Crack the Payroll Code: Your Essential Guide to Gross Pay and Tax Deductions

What Is Gross Pay?

What you see isn’t always what you get. 

This saying is especially true when it comes to your paycheck. While you work for a specific wage, the amount that lands in your bank account generally pales in comparison to the amount you’ve actually earned. 

In this article, we’ll unravel the mystery behind all those numbers on your paycheck, examine the deductions that cut into your compensation, and provide a clear understanding of how and why Uncle Sam takes what he takes. 

So, grab a recent pay stub. It’s time to take control of your financial future.

Defining Gross Pay

The total amount of money an employee earns is defined as “gross pay.” Gross pay incorporates all compensation before any deductions are taken out, including wages or salary earned for hours worked, bonuses, commissions, overtime pay, etc. Gross pay serves as the base amount from which various deductions are made to arrive at net pay, or the amount of money an employee receives after deductions. 

Employers and employees typically use the gross pay figure when discussing compensation with employees, i.e. an employee earning $60,000 per year or $25 per hour. Gross pay is also the amount that’s commonly referenced on federal and state income tax documents. 

But, in the payroll realm, where exactly did the word “gross” come from? In modern-day terms, gross is defined as “gravely deficient in civility or decency; crudely vulgar; or inspiring disgust or distaste.” According to the Etomylogy dictionary, the term “gross” comes from an old French and Latin word that meant "big." Over time, the term evolved to mean “the whole thing."

What’s Included in a Gross Wage?

As mentioned, gross wages typically include all forms of compensation an employee receives from his or her employer before any deductions are made. Let’s further define a variety of items that tend to constitute gross pay.

• Base Salary or Hourly Pay: This is the primary compensation for the work performed, which may include a fixed salary for a salaried employee or an hourly rate for an hourly employee.

• Piece Rate Pay: Employees who receive piece rate pay are paid based on output or productivity rather than hours worked. Individuals are paid a specified rate for each unit of product they produce or task they complete. For instance, a freelance journalist might be paid for each article he or she writes. 

• Overtime Pay: Overtime pay is additional compensation for hours worked beyond the standard workweek or workday, often distributed at a higher rate than regular pay.

• Bonuses and Commissions: Any extra payments based on performance, sales, or other criteria set by the employer.

• Holiday Pay: Additional compensation for working (or not working) on holidays, usually at a higher rate than regular pay.

• Vacation Pay: Payment for unused vacation time accrued by the employee.

• Sick Pay: Payment for unused sick days, if provided by the employer.

• Shift Differentials: Additional compensation for working during certain shifts, such as night shifts or weekends.

• Tips and Gratuities: If applicable to the job, any tips or gratuities received by the employee.

• Allowances and Reimbursements: Payments made by the employer to cover expenses incurred by the employee, such as travel expenses or uniform costs.

• Other Forms of Compensation: Any other forms of payment or compensation provided by the employer, such as housing allowances or educational assistance. 

Calculating Gross Wages

Calculating gross wage depends on whether the employee is paid on an hourly basis or receives a salary. 

To calculate the gross wage for an hourly employee, you’ll need to know the individual’s hourly rate and the number of hours worked during the pay period. The formula (rate x hours) is fairly straightforward. For example, if we had an employee who earns $15 per hour and worked 40 hours, the equation would look like this:

$15 x 40 = $600

Calculating the gross wage for salaried employees is a bit different because they typically receive a fixed amount of pay for each pay period, regardless of the number of hours worked. To calculate gross wage for a salaried employee, you'll need to know the employee’s annual salary and the frequency of his or her pay (i.e., weekly, biweekly, monthly). Then, you divide the annual salary by the number of pay periods in a year. The formula looks like this: 

Gross Wage = Annual Salary / Number of Pay Periods in a Year

If an employee earns an annual salary of $100,000 and is paid biweekly (26 pay periods in a year), the equation is: 

$100,000 / 26 = $3,846.15

If that employee is paid semi-monthly (24 times a year), the equation would be: 

$100,000 / 24 = $4166.67

Gross Wage Deductions

Gross wages are subject to an extensive list of possible deductions. Some of these apply to all employees, whereas others are only necessary in certain circumstances. Here are a few common examples.

