is withheld at 1.45% on all earnings, with an additional 0.9% on earnings above a certain threshold. These withholdings reduce the gross retroactive pay amount to the net amount the employee ultimately receives.