What Is Retropay? How It’s Calculated and Taxed

Retropay, short for retroactive pay, is a payment an employer issues to an employee to correct an underpayment from a previous pay period. It addresses situations where an individual was not paid correctly for work already performed.

Retropay differs from “back pay,” which typically refers to wages owed because an employee was not paid at all for work performed or due to legal disputes. Retropay specifically rectifies situations where the pay rate or calculation was incorrect, leading to an underpayment rather than a complete absence of payment.

Understanding Retropay

One common reason is a delayed pay raise or promotion. If a salary increase is approved to be effective from a specific date but is not implemented in the payroll system until later, retropay covers the difference for the period the new rate should have applied.

Payroll errors are another frequent cause of retropay. These can include clerical mistakes, technical glitches in payroll software, or incorrect data entry, such as using the wrong hourly rate or salary amount for an employee. Such errors lead to an underpayment that needs to be corrected.

Miscalculations related to overtime or other special compensation also often necessitate retropay. If an employee’s overtime hours are not compensated at the legally required rate, typically 1.5 times their regular rate, the employer owes retropay to cover the shortfall. This also applies to missed or underpaid commissions, bonuses, or shift differentials.

Retropay ensures employees receive the full compensation they earned, correcting past discrepancies and reinforcing adherence to fair pay practices. This process rectifies a past underpayment, not future earnings or advances.

Calculating Retropay Amounts

Calculating retropay involves determining the precise difference between what an employee was paid and what they should have been paid for specific past periods. The first step is to identify the exact pay periods affected by the underpayment. This includes pinpointing the start and end dates when the incorrect pay rate or calculation was in effect.

For hourly employees, the calculation typically involves finding the difference between the correct hourly rate and the rate actually paid, then multiplying this difference by the total hours worked during the affected period. For example, if an employee was paid $15 per hour but should have received $17 per hour for 80 hours, the retropay would be $2 per hour multiplied by 80 hours, totaling $160.

For salaried employees, the process involves calculating the difference between the old salary and the new, correct salary per pay period. This per-period difference is then multiplied by the number of pay periods during which the employee was underpaid. This method accounts for the full retroactive period.

The calculation must also factor in any other components of compensation that were miscalculated, such as overtime, commissions, or bonuses. The goal is to sum all underpaid amounts across all affected pay periods to arrive at the total gross retropay.

Taxation and Reporting of Retropay

Retropay is generally considered taxable income, similar to regular wages. It is subject to federal income tax withholding, state income tax withholding (where applicable), Social Security (FICA), and Medicare taxes. Employers are required to withhold these taxes from the retropay amount before it is disbursed to the employee.

For federal income tax purposes, retropay is often treated as “supplemental wages.” Employers have options for withholding federal income tax from supplemental wages. They can either apply a flat 22% withholding rate, particularly if the retropay is paid separately, or they can combine the retropay with the employee’s regular wages and use the aggregate method, withholding taxes based on the combined amount.

The crucial aspect for employees is that retropay is taxed in the period it is paid, not necessarily the period it was earned. This means that a large retropay amount received in a single pay period could potentially place an employee into a higher tax bracket for that specific pay period or tax year.

Retropay typically appears on an employee’s pay stub, often designated as “retropay” or a similar notation, to distinguish it from regular earnings. At year-end, the total retropay received will be included in Box 1 (Wages, Tips, Other Compensation) of Form W-2, along with all other taxable wages for the year. This consolidated reporting ensures all income is accurately reflected for tax purposes.

Receiving and Verifying Retropay

When retropay is issued, employees typically receive it either as a separate payment, such as a check or direct deposit, or it may be added to their regular paycheck. This payment method can vary by employer.

Upon receiving retropay, verify the amount’s accuracy. Review the pay stub or accompanying documentation, which should clearly indicate the retropay amount and applied taxes and deductions.

Compare the gross retropay against your own calculations based on the underpaid periods and correct pay rates. Reviewing past pay stubs and communications regarding pay rate changes helps verify the amount, especially for overtime or other components.

Should there be any discrepancies or questions regarding the retropay amount, the employee should promptly contact their employer’s human resources or payroll department. Providing specific details, such as affected pay periods and the perceived difference, can help facilitate a swift review and resolution.