What Is a Retro Payment and How Does It Work?

A retro payment, or retroactive payment, is compensation an employer provides for work performed in a past pay period. This type of payment corrects an underpayment or applies a delayed adjustment to an employee’s earnings. Its purpose is to ensure that employees receive the correct amount of wages they were entitled to for their work during a previous time.

Common Reasons for Retro Payments

One frequent scenario leading to a retro payment is a delayed pay raise. When a salary increase is approved, but payroll updates take time, the new rate may be applied retroactively to the date it was effective. This means an employee receives the difference between their old pay rate and the new rate for the period before the new rate was reflected in regular paychecks.

Correcting payroll errors also frequently results in retro payments. These errors can include an incorrect hourly rate, missed hours, or miscalculations of overtime pay in a prior period. For instance, if an employee’s overtime was mistakenly paid at time-and-a-half instead of double time for certain hours, a retro payment would cover the difference.

Back pay stemming from negotiations or agreements is another reason for these payments. This occurs when collective bargaining agreements or individual employment contracts are finalized after work has already been performed under the new terms. The retro payment then covers the period between the effective date of the new agreement and the date it was implemented in regular payroll.

Adjustments to previously paid bonuses or commissions that were undercalculated can also necessitate a retro payment. If a sales commission was based on an incorrect percentage or a performance bonus was miscalculated, the employer would issue a retro payment to cover the shortfall.

How Retro Payments are Determined and Paid

Determining a retro payment involves calculating the precise difference between what an employee was paid and what they should have been paid for a specific past period. For example, if a pay raise of $2.00 per hour was retroactive for 80 hours worked, the retro payment would be $160.00 before any deductions.

Employers can disburse retro payments in several ways. They might issue a separate check or direct deposit specifically for the retroactive amount, clearly distinguishing it from regular wages. Alternatively, the retro payment could be included with a regular payroll run, often appearing as a distinct line item on the pay stub. The chosen method depends on the company’s internal payroll policies and the capabilities of their payment system.

Upon receiving a retro payment, employees receive a statement or explanation detailing the payment. This documentation clarifies the period covered and provides a breakdown of how the amount was calculated. This helps employees understand the correction and verify the accuracy of the payment they received.

Tax Treatment of Retro Payments

Retro payments are considered taxable income, just like an employee’s regular wages. They are subject to federal income tax withholding, and state income tax withholding if applicable in the employee’s state of residence. These payments are also subject to Social Security and Medicare taxes, collectively known as FICA taxes.

For Social Security, the tax rate is 6.2% for both the employee and employer on wages up to the annual taxable limit, which is $168,600 for 2024. Medicare tax is 1.45% for both parties on all wages, with no income limit. Retro payments will be reported on the employee’s Form W-2 for the calendar year in which they are actually received. A large retro payment, when combined with regular pay, might result in a higher percentage of federal income tax withholding for that specific pay period due to the progressive tax system.