Gross versus net pay

In short

I remember the first time I looked at an offer letter and then saw my first paycheck. The gap felt like a mistake. Gross pay is the full amount your employer promises you before anything comes out, whether that is an annual salary, an hourly wage times your hours, or a commission. Net pay is what actually arrives in your bank account after federal income tax, Social Security, Medicare, state and local taxes, and any benefits you elected come off the top. The difference between the two is not a fee or a trick. It is the sum of everything the law requires and everything you chose when you signed your enrollment forms. Understanding each line between gross and net shows where every dollar goes.

The whole of it

What it is

A neighbor once asked me why his February check was smaller than his January check even though his pay rate had not changed. He had enrolled in dental coverage that month. Gross pay is the starting number, the one printed on your offer letter or calculated by multiplying your hourly rate by the hours you worked. It is the figure your employer uses to report your wages to the Social Security Administration and the IRS. Net pay is what remains after every mandatory deduction and every voluntary deduction has been subtracted. The difference between gross and net is not one thing. It is a stack of separate lines, each with its own rule and its own destination.

How it works

You earn gross pay by working, whether you are salaried or paid by the hour. Your employer takes that gross figure and begins subtracting in a specific order, though the order on your pay stub may not match the order in which the money is legally considered. Federal income tax comes out based on the W 4 you filled out, which tells your payroll system how much to withhold. Social Security tax takes the current figure, which the official source publishes each year of your gross wages up to an annual cap of the current figure, which the official source publishes each year. Medicare tax takes the current figure, which the official source publishes each year of all your wages with no ceiling, and if your year to date wages cross the current figure, which the official source publishes each year as a single filer or the current figure, which the official source publishes each year filing jointly, an additional the current figure, which the official source publishes each year applies to everything above that line. State income tax, if your state has one, uses its own brackets and its own withholding certificate. Local taxes, school district levies, and city earnings taxes come next if you live or work somewhere that charges them. After the government takes its share, your employer subtracts the premiums for health insurance, dental and vision coverage, life insurance, and disability if you elected them. Contributions to a traditional 401(k) or a SEP IRA come out pre tax, which lowers your taxable wages before federal and usually state income tax is calculated, but Social Security and Medicare still see the full gross amount in most cases. Contributions to a Roth 401(k) come out after income tax has already been figured. Finally, wage garnishments for child support, unpaid taxes, or defaulted student loans come off if a court or agency has ordered them. What remains is your net pay.

The numbers, and where to find yours

Every pay stub shows gross pay at the top, then a column of deductions, then net pay at the bottom. If you are salaried, gross pay for one check is your annual salary divided by the number of pay periods in a year. Twenty six pay periods if you are paid biweekly. Twenty four if you are paid twice a month. If you are hourly, gross pay is your hourly rate times all compensable hours, including overtime at time and a half or double time if your state or your contract requires it. The stub will list federal income tax withheld, Social Security as OASDI or SS, Medicare as FICA Med or MEDI, and state tax under the state's own abbreviation. It will show each insurance premium and each retirement contribution by name. Your year to date gross, year to date net, and year to date totals for each deduction sit in a column to the right or below. If a number looks wrong, compare the year to date figure to the sum of every prior stub. A mismatch means an error. The IRS publishes federal income tax withholding tables in Publication 15 T each year, and your state revenue department publishes equivalent tables if your state has an income tax. You can check your federal withholding by hand using the worksheet in Publication 15 T or by running the IRS Tax Withholding Estimator on irs.gov.

A worked example

Suppose Maria earns a salary of 60,000 dollars a year and is paid every two weeks, giving her 26 pay periods. Her gross pay each period is 60,000 divided by 26, which is 2,307.69 dollars. She is single, claims standard withholding on her W 4 with no adjustments, and lives in a state with a flat income tax of 5 percent. She contributes 4 percent of gross pay to a traditional 401(k), and her employer deducts 90 dollars per pay period for health insurance. First, the 401(k) contribution comes out pre tax, which is 4 percent of 2,307.69, or 92.31 dollars. Her taxable wages for federal and state income tax drop to 2,307.69 minus 92.31, which is 2,215.38 dollars. Federal income tax withholding, according to Publication 15 T, is calculated using the biweekly tables for a single filer claiming standard withholding. For this example we will use 168 dollars as the withheld amount, though your exact withholding depends on the tables in effect and your specific W 4 entries. State income tax is 5 percent of 2,215.38, or 110.77 dollars. Social Security tax is the current figure, which the official source publishes each year of the full gross 2,307.69, which is 142.88 dollars. Medicare is the current figure, which the official source publishes each year of 2,307.69, which is 33.46 dollars. Health insurance is 90 dollars. Add those deductions: 92.31 plus 168 plus 110.77 plus 142.88 plus 33.46 plus 90, totaling 637.42 dollars. Subtract 637.42 from the gross 2,307.69, and Maria's net pay is 1,670.27 dollars. That is what hits her account. The difference of 637.42 dollars did not vanish. It went to six different places, each with a receipt.

Where it goes wrong

I have seen people set their W 4 to claim exempt because they wanted a bigger check, then owe thousands in April with no way to pay. The withholding system is a pay as you go estimate, not a bill. If you under withhold by more than the current figure, which the official source publishes each year, you will owe a penalty on top of the tax. Some workers think Social Security and Medicare are optional or negotiable. They are not. If you are an employee, those come out automatically, and your employer sends a matching amount on your behalf. If you are self employed, you pay both halves yourself through self employment tax on Schedule SE, roughly the current figure, which the official source publishes each year of net earnings up to the Social Security cap. Pre tax retirement contributions lower your take home immediately, and some people stop contributing because the hit feels too large, not realizing they are trading a small sting now for a much larger tax bill later if they save in a taxable account instead. Health insurance premiums also come out pre tax in most employer plans, which means every dollar of premium saves you the marginal federal and state tax on that dollar. Dropping coverage to raise net pay costs you that tax benefit and leaves you uninsured. Pay stubs sometimes contain errors. A misplaced decimal in your 401(k) election, a wrong tax filing status, or a stale garnishment that should have been released will all shrink your net pay incorrectly. Check every line every pay period for the first three months of any new job or any benefit change. After that, check quarterly and whenever something feels off.

Questions to answer before you leave this page

What is your current gross pay per period, and where on your pay stub does that number live? What is your year to date gross, and does it match the sum of every check so far this year? How much federal income tax has been withheld year to date, and does the IRS withholding estimator say that will cover your expected liability or leave you with a balance due? If you are contributing to a retirement plan, is that contribution coming out before or after federal income tax, and do you know which type of account you elected? What is your effective take home percentage, net divided by gross, and has it changed since your last benefit enrollment or W 4 update? If you received a raise, did your net pay increase by less than you expected, and can you identify which deduction absorbed the difference? Are any lines on your stub labeled garnishment, levy, or child support, and do you have the court or agency order that authorizes them? If your state has income tax, does the amount withheld each period match the state's withholding formula for your filing status and income, and when did you last check your state W 4 equivalent? Do you know where each dollar of the gap between gross and net is going, and could you explain every line to someone who has never seen a pay stub?