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Gross Pay vs. Net Pay

Step-by-Step Guide to Understanding Gross Pay vs. Net Pay

Last Updated May 30, 2024

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Gross Pay vs. Net Pay

In This Article
  • Gross pay refers to the total yearly earnings of an individual employee before any deductions are taken out, such as taxes, insurance premiums, and retirement contributions.
  • Gross pay includes wages, salaries, bonuses, commissions, and any other compensation received from an employer for work performed.
  • Gross pay is a pre-tax measure of an employee’s earnings in a pay period before any deductions, most often denoted on a yearly-basis for tax purposes.
  • The formula to calculate the gross pay is equal to the sum of all the income earned in a given period.
  • Alternatively, the gross pay can be calculated by multiplying the employee’s hourly rate by the number of hours worked, or by their annual salary divided by the number of pay periods.
  • The fixed base compensation, performance-based bonuses, overtime pay, commissions, tips, and other monetary incentives are included in the calculation of an individual taxpayer’s gross pay.
  • The gross pay of an individual is distinct from the net pay, which refers to the amount that an employee receives after all deductions are taken out (i.e. “take-home”).

Gross Pay vs. Net Pay: What is the Difference?

For an individual taxpayer, the gross pay—or “gross wages”—is inclusive of the fixed salary (i.e. base compensation), performance-based bonuses, commissions, overtime pay, and other sources of taxable income.

Conversely, in the case of a business, gross income—or “gross profit”—is the residual profits after subtracting its cost of goods (COGS).

The higher the gross pay, the higher the net pay of the employee — all else being equal.

  • Higher Gross Pay (Gross Salary) ➝ Higher Net Pay (Take-Home)
  • Lower Gross Pay (Gross Salary) ➝ Lower Net Pay (Take-Home)

Once taxes and deductions are deducted from an individual’s gross pay, the remaining amount is the individual’s net pay for the given period, which illustrates the relationship between the gross and net pay.

  • Gross Pay ➝ The gross pay of an individual represents the total earnings a person receives in the taxable year before taxes and any deductions are considered
  • Net Pay ➝ On the other hand, the net pay is the leftover amount of money belonging to the individual (“take home”).

The percentage difference between gross income and net income tends to be more predictable for individuals rather than companies because the two values can vary substantially more and fluctuate year-to-year for companies.

If the variance between a company’s gross profit and net income is substantial, that may mean that the company needs to reconsider its spending habits and implement cost-cutting measures to improve its profitability, i.e. eliminate or reduce unnecessary costs.

What is Gross Pay?

The gross pay is defined as the total amount of income earned by an individual before taxes or any applicable deductions.

  • Individual Taxpayer ➝ For an individual taxpayer, the gross pay—or “gross wages”—is inclusive of the fixed salary (i.e. base compensation), performance-based bonuses, commissions, overtime pay, and other sources of taxable income.
  • Business ➝ Conversely, in the case of a business, gross income—or “gross profit”—is the residual profits after subtracting its cost of goods (COGS).

The gross pay metric, or annual gross wages, is inclusive of income sources such as the following:

  • Employee Wages (i.e. Annual Salary)
  • Rental Income
  • Interest Income (e.g. Certificate of Deposit, Checking Account, Savings Account)
  • Shareholder Dividends
  • Capital Gains
  • Pensions
  • Royalties

How to Calculate Gross Pay

With that said, the gross income of an individual is the starting point from which the taxable income is calculated.

The gross pay is equal to the sum of an individual’s total earned income, subtracted by any tax-exempt sources of income.

For most individuals, the gross wage comprises the majority of one’s total yearly earnings, but other sources of income earned on the side must also be accounted for, such as the interest income from investments (e.g. savings accounts and the realized gains from stocks).

On the W-2 statement of an individual, the gross pay is often used interchangeably with the term “gross wages”, albeit there are adjustments to be aware of.

Gross Pay Formula

The formula for calculating gross pay is the sum of all income sources earned by an individual for a given year.

Gross Pay = Σ Income Earned

The gross pay can be calculated using an hourly pay rate for employees paid on a hourly basis, rather than salaried employees.

