Net pay is the total amount of money that the employer pays in a paycheck to an employee after all required and voluntary deductions are made. To determine net pay, gross pay is computed based on how an employee is classified by his or her organization.
An hourly or nonexempt employee is paid by the hours worked x the agreed upon hourly rate of pay. The nonexempt employee's paycheck may also include payment for overtime, bonuses, reimbursements, and so forth.
The salaried or exempt employee is paid an annual, agreed-upon salary, usually in bi-weekly payments. The amount of the paycheck is determined by the total annual salary divided by the number of pay periods in a year, normally 26.
From this total pay which is known as gross pay, the employer is required by law to withhold certain percentages of an employee's paycheck to pay required tax withholdings. After voluntary payroll deductions are subtracted and legally required payroll deductions are subtracted, the pay that the employee receives is called net pay.
In all cases, to calculate the employee's net pay, the amount to subtract from gross pay is determined by using the number of deductions declared by the employee on the W-4 form in conjunction with the tax charts provided by the Internal Revenue Service (IRS). See Taxes 101 for additional information about taxes.
In addition to the required payroll deductions for taxes, Medicare and Social Security, the employer also subtracts voluntary deductions from an employee's gross pay. Voluntary deductions from gross pay include items such as charitable contributions (for example, United Way) and the employee's required contribution to healthcare insurance coverage.
Any court ordered garnishment is also subtracted from an employee's gross pay.
Simply put, net pay is whatever is left over from an employee's pay after all legally required and voluntary deductions are subtracted.
Because the US tax laws are confusing, you might also want to talk with your state Department of Labor and / or an employment law attorney when you venture down the road of hiring employees. Your business accounting firm is also another expert in matters relating to payroll taxes and deductions.
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