Understanding Gross Pay vs Net Pay

Running a small business comes with enough challenges—figuring out the difference between gross pay and net pay shouldn’t be one of them. Still, many business owners and employees may find these terms confusing. You might ask yourself: "Why is my own take-home pay lower than my salary?"

The answers all come down to understanding how gross pay (what is earned before deductions) and net pay (what’s left after deductions) work. Knowing the difference is important for both employers and employees. It impacts everything from salary discussions and payroll accuracy to budgeting and tax compliance.

In this article, we’ll break down gross pay vs net pay in plain language. You’ll learn:

• What gross pay and net pay really mean.
• Why the difference matters to both employees and employers.
• How to calculate net pay step-by-step.
• What deductions and withholdings affect take-home pay.
• Answers to common questions about gross and net pay.

At Paper Trails, we work with small businesses every day to simplify payroll and compliance headaches. We know this can be overwhelming, so we are here to help you understand one of the most essential parts of paying employees. Let’s dive in.

Defining gross pay

Gross pay is the total amount of money an employee earns before anything is taken out. It’s the “headline” number you see when someone talks about a salary or hourly wage. For example, if you tell a new hire that they’ll earn $20 an hour, and they work 40 hours in a week, their gross pay for the week would be $800 ($20/hour x 40 hours). For salaried workers, if you offer a $50,000 annual salary, that’s their gross annual pay.

Gross pay isn’t just regular wages. It can also include:

• Overtime pay.
• Bonuses or commissions.
• Paid time off (vacation, sick pay, etc.).
• Other forms of compensation, like stipends or allowances.
  
  

How to calculate gross pay per pay period

To calculate the gross pay per pay period for hourly employees, multiply the hours worked in a pay period by the hourly rate. If someone worked 40 hours at $20 an hour, their gross pay for that period is $800. Add overtime pay if they worked more than 40 hours in a week.

For salaried employees, divide the annual salary by the number of pay periods. If you pay someone $50,000 annually on a biweekly schedule (26 pay periods), each paycheck will show a gross pay of about $1,923.08 before deductions.

Defining net pay

Net pay, also called “take-home pay,” is what’s left after all required payroll taxes and deductions are taken out of the gross pay. It’s the amount your employees actually see in their bank accounts or on their paychecks.

To put it simply:
Gross Pay – Deductions = Net Pay

If an employee’s gross pay is $800, but you deduct $150 for taxes, benefits, and other withholdings, the net pay will be $650 ($800 - $150). This is the amount they can actually spend or save.

Net pay varies from employee to employee because everyone’s deductions can be different. Things like retirement contributions, healthcare premiums, and even wage garnishments can change the final number.

Differences between gross pay and net pay

The easiest way to think about it is:

• Gross pay is what you offer or earn.
• Net pay is what you actually take home.

Gross pay is always higher because it doesn’t account for:

• Federal and state income taxes.
• Social Security and Medicare (FICA taxes).
• Employee-paid benefits like health insurance or retirement contributions.
• Court-ordered deductions (e.g., child support or wage garnishments).

Understanding this difference helps business owners avoid confusion when hiring. When you offer someone a job, they’ll likely want to know what their “take-home” pay will be. If you only discuss gross pay, they might feel misled when their paycheck is smaller than expected.

The importance of understanding net pay

Implications for employees

For employees, net pay is the number that matters most—it’s what they budget with for bills, groceries, and savings. If an employee doesn’t understand how gross pay turns into net pay, they may be surprised or even frustrated when they receive their paycheck. Clear communication about deductions and taxes can help build trust and reduce questions.

Implications for employers

For business owners, understanding net pay is critical to running payroll correctly and staying compliant with tax laws. Mistakes in calculating deductions can lead to tax penalties or unhappy employees. Knowing the difference between gross and net pay also helps when setting compensation. If you know roughly how much will be deducted, you can better explain take-home pay to new hires.

Calculating net income

So, how do you go from gross pay to net pay? It’s a simple process once you know the steps.

Step one: start with gross pay

For hourly employees, calculate hours worked (including overtime) and multiply by the hourly rate. For salaried employees, divide their annual salary by the number of pay periods in the year.

Step two: subtract deductions and withholdings

Next, you remove all mandatory and voluntary deductions. This includes:

• Federal and state income taxes (based on their W-4 and state requirements).
• Social Security (6.2% of gross pay) and Medicare (1.45% of gross pay).
• Health insurance premiums or retirement contributions, if applicable.
• Court-ordered wage garnishments, if applicable.

