How to Calculate Retroactive Pay Step by Step

Retroactive pay is compensation for work already performed when an employee was paid less than the correct amount. It makes up the difference between what an employee should have received and what they actually received for a past period. Understanding how to calculate retroactive pay is important for employees to ensure rightful earnings and for employers to maintain accurate payroll records and comply with labor laws.

Common Situations for Retroactive Pay

Retroactive pay often becomes necessary due to payroll adjustments or errors. A common scenario involves delayed pay raises, where an increase in an employee’s wage or salary is approved but not immediately reflected in their paycheck. This can occur when a new employment agreement takes effect retroactively or a promotion with a higher pay rate isn’t timely updated.

Minimum wage increases can also trigger retroactive pay if an employer continues to pay employees at the old rate past the new minimum wage’s effective date. Clerical errors, such as incorrect data entry or miscalculations of regular or overtime hours, frequently lead to underpayments requiring correction. For instance, if overtime hours are paid at the regular rate instead of 1.5 times, retroactive pay covers the difference.

Calculating the Gross Retroactive Amount

Calculating the gross retroactive amount involves a clear, step-by-step process to determine the total underpayment before any deductions. First, identify the affected period: the range of dates when the incorrect pay rate was applied, from the pay change’s effective date until the correct rate was implemented.

Next, determine the old pay rate paid and the new rate that should have been applied during the affected period. This could involve comparing hourly wages, annual salaries, or commission rates. After identifying these rates, calculate the difference between the new rate and the old rate per pay unit, such as per hour, per week, or per month.

Multiply this per-unit difference by the total hours worked or pay units within the affected period. For example, if an hourly employee was underpaid by $2 per hour for 80 hours, the gross retroactive pay would be $160. When overtime hours are involved, factor in the adjustment by calculating the difference in old and new overtime rates for those specific hours. If performance-based bonuses were underpaid, add that difference to the gross retroactive total.

For salaried employees, the calculation often involves determining the difference between the old and new semi-monthly or bi-weekly pay periods and multiplying that by the number of affected pay periods. For instance, if a salaried employee’s semi-monthly pay should have been $2,406.25 but was $2,292, the $114.25 difference per pay period is multiplied by the number of underpaid periods.

Accounting for Taxes and Deductions

After determining the gross retroactive amount, account for taxes and other payroll deductions. Retroactive pay is generally treated as regular wages for tax purposes in the period it is paid, not earned. Employers must withhold federal income tax, state income tax (if applicable), local taxes, Social Security (FICA), and Medicare taxes from the gross retroactive payment.

The IRS considers retroactive pay as supplemental wages for federal income tax withholding. Employers have options for withholding federal income tax from supplemental wages: either a flat 22% from the sum of the retroactive pay (especially if paid separately), or if combined with regular wages, adding the retroactive amount to the employee’s normal wages for the current payroll period and applying standard income tax withholding tables to the combined amount.

Beyond taxes, other common deductions apply, including retirement plan contributions (e.g., 401(k)), health insurance premiums, or other pre-tax or post-tax deductions. For example, if a 401(k) contribution is based on a percentage of gross pay, the retroactive pay will increase the amount subject to that percentage. The employer is responsible for correctly calculating and remitting all these withholdings.

Receiving and Verifying Retroactive Pay

Once calculated and processed, employees typically receive retroactive pay as a separate payment or included with a regular paycheck. Employers should clearly communicate the payment details, including the reasons, amount, and expected date.

Employees should verify the accuracy of the retroactive payment by reviewing their pay stub or statement for specific line items. Ensure the gross amount matches expectations and all applicable taxes and deductions have been correctly applied.

If a discrepancy is found or the amount doesn’t align with personal calculations, contact the employer’s human resources or payroll department. Providing documentation of personal calculations and affected pay periods can help facilitate a swift resolution.