Gross Pay Vs. Net Pay: What’s The Difference? (With Examples)

If you haven’t already, you’ll quickly learn that there is a significant difference between the amount of money your employer pays you and the amount you get to take home at the end of the day. These two numbers are called gross pay and net pay, and it’s important to understand the difference between the two for your financial planning and reporting.

In this article, we’ll teach you the difference between gross and net pay and how to calculate each one.

Key Takeaways

• Gross pay is your salary before your taxes, 401k contributions, health benefits payments, and other deductions are removed.

• Net pay is the amount of money you get to take home after all the necessary deductions have been removed.

• You’ll need to know your gross pay when you’re applying for a credit line, mortgage, or anything else that requires a loan or credit check.

• You need to know your net pay for personal financial planning and budgeting purposes.

The Difference Between Gross And Net Pay

The big difference between the gross and net pay numbers is accounting for taxes and deductions. Net pay is the result of gross pay after deductions have been made. Usually, your net pay will be emphasized on your check because this is the amount that will be available for you to use.

What Is Gross Pay?

Gross pay refers to the all-encompassing number that accounts for every hour an employee has worked. This amount does not have deductions taken out of it yet, and therefore, will be the highest number on an employee’s paycheck.

An employee’s gross pay will include all sources of income that they receive. This includes overtime they’ve worked, tips they’ve collected, and any other bonuses they’ve received in their time working. It will also change if receiving a raise or taking off unpaid time from work.

For example, when an open job listing states that you’ll be making $50,000 per year, this is the gross pay amount before taxes and deductions.

Why Do You Need to Know Your Gross Pay?

The most common reason for needing knowledge of your gross annual or monthly income is for lenders.

When you’re applying for a mortgage, apartment, or any large purchase that requires a loan, they’ll ask for your gross income, as opposed to your net pay. Credit card companies will also ask for your gross earnings information before deciding on approving you for a card.

Lenders turn to an individual’s gross annual income to measure their standard salary before getting into the complexities of deductions and taxes.

In interviews, you will also refer to your gross pay when being asked about your salary requirements.

IRS Definition of Gross Pay

The definition of gross pay can get a bit muddier when it comes to the IRS. Your W-2 will include your gross salary for the year, but employers have to include some non-monetary benefits in their calculations.

Benefits like tips, some forms of expense reimbursement, educational spending not required for your job, and certain life insurance policies may be included in your gross pay.

Additionally, any contributions to a retirement plan like 401(k) or 403(b) will not count towards your gross income. Note that contributions to some retirement plans, like Roth IRAs, do still count toward your gross income.

What Deductions Are Made From Gross Pay?

Most professionals understand that deductions will be made from their gross pay to arrive at the amount they will have in their pocket. However, not everyone is clear on what these deductions are.

Some paycheck deductions are mandatory in the United States.

Examples of mandatory deductions include:

• Federal, State, and local taxes

• Payroll taxes

• Social security

Additionally, your employer can include voluntary deductions from your gross pay for other reasons.

Examples of voluntary deductions include:

• Compensation for equipment or uniforms

• Pension account

• 401(k)

• Automatic savings account

Certain deductions won’t be forever inaccessible to you, such as an automatic savings account that takes a percentage of your paycheck every week. These are deductions that you eventually have access to after a definitive amount of time, which often spans many years.

Examples of Factors That Impact Tax Deductions

Even though you may be receiving that same gross pay as a co-worker in the same position, the net pay you receive may differ significantly depending on your life circumstances.

Below are factors that commonly impact an individual’s tax deductions.

1. Getting married. Legally wedding the love of your life can have an impact on your tax deductions. Some married couples receive a welcome tax break once they’re legally bound, especially if they file jointly. Similarly, going through a divorce can also have implications on your tax rate.

2. Having children. While most people associate having a baby with a lot of expenses, it can give you credit come tax season. Claiming a dependent awards parents with tax benefits for raising their children.

3. Buying a house. Another massive expense that comes with the pro of tax deductions is buying a house. Alternatively, when selling a house, you’ll likely come across a hefty tax rate unless you can take advantage of stipulations like filing jointly.

4. Getting a promotion. Receiving a promotion acknowledges all the hard work you’ve put forth in your position and usually comes with a pay raise.

   While this is a cause for celebration, it also can have repercussions on your taxes. A salary increase has the potential to put you in a different tax bracket, which would leave you paying a new percentage in taxes that year.

5. Going to school. Getting a higher education is an endeavor that takes a lot of time and money. To ease the burden of paying for going to school, your taxes are impacted by making this life decision. Most students can write off or offset educational expenses through their tax deductions.

What Is Net Pay?