• Federal Income Tax: The amount withheld from an employee's pay to cover his or her federal income tax liability.

• State Income Tax: In states that impose income taxes, a portion of an employee's pay may be withheld to cover his or her state income tax liability. States that currently have no income tax include Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.

• Social Security Tax: This Federal Insurance Contributions Act (FICA) tax deduction goes toward funding Social Security, which is designed to provide retirement, disability, and survivor benefits. Employers and employees each contribute 6.2% of wages toward social security, up to the taxable maximum of $168,600.

• Medicare Tax: Another FICA tax, Medicare exists to fund the Medicare program, which provides health insurance for individuals aged 65 and older as well as certain younger people with disabilities. Employers and employees contribute 1.45% with no wage limit to Medicare. An additional 0.9% Medicare tax applies to individuals earning in excess of $200,000.

• Local Income Tax: In some areas, there may be additional local income taxes imposed, leading to further deductions from an employee's pay.

• Health Insurance Premiums: If the employer offers health insurance coverage, the employee's share of the premiums may be deducted from his or her pay.

• Retirement Contributions: Contributions to retirement savings plans, such as 401(k), 403(b), or IRA accounts, may be deducted from the employee's pay.

• Life Insurance Premiums: If an employer offers life insurance coverage, the employee's share of the premiums may be deducted.

• Dental and Vision Insurance Premiums: Similar to health insurance, if the employer offers dental or vision insurance coverage, the employee's share of the premiums may be deducted.

• Flexible Spending Account (FSA) Contributions: Employees may elect to contribute to an FSA to cover qualified medical expenses or dependent care expenses on a pre-tax basis.

• Union Dues: If the employee is a member of a union, union dues may be deducted from his or her pay.

• Garnishments: If the employee has legal obligations, such as child support payments or unpaid debts, a portion of his or her pay may be subject to garnishment.

Pre-tax and post-tax deductions

Deductions generally fall into one of two buckets: pre- and post-tax. The main difference between the two lies in the timing of when they are taken out of an employee's gross pay and the tax treatment they receive.

Pre-tax deductions are subtracted from an employee's gross pay before any taxes are withheld. This means the deduction reduces the employee's taxable income, potentially lowering the amount of income tax owed.

Common pre-tax deductions include contributions to retirement savings plans, such as 401(k), 403(b), or traditional IRA accounts, as well as contributions to FSAs for health care or dependent care expenses. Since pre-tax deductions reduce taxable income, they can provide immediate tax savings for the employee by lowering the amount of income subject to taxation.

Post-tax deductions are subtracted from an employee's gross pay after taxes have been withheld. This means the deduction does not reduce the employee's taxable income. Common post-tax deductions include contributions to Roth IRA accounts, union dues, certain insurance premiums (such as voluntary life insurance), and garnishments for things like child support or unpaid debts. Since post-tax deductions are not subtracted from taxable income, they do not provide immediate tax savings for an employee. However, they may still offer other benefits, such as insurance coverage or fulfilling legal obligations.

Calculating Deductions

For the sake of this example, let’s examine the taxes and deductions an employee in California – we will call him Joe – earning an annual salary of $60,000 may encounter. Paid 26 times a year (biweekly), Joe’s gross pay for each paycheck is $2,307.69. 

1. Pre-Tax Deductions: The first step in calculating Joe’s paycheck is to deduct all pre-tax deductions. As previously noted, pre-tax deductions are subtracted before tax is withheld, and they can reduce the amount of tax Joe is required to pay.
1. Joe contributes 5% of his salary ($2,999.88 annually) to his 401(k) plan. Since there are 26 pay periods, he will pay $115.38 each pay period. 
2. Joe also contributes $2,000 to an FSA health care account. Divided by 26 pay periods, Joe’s check is reduced by $76.92 to cover this expense.
3. Because Joe has children, he also contributes $3,000 annually, or $115.38 per pay period, to a dependent care FSA account. 

Adding up the pre-tax deductions for each pay cycle ($115.38 + $76.92 + $115.38 = $307.68) and subtracting them from his gross pay ($2,307.69 - $307.68) means Joe is left with a taxable income of $2,000.01 per pay period or $52,000.26 annually.

