What is the relationship between gross pay and net pay?

Gross pay represents the total amount an employee earns before any subtractions. Various deductions are applied, leading to what is known as net pay. Understanding this distinction and the factors that bridge the two is important for managing personal finances. This article explains the difference between gross and net pay and details the components that contribute to this change.

Defining Gross Pay

Gross pay is the total compensation an employee earns from an employer before any deductions are withheld. Common components include regular hourly wages or a fixed salary. For instance, if an employee works 40 hours at $20 per hour, their gross wage for the week would be $800.

Gross pay can also incorporate additional earnings like commissions, which are payments based on sales performance. Bonuses, often awarded for individual or company achievements, also factor into the gross amount. Overtime pay, calculated at a higher rate for hours worked beyond a standard workweek, adds to gross earnings.

Understanding Payroll Deductions

After gross pay is determined, various deductions are subtracted, which can be categorized as either mandatory or voluntary. Mandatory deductions are required by law and include federal, state, and local income taxes. Federal income tax withholding is calculated based on information provided on an employee’s Form W-4, along with their income and pay frequency, and is sent to the IRS on their behalf. State income taxes are also withheld in most states, with the amount depending on factors similar to federal withholding, though some states do not have an income tax. Local income taxes may also be withheld in certain cities, counties, or school districts, with rates and rules varying by location.

Another significant mandatory deduction is FICA (Federal Insurance Contributions Act) taxes, which fund Social Security and Medicare programs. For employees, the FICA tax rate is currently 7.65%, comprising 6.2% for Social Security and 1.45% for Medicare. The Social Security portion applies up to a certain annual wage base, which is $176,100 for 2025, while the Medicare tax has no wage limit. An additional 0.9% Medicare tax applies to earnings exceeding specific thresholds, such as $200,000 for single filers. These FICA taxes are designed to provide benefits for retirees, people with disabilities, and survivors.

Voluntary deductions are those an employee authorizes to be withheld from their pay for benefits or other optional expenses. Common examples include premiums for health, dental, and vision insurance plans. Contributions to retirement plans, such as 401(k)s or 403(b)s, are also popular voluntary deductions, allowing employees to save for their future. Other voluntary deductions might encompass life and disability insurance premiums, contributions to Flexible Spending Accounts (FSAs) or Health Savings Accounts (HSAs), and union dues.

Calculating Net Pay

Net pay, often referred to as “take-home pay,” is the amount of money an employee actually receives after all mandatory and voluntary deductions have been subtracted from their gross pay. This is the final sum deposited into an employee’s bank account or provided as a physical check. The calculation is straightforward: Gross Pay minus Total Deductions equals Net Pay.

A pay stub serves as a detailed record that visually summarizes this entire process. It itemizes the gross earnings, lists each individual deduction taken, and clearly presents the resulting net pay. This document allows employees to see precisely how their total earnings are reduced to the final amount they receive.