Net pay is the amount of money a company issues to an employee after subtracting payroll deductions and withholdings.
In other words, net pay, also known as net income, or take-home pay, is the sum left over from a worker’s gross wages after the employer has taken a portion to cover things like income taxes and voluntary contributions on behalf of the employee.
An employer must deduct a number of different payroll deductions from an employee’s gross income each pay period. The deductions can differ depending on what country the employee lives in and the company they work for.
Some of these deductions are mandatory, meaning an employer is legally obligated to withhold this money from an employee’s paycheck. Other deductions are voluntary, meaning they are optional. The employee must agree to have these voluntary deductions withheld from their paycheck.
Here are some of the most common deductions visible on an employee’s paycheck in the pay stub section:
Taxes: These are involuntary deductions based on the government’s taxation system. An employer deducts tax from a salaried employee’s gross pay according to the country’s tax rate. The payroll tax will be a percentage of the employee’s overall income
In the US, depending on an employee’s filing status, involuntary tax deductions paid to the IRS include federal income tax withholding, state income tax, Social Security tax, medicare tax (FICA taxes), and local income tax
Court-ordered wage garnishment: An employee may need to pay child support or repay other debts
Voluntary deductions (pre-tax deductions)
Retirement contributions: This is often a voluntary deduction where the employee chooses to devote a percentage of their gross salary towards their pension or retirement plan
Incentives: These can be long or short-term. For example, a short-term incentive could be a bonus paid to an employee within the same year after they have met certain targets. A long-term incentive could be a 3-to-5-year bonus paid as cash, equity, or shares in the company. It’s important to remember that these bonuses are taxable income
Insurance: Employers commonly provide health insurance as part of their employee’s benefits package. Depending on the company and insurance scheme in that country, the employer deducts a percentage of the health insurance premium from the employee’s gross pay. The same applies to dental, vision, and life insurance plans
Union dues: Employees may choose to make regular payments to remain a local union member
Charitable contributions: Employees may elect to deduct money for charitable causes
Uniform and tool deductions: An employee may owe money for uniforms, tools, loans, etc.
What is gross pay vs. net pay?
Gross pay is the total amount of pay before deductions. Jobs advertising a $40,000 annual salary are referring to gross pay. Gross pay can include tips, bonuses, commissions, overtime, wages, etc.
Net pay is your take-home earnings paid into your bank account after deductions.
How do you calculate net pay?
One of the many responsibilities of a large or small business owner is to ensure that an employee’s net pay is calculated accurately.
When calculating net pay, use this formula:
Net Pay = Gross Pay – Taxes and Deductions