Net pay only includes the amount of money that will be directly available to you. It is the sum of your wages after taxes and deductions have been removed. An employee’s net pay will be more noticeable on their paycheck since this is the total you will receive.

Let’s look at the previous example of a job opening that pays a yearly salary of $50,000. This number has not been taxed yet to reflect accurately. At an average tax rate of 18%, the employee would be paying $9,000 of their income in taxes and actually only receive $41,000 for their work. This is their net pay.

Why Do You Need To Know Your Net Pay?

Net pay is important for creating a budget and planning your financial future. Unlike gross pay, you probably won’t need to know your net pay when applying for loans or big purchases, but it helps you decide whether you can afford these endeavors.

Since the dollar amount you’ll end up with after deductions is your net pay, it shows you how much money you’ll have at your disposal immediately after cashing your paycheck. This amount will differ between employees, even if they’re working in the same position with the same responsibilities, because their tax deductions differ.

You build a budget around your net pay instead of gross because it’s a more accurate representation of the money you’ll have available to use in your account every month.

How to Calculate Gross Income for a Salary Job

Usually, in a position with a salary, the employee will be told their gross salary during onboarding. It will be the number that is disclosed as the year’s amount they make.

When you haven’t been given this number, don’t worry. To figure out your gross income for a salary position, you just need a recent pay stub and a simple math equation.

Where this can get a little tricky is when you have multiple sources of income. These can be in the form of yearly bonuses, freelance work, or tips. You need to add this amount to your gross income salary to get an answer that’s completely reflective of your income.

How to Calculate Gross Income for an Hourly Job

Calculating gross income for an hourly job requires a little more math than a salaried role, but it’s still basic enough that anyone can do it.

Employees who don’t work consistent hours throughout the year are advised to wait until they receive their final paycheck to see their gross income as printed on their paychecks. This removes any room for error and legwork you have to do to arrive at a number that may not be entirely correct.

Employees who work a consistent number of hours every week may have a smoother time arriving at a dependable gross income through math. To figure out your annual income, you must first do the math to find your weekly and monthly income.

How to Calculate Net Pay

Net pay is far more complicated to calculate than gross pay, because you have to account for all of the deductions from your paycheck, which may or may not change depending on your tax situation, your contributions to retirement plans, and your choice of health insurance policy, to name a few common factors.

First, try looking at your paystub closely and understand what’s being taken out of your pay and at what rate. If that leads to inconclusive results, you can reach out to your company’s HR department and ask exactly what expenses are taken from your pay and how those rates are calculated. From there, you can probably come up with a fairly accurate estimation of your net pay.

Then you’ll have to add your net pay from any other income sources, like a side hustle or your own business. As you can see, this rather murky set of calculations will likely lead to an inexact answer until you can look back on the year retrospectively. That’s why lenders stick with the much more straightforward figure of gross pay instead.

Gross Pay Vs. Net Pay FAQ

1. Which is better, gross or net pay?

   Neither gross pay nor net pay is better. Gross pay is simply the total pay you earn from your salary, hourly wages, commissions, bonuses, and tips, while net pay is all of that minus taxes and benefit deductions.

   In other words, gross pay is the total amount of money you earn, while net pay is the amount of that money that you actually take home.

2. Are you taxed on gross or net pay?

   You’re taxed on gross pay. Net pay is what you’ll take home after your taxes, retirement fund contributions, and other benefit costs are deducted from your paycheck.

3. Is monthly salary gross or net pay?

   Your monthly salary is gross pay before taxes and other deductions are removed.

   When companies tell you what your monthly salary will be, they’re telling you the gross salary. If you’re calculating your monthly salary according to the amount that goes into your bank account every month, that would be your net monthly pay.

   When banks or creditors are asking for your gross income, they’re usually looking for your annual gross income, which includes your gross salary, tips, commissions, and other income sources from the whole year before taxes and other deductions were taken out.

Final Thoughts

The answer to the question, “what’s your annual salary” is often trickier than we think. For both nonexempt and exempt employees, determining gross wages and salaries is as simple as multiplying your hourly wage by your hours worked in a year.

It’s only when it comes to tax withholding and other deducted items where things become complicated. Take-home pay isn’t usually what hiring managers talk about when they’re discussing a salary offer, and it’s not the number you tell a bank when you apply for a mortgage.

Just remember that while knowing gross pay is useful for certain things, it fails to take into account the value of the rest of your benefits package or the deductions from your paycheck.

Author

Sky Ariella

Sky Ariella is a professional freelance writer, originally from New York. She has been featured on websites and online magazines covering topics in career, travel, and lifestyle. She received her BA in psychology from Hunter College.