Payroll Basics: Gross to Net

Gross pay vs. net pay

Gross pay is the full amount earned before any deductions. Net pay ('take-home pay') is what actually lands in the employee's account after all withholdings. Everything in between is either withheld from the employee or paid separately by the employer.

Employee withholdings (deducted from gross pay)

These reduce the employee's paycheck but are not an added cost to the employer — the employer is simply collecting and forwarding money the employee already earned.

• Federal income tax — based on the employee's W-4 elections and IRS withholding tables (U.S. example; rules vary by country).
• State/local income tax — varies by jurisdiction, and some jurisdictions have none.
• Social Security — 6.2% of wages up to an annual wage base cap (U.S. figure, adjusted periodically).
• Medicare — 1.45% of all wages, with an additional 0.9% surtax on high earners in the U.S.
• Voluntary deductions — health insurance, 401(k)/retirement contributions, garnishments.

Employer payroll taxes (an added employer cost)

These come out of the employer's pocket, on top of gross wages — they are never deducted from the employee's check.

• Employer Social Security match — 6.2% of wages, mirroring the employee's share.
• Employer Medicare match — 1.45% of wages, mirroring the employee's share.
• FUTA (federal unemployment) and SUTA (state unemployment) — employer-paid, rates vary significantly by state and claims history.

Why this all matters for the books

The employee's gross wages become an expense (Wages Expense). Withholdings become liabilities until they're remitted to the taxing authority or benefit provider. Employer taxes are a separate, additional expense — total payroll cost to the company is always higher than the sum of employees' gross wages.

1. 1. Calculate gross pay

Salaried employees: annual salary divided by the number of pay periods. Hourly employees: hours worked times the hourly rate, with overtime (typically 1.5x) for hours over 40 in a week under U.S. federal rules — overtime rules vary elsewhere.

Salaried, biweekly (26 pay periods/year), $62,400/year:
  $62,400 / 26 = $2,400.00 gross per period

Hourly, weekly, $22/hour, 46 hours worked:
  40 hrs x $22.00       = $880.00
  6 hrs x $33.00 (OT)    = $198.00
  Gross pay              = $1,078.00

2. 2. Apply employee tax withholdings

Using the hourly employee's $1,078.00 gross as an example, with a simplified flat 12% federal rate and 4% state rate for illustration (real withholding tables are more granular and depend on W-4 elections and filing status).

Gross pay                          $1,078.00
Federal income tax (12%, illus.)     (129.36)
State income tax (4%, illus.)         (43.12)
Social Security (6.2%)                (66.84)
Medicare (1.45%)                      (15.63)
Health insurance (fixed)              (60.00)
401(k) contribution (5%)              (53.90)
Total withholdings                   (368.85)
Net pay                              $709.15

3. 3. Calculate employer payroll taxes

Separately from the paycheck, the employer owes matching Social Security and Medicare, plus unemployment taxes.

Employer Social Security (6.2%)       $66.84
Employer Medicare (1.45%)              $15.63
FUTA (0.6% up to wage base, illus.)     $6.47
SUTA (2.7% up to wage base, illus.)    $29.11
Total employer taxes                  $118.05

4. 4. Record the payroll journal entry

The gross wage is the expense; each withholding is a liability until paid; net pay is the cash that actually goes out.

Dr Wages Expense                1,078.00
    Cr Federal Income Tax Payable          129.36
    Cr State Income Tax Payable             43.12
    Cr Social Security Payable              66.84
    Cr Medicare Payable                     15.63
    Cr Health Insurance Payable             60.00
    Cr 401(k) Payable                       53.90
    Cr Cash (net pay)                      709.15

5. 5. Record the employer tax journal entry

This is a separate entry — it's additional expense to the company, not a deduction from the employee.

Dr Payroll Tax Expense             118.05
    Cr Social Security Payable              66.84
    Cr Medicare Payable                     15.63
    Cr FUTA Payable                          6.47
    Cr SUTA Payable                         29.11

6. 6. Remit withholdings and taxes on schedule

Federal and state tax deposits are typically due on a schedule based on the size of the payroll (semiweekly, monthly, or quarterly in the U.S.), and unemployment taxes are typically remitted quarterly. When paid, the liability accounts are cleared against cash.

Remitting the combined Social Security + Medicare liability of $198.75 (both employee and employer shares, 6.2%+6.2%+1.45%+1.45%):
Dr Social Security Payable    133.68
Dr Medicare Payable            31.26
    Cr Cash                          164.94
(Note: figures illustrate the combined employee+employer remittance for this single paycheck example.)

7. 7. Reconcile payroll liability accounts

At month-end, each payroll liability account balance should equal exactly what's owed and not yet remitted — a lingering balance after a scheduled remittance date is a red flag worth investigating immediately.

8. 8. File required payroll tax returns

In the U.S., this includes quarterly Form 941 (federal payroll taxes) and annual Form 940 (FUTA), plus state equivalents, along with year-end W-2s for employees. Requirements and forms vary significantly by country and jurisdiction.

What's the difference between gross pay and net pay?

Gross pay is total earnings before deductions; net pay is what actually lands in the employee's account after all withholdings.

Why are employer payroll taxes recorded in a separate journal entry from the employee's paycheck?

Because they're an additional company expense, not a deduction from the employee's wages — mixing them understates or misstates both figures.

Name three employee withholdings and one employer-only tax.

Federal income tax, Social Security, and Medicare are withheld from employees; FUTA (or SUTA) is paid entirely by the employer.

Why is worker misclassification risky?

Treating an employee as a contractor to avoid payroll taxes can trigger significant back taxes and penalties if the classification is challenged and overturned.

What should you check if a payroll liability account doesn't zero out after remittance?

Look for a calculation error, a missed remittance, or a duplicate/omitted entry — the balance should reflect exactly what's currently owed and unpaid.

Do all employers pay the exact same payroll tax rates?

No — rates like SUTA vary by state and by employer claims history, and Social Security/Medicare rates and wage bases can change; always verify current figures.

What happens if I withhold too little from an employee's paycheck?

The shortfall typically needs correcting in a subsequent paycheck, and repeated errors can create issues at year-end tax filing for the employee.

Is overtime always calculated at 1.5x?

In the U.S. it's the federal standard over 40 hours/week, but some states and situations use different multipliers or thresholds — verify local rules.

Can a salaried employee ever be owed overtime?

Yes, if they're classified as non-exempt under wage-and-hour law rather than exempt — salary alone doesn't automatically exempt someone from overtime rules.

What records should be kept for payroll?

Timesheets, pay stubs, tax filings, and W-4/withholding forms, generally retained for several years per jurisdiction requirements.

How often are payroll tax deposits due?

It depends on the size of the payroll and jurisdiction — could be semiweekly, monthly, or quarterly; check current rules rather than assuming a fixed schedule.