• Federal Taxes: Next, we must account for the amount of federal tax Joe has to pay based on the amount he’s left with after pre-tax deductions. Because Joe lives in California, the tax liability is unique. At his salary ($60,000), Joe is taxed at an effective tax rate of 9.10%.

$52,000.26 x 9.10% = $4,732.02 

Joe’s federal income tax liability is $5,460. Split amongst his 26 paychecks, Joe is responsible for $182 in federal taxes every pay period. 

• State Taxes: Joe also has to pay California’s state income tax. To do this, we have to identify Joe’s taxable income bracket. After pre-tax deductions, Joe earns approximately $52,000, his tax rate for the 2023-2024 tax season is 6%. Thus, Joe is taxed at a rate of $960.56 plus 6% of any income exceeding $38,959. 

$52,000 - $38,959 = $13,041 in taxable income at 6%

6% x $13,041 = $782.46

$782.46 + $960.56 = $1,743.02

Joe’s state tax liability is $1,743.01. Split amongst his 26 paychecks, Joe is responsible for $67.04 in state taxes per pay period. 

1. FICA Taxes: Joe also has to pay the FICA taxes, which include Social Security and Medicare. Social Security is taxed at 6.2%. 

$52,000 x 6.2% = $3,224

Split amongst 26 pay periods, Joe will pay $124 per pay period in Social Security tax. 

Medicare is taxed at 1.45%.

$52,000 x 1.45% = $754

Split amongst 26 pay periods, Joe will pay $29 per pay period in Medicare tax. 

Altogether, Joe, earning $60,000 in California (with $52,000 in taxable income), is responsible for $10,453 in taxes. This breaks down to $4,732.02 (federal taxes) + $1,743.01 (state taxes) + $3,224 (Social Security) + $754 (Medicare). Per pay period, his tax liability is $402.04. 

The included example does not include any post-tax electives Joe may be responsible for (Roth IRA, life insurance, etc.). 

Please note that these are simplified calculations that do not account for adjustments, credits, or other factors that could affect Joe’s tax liability.

Difference Between Gross Wages and Net Wages

Net pay is the amount of money an employee receives after deductions have been taken out of his or her gross pay. In simpler terms, net pay is what's left over from an employee's gross pay after all required and voluntary deductions have been subtracted (aka take-home pay). 

Using the example above, Joe’s net pay would be $41,547. This can be found by subtracting his tax liability from his taxable income.

$52,000 - $10,453 = $41,547

Enhancing Payroll Accuracy with Modern Technology

One way to enhance your proficiency in calculating gross wages is by integrating technology into your payroll procedures. Utilizing modern payroll software streamlines the entire process, automating calculations for gross wages, taxes, and deductions effortlessly. Integrating technology isn’t just about error reduction; it liberates small business owners' time, allowing them to focus theri attention on other crucial aspects of operations. 

Consider the complexity introduced by nontraditional earnings, such as bonuses, stock options, and other incentives, particularly in the context of flexible work arrangements. Understanding how these elements factor into gross wages is paramount, as they significantly impact total pay, taxes, and benefits. Manually accounting for these nuances can be challenging, to say the least. 

One efficient way to navigate these hurdles is to incorporate time tracking software, which will ensure smooth and accurate payroll administration, consistent compliance with laws, and transparent time records. 

Modern time tracking software, such as OnTheClock, does much more than track employees’ time and simplify payroll – such programs offer numerous features, including geofencing, time audits, PTO scheduling, and much more. 

In Conclusion

Understanding gross pay, deductions, and net pay is essential for managing personal finances and making informed decisions about compensation and benefits. This article has delved into the intricacies of payroll calculations, exploring the components of gross pay, common deductions, and the resulting net pay. 

As always, consult with financial professionals or resources for personalized advice tailored to your specific circumstances. With diligence and proactive financial management, you can pave the way toward a brighter financial future.

From calculating salaries to tracking an employee’s whereabouts to improving workplace accountability, consider empowering your business with OnTheClock. Try it out for free, for 30 days, today, by clicking here.