Gross Pay = Hourly Pay Rate × Number of Hours Worked

The pay stub received by the employee, most frequently issued on a bi-weekly basis, will fluctuate based on the number of hours worked for the stated time frame.

The employee’s gross pay will therefore be less consistent compared to a salaried employee, considering the hours worked per week will be different each week.

For companies, gross pay—more often reported as “Gross Profit”—is calculated by subtracting the cost of goods sold (COGS) from its revenue for the year.

Gross Income = RevenueCost of Goods Sold (COGS)

Where:

  • Revenue ➝ The amount of sales generated by the company from selling its products or services.
  • Cost of Goods Sold ➝ COGS are the expenses incurred that are directly tied to its revenue model such as the cost of material and the cost of direct labor.

The lower the company’s COGS, the higher its gross profit and gross margin (and vice versa).

Note: While “gross pay” and “gross income” are interchangeable at the individual level, that does not apply at the corporate level.

What is Net Pay?

The net pay is the “take-home” pay or salary earned by an employee.

Unlike the gross pay, the net pay represents the earnings actually received by the worker post-deductions.

In short, the net pay reflects the cash proceeds that an employee receives and takes home once the required deductions have been applied.

Therefore, the net pay is basically the total compensation received by an employee once income taxes, benefits, and other deductions were subtracted from the gross pay.

How to Calculate Net Pay

To calculate net pay, the first step is to determine the employee’s gross pay, or “gross wages”, which to reiterate from earlier, is the total earnings before any deductions.

Once complete, subtract all applicable deductions from the gross pay to obtain the net pay amount. This final amount represents the actual take-home pay that the employee will receive.

The calculation of an employee’s net pay is straightforward from that point onward, since the metric is equal to the gross pay subtracted by deductions.

Net Pay Formula

The formula for calculating net pay is equal to the gross pay subtracted by deductions.

Net Pay = Gross Pay Taxes – Deductions

The most common deductions include the following:

  • Income Taxes
  • Social Security Contributions
  • Retirement Contributions
  • Authorized Withholdings
  • Retirement Planning
  • Union Dues

What are Tax-Exempt Sources of Income?

While the sources of income that constitute the annual gross salary received from an employer are subject to taxation, other forms of income are either partially or entirely exempt from being taxed, such as:

  • Inheritance
  • Municipal Bonds
  • Workers’ Compensation
  • Proceeds from Life Insurance
  • Health Benefits
  • Gifts
  • Voluntary Benefits
  • Roth IRA Contributions

The tax status of each item is determined by the Internal Revenue Code (IRC), i.e. the “IRS tax code”.

Gross Pay: Tax Reference Material

What is Adjusted Gross Income (AGI)?

To calculate adjusted gross income, the gross earnings figure is adjusted for any deductions or exemptions, which are formally referred to as “above-the-line” deductions.

After subtracting the appropriate amount with guidance from a professional accountant, the post-deduction amount results in adjusted gross income (AGI).

However, the amount the individual owes in taxes is neither based on the non-adjusted nor the adjusted gross figure.

Instead, the adjusted gross income (AGI) metric must be adjusted for the standard deduction or itemized deductions, which then results in the individual’s taxable income for the given year.

The reduction amount is the greater of either the:

  • Standard Deduction (or)
  • Itemized Deduction

Gross Pay Calculator — Excel Template

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

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Gross Pay Calculation Example

Suppose an individual has begun the process of filing their taxes with the IRS for fiscal year 2021.

In 2021, the individual’s annual gross salary was $200,000, along with three other sources of income:

  1. Capital Gains = $10,000
  2. Dividends = $2,000
  3. Interest Income = $2,000

The total dollar value of the realized capital gains from stocks was $10,000, along with $2,000 in dividends received as a shareholder and $2,000 in interest income from other investments.

After calculating the sum of all four sources of income, we arrive at a gross pay figure of $214,000 for the individual in 2021.

  • Gross Pay = $200,000 + $10,000 + $2,000 + $2,000 = $214,000

Gross Pay Calculator

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