Net Pay
An Employer's Guide to Calculating Take-Home Pay
OCT 23, 2020
As a new business owner, there will be many determinations as you build the organization into the success you envision. The steps to take before getting to that point can range from location to product or service ideas, or to balance the size of the workforce that the business needs with the workforce it can afford.
Part of that business plan, particularly regarding the staffing, includes payroll decisions.
At its most fundamental level — compensating employees for their work — payroll is a simple concept. However, there are several factors that, while making the process a bit more complex, ensure employees receive the correct amount of net pay along with the complete package of benefits they deserve.
Understanding the ins and outs of payroll can result in an array of positive effects. Not only will it offer a more detailed picture of the company’s bottom line, but it will allow it to compete for a more talented pool of prospective hires and avoid any confusion or compliance issues.
For those building a business from the ground up or simply in need of a refresher, let’s break down the fundamentals of calculating take-home pay.
Difference Between Gross Pay and Net Pay
Understanding the payroll system ultimately comes down to understanding the difference between gross pay and net pay.
Gross pay is simply the amount of money the employee makes before the necessary deductions are taken out. Whether determined by salary or by an hourly wage, it is the total amount of money owed to the employee.
Net pay is the amount the employee receives after taxes and benefits have been accounted for. Otherwise called take-home pay, it is how much remains to be included in the paycheck an employee collects each pay period. Though gross pay is often the most publicized, the easiest to communicate, and most discussed in the hiring process, net pay may be the most important to employees at the end of the day.
Appreciating the relationship between gross and net pay is one vital aspect of successful business owners creating and maintaining an efficient payroll system.
Determining Salary in General for Gross Pay
Landing on the proper gross pay for prospective hires requires research on many fronts.
First, employers must know the tasks or duties they expect a hire to fulfill and the skills prospects would have to possess in order to meet those responsibilities. How much value could this position create for the business?
Once those factors are worked out, employers must recognize what salary or hourly rate those responsibilities and skills would garner from other comparable businesses in the same industry. Cost of living is likely another factor to consider.
It is important to build a knowledge of the market and talent pool when making determinations surrounding gross pay.
Attracting Top Talent
Successful business owners want to offer competitive wages in order to attract the top talent while also keeping the bottom line in mind.
Knowing how much your business can afford to spend on payroll without sacrificing profitability will allow the ability to set a target salary range for the hire.
The process of finding the best prospect should also allow for their own expectations. Job seekers often enter negotiations after having gained useful, relative experience and an idea of what their experience and skills are worth.
If the two fit, you’ve likely just agreed on the gross pay for that new employee.
Now that you have the starting figure, you can begin calculating net pay by identifying any taxes or deductions that would come out of their paycheck.
Pre-Tax Benefits and Deductions
Studies show that while meeting industry salary standards is still important, it is only one element contributing to overall job satisfaction.
Benefits packages are an important part of payroll and an important consideration for prospective employees when deciding on a job offer. In the process of growing a business, the opportunity to provide better benefits could extend a business’s reach for talented prospects.
Whether they involve healthcare or retirement plans, these benefits are an essential aspect in calculating take-home pay. When each new employee takes part in the onboarding process, they will have an opportunity to enroll in the benefits — of those offered by the business — that best suit their needs.
Most benefits, specifically the usual healthcare and retirement contributions, may be taken out of the gross pay on a pre-tax basis along with the withholding allowances claimed by the employee, resulting in the amount of remaining income that is eligible to be taxed.
That leads to the next calculation.
Taxes Taken Out
Perhaps the most obvious factor of calculating take-home pay is determining which taxes must be taken out of the paycheck. Though it’s a known factor to any business owner, calculating each employee’s tax contribution can often be complex.
To begin, each employee’s taxable income will be determined by the pre-tax benefits and deductions that have been subtracted from the original gross pay. The determination for amounts will require compliance with federal, state, and local income tax laws.
Federal income taxes are based on the income bracket into which the employee qualifies, but the tax rate may change with any new legislation. Of course, state and local taxes must be closely monitored, as they vary from state to state and city to city.
Beyond income taxes, wages would also be withheld for Social Security and Medicare, which are collected together as FICA (Federal Insurance Contributions Act) taxes. Depending on the employee’s income, they may not meet the threshold for Social Security taxes.
When the pre-tax benefits and deductions and all of the necessary taxes have been subtracted from the initial gross pay, you have arrived at the net pay for the employee to take home in his or her paycheck.
How Do Gross and Net Pay Affect Employers?
While the numerous calculations previously described are used to determine the take-home pay for employees, they are also useful information for employers.
Outside of that knowledge being used to better inform the processes for recruiting and salary negotiation, it is also necessary for the business’s own records and tax responsibilities.
Employers are responsible for paying Social Security and Medicare (FICA) taxes along with their employees. They are also required to pay both state and federal unemployment taxes (FUTA), along with any other necessary state taxes. These are taken as percentages of the employee’s gross pay.
The amount of taxes owed by an employer depends on knowing the breakdown of its employees’ gross and net pay, and understanding both of those figures can go a long way towards simplifying the payroll process.
Get Help by Outsourcing Payroll
For many employers, payroll is a headache.
While they may understand the fundamentals of gross and net pay and can calculate take-home pay, it can become an arduous task that takes up valuable time. Small-business owners may be juggling too much to oversee payroll. Owners of growing businesses with a larger staff may have too many employees to realistically keep track of payroll responsibilities.
This is often where outsourcing becomes a welcome opportunity.
When employers become overwhelmed with the payroll process, services such as Payroll Vault offer peace of mind by executing payroll, maintaining clean records, and communicating those processes clearly.
Not only can outsourcing payroll alleviate much of the stress associated with this aspect of running a business, but it can also ensure businesses stay compliant and avoid any costly errors that may occur.
For those wanting to outsource payroll, get a quote, contact us, find a location, or visit Payroll Vault’s website.
Original content posted on PayrollVault.com.