The remaining amount is the employee’s net pay.

Deductions and withholdings: explained

Deductions can be confusing because they aren’t the same for every employee. Some workers may only have a few deductions, while others might have a long list that significantly impacts their take-home pay. Here are the most common types of payroll deductions and how they work:

Federal income tax

This is based on IRS tax tables and the information provided on an employee’s W-4 form, such as filing status and dependents. The more allowances or dependents an employee claims, the less federal tax is withheld. For example, a single employee with no dependents will typically see more tax withheld than a married employee with two children.

State income tax

Not all states collect income tax, but Maine does. Employers must withhold state income tax according to Maine’s rates. If you have remote workers in another state, you’ll need to account for that state’s tax rules instead of just Maine’s.

Social security and medicare (FICA)

These mandatory contributions fund Social Security and Medicare programs. Employees pay 6.2% of gross wages for Social Security and 1.45% for Medicare, and employers match these amounts dollar-for-dollar. For instance, if an employee earns $1,000 in gross pay, $62 will go toward Social Security and $14.50 toward Medicare.

Health insurance

Employees who choose employer-sponsored health insurance will see a portion of their premium deducted from their paychecks. These deductions are often pre-tax, which means they reduce the taxable income before federal and state taxes are calculated.

Retirement contributions

Contributions to retirement plans like 401(k) or IRA accounts are typically deducted from gross pay on a pre-tax basis. This not only helps employees save for the future but can also lower their taxable income. For example, if an employee contributes $100 per paycheck to a 401(k), that amount is removed before calculating income tax.

Wage garnishments

These are court-ordered deductions, often for child support, alimony, back taxes, or other debts. Employers are legally required to withhold the specified amount and send it to the appropriate agency.

Maine Paid Family and Medical Leave (PFML)

This is a new deduction that will impact both employers and employees. The state’s PFML program provides wage replacement for workers who need time off to care for family or personal medical needs. Contributions to this program will be mandatory for eligible employees and businesses and must be factored into payroll deductions.

Other deductions might include life insurance premiums, union dues, or flexible spending account (FSA) contributions. Each of these items further reduces the gross pay to determine the net pay. For small business owners, using payroll software or a trusted payroll provider ensures that these deductions are calculated accurately and in compliance with federal and state laws.

Managing employee compensation

Estimating tax withholdings

When onboarding a new employee, you’ll collect a W-4 form that determines how much federal income tax to withhold. Employers can use IRS calculators or payroll software to estimate the correct amount.

Adjusting for deductions

Voluntary deductions (healthcare, retirement contributions) should be explained clearly during onboarding. Knowing how these impact net pay helps employees avoid paycheck surprises.

Impact on take-home pay

If an employee earns $1,000 in gross pay and has $300 in combined deductions (taxes and benefits), their net pay will be $700. It’s that $700 that they’ll actually use to pay bills. This difference is why understanding the breakdown is so important.

FAQs: Gross pay vs net pay

How do I calculate my net pay from gross pay?

To calculate net pay, start with your gross pay and subtract all taxes and deductions, like healthcare and retirement contributions. Your pay stub usually shows this breakdown.

What is included in gross pay?

Gross pay includes your regular wages or salary, plus bonuses, overtime, commissions, and other taxable earnings.

Why does my net pay seem lower than expected?

Net pay is always lower than gross pay due to taxes, Social Security, Medicare, and any voluntary deductions like insurance or retirement plans.

Are tips included in gross pay?

Yes, tips are considered part of an employee’s gross pay. For tipped employees, employers must ensure that the combination of the hourly wage (including Maine’s tipped credit rules) and reported tips equals at least the state minimum wage, which is $15.00 per hour in 2025. Employers are responsible for tracking and reporting tips as part of gross wages, and these amounts are also subject to payroll taxes like Social Security, Medicare, and federal and state income taxes.

How can I increase my net pay?

You can adjust your W-4 withholding, increase pre-tax retirement contributions, or negotiate a higher gross salary. Keep in mind that benefits and taxes will always affect your take-home pay.

Conclusion

Understanding the difference between gross pay and net pay is essential for both employees and employers. For employees, it clarifies why their take-home pay is less than their hourly rate or salary. For employers, it ensures payroll is accurate, transparent, and compliant with tax regulations.

At Paper Trails, we know payroll can feel overwhelming. That’s why we’re here to support small businesses across Maine and New England with the tools, education, and expertise they need to stay on track. If you’re ready to simplify payroll and HR, we’re always just a phone call away.