Gross pay vs net pay: Key differences for your small business

Published Thursday 2 July 2026

Table of contents

• What is the difference between gross pay and net pay?
• What is gross pay?
• What is net pay?
• How to calculate gross pay and net pay
• Why gross and net pay matter for your business
• Run payroll with confidence in Xero
• FAQs on gross pay and net pay

Key takeaways

• Gross pay is earnings before taxes and deductions; net pay is take-home pay after all withholdings.
• Use the right method for hourly and salaried staff, then add overtime, bonuses, and commissions.
• Reduce taxable wages with pre-tax benefits, then withhold taxes and apply post-tax deductions to get net pay.
• Use payroll tools connected to your accounting to automate gross-to-net calculations and keep clean records.

What is the difference between gross pay and net pay?

Gross pay is the total amount an employee earns before any taxes, benefits, or other deductions are withheld. Net pay is the amount left after all those deductions, also known as take-home pay.

When doing small business payroll, you enter your employees' gross pay. Then, you subtract taxes and other deductions. The remaining amount is their net pay.

Here's how gross pay and net pay compare:

• Definition: Gross pay is total earnings before deductions; net pay is take-home pay after deductions
• What's included: Gross pay covers wages, salary, overtime, bonuses, commissions, and tips; net pay reflects what's left after taxes, insurance, and retirement contributions
• Calculation basis: Gross pay starts from hourly rate or annual salary; net pay starts from gross pay minus all withholdings
• Purpose: Gross pay sets the baseline for employer costs and job offers; net pay determines what employees actually receive

Here's an example: A manager earns a $120,000 annual salary, which is their gross pay. You withhold $40,000 for taxes and other deductions, making their net pay $80,000.

What is gross pay?

Gross pay is the total amount an employee earns before any taxes or deductions are withheld from their paycheck.

Gross pay can include several types of compensation:

• hourly wages or annual salary
• overtime pay
• bonuses
• commissions
• tips
• payments for paid time off (PTO)

Gross pay generally doesn't include non-cash benefits such as healthcare premiums paid by employers, but it does include the value of taxable benefits, such as gym memberships and personal use of company cars.

Learn more about how benefits affect gross pay from the IRS's resource on fringe benefits.

What is net pay?

Net pay is the amount a worker takes home after all deductions are subtracted from their gross pay. When you run payroll for employees, net pay is the amount you write on their check or direct deposit into their bank account.

To arrive at net pay, you subtract two categories of deductions from gross pay: pre-tax deductions and post-tax deductions, along with required tax withholdings.

Common pre-tax deductions include:

• health insurance premiums
• traditional 401(k) contributions
• health savings account (HSA) or flexible spending account (FSA) contributions

These deductions lower an employee's taxable income, which means less is withheld for income tax.

You're also required to withhold Federal Insurance Contributions Act (FICA) taxes from each employee's gross pay. FICA includes Social Security tax at 6.2% and Medicare tax at 1.45%, for a combined rate of 7.65%. As the employer, you match that same 7.65%, according to the IRS.

After taxes, post-tax deductions are subtracted. Common post-tax deductions include:

• Roth 401(k) contributions
• wage garnishments (for example, child support or court-ordered payments)
• union dues

Learn more about the taxes you must withhold from the IRS's Employers' Tax Guide.

How to calculate gross pay and net pay

To calculate gross pay for hourly employees, multiply their hourly rate by the number of hours worked. Account for overtime, and add on any extra pay for bonuses, commissions, or tips. For salaried employees, divide their annual salary by the number of pay periods in the year.

Then, determine net pay by subtracting taxes and other deductions. Payroll software handles all the calculations, but here are examples to help you understand what's happening.

Gross pay calculations for hourly employees

Say an employee earns $20 per hour and works 50 hours during the week: 40 hours of regular time and 10 hours of overtime. Plus, they earn $500 in commission. To calculate their gross pay:

• Multiply their hourly rate times 40 for the first 40 hours.
• Multiply their hourly rate times 1.5 for the overtime rate.
• Multiply the overtime rate by 10 for the 10 hours of overtime.
• Add the totals together and add on the $500 in commission for their gross pay.

Here are the numbers:

• $20 x 40 = $800 (regular pay)
• $20 x 1.5 = $30 (overtime rate)
• $30 x 10 = $300 (overtime pay)
• $800 + $300 + $500 = $1,600 (gross pay)

Gross pay calculations for salaried employees

The process is a bit different for salaried workers. First, consider what the gross annual pay is for the employee. Then, divide that number by the number of pay periods in the year.

Say your employee's annual salary is $100,000 and you pay them weekly. To calculate their gross pay for the week, divide their annual salary by 52.14 (the number of weeks in the year).

$100,000 / 52.14 = $1,917.91

In contrast, if you pay them monthly, you divide their annual wages by 12.

$100,000 / 12 = $8,333.33

Net pay calculations

Calculating net wages is a bit trickier, but the concept is straightforward. Start with gross pay and subtract all deductions.

Gross pay - deductions = net pay

Here's an example:

• $2,000 gross pay
• -$153 FICA taxes
• -$200 federal income tax
• -$80 state income tax
• -$100 contribution to retirement account
• = $1,467 net pay

The tricky part is ensuring you withhold the right amount of income tax, and it varies from employee to employee based on their total income and the information on their W-4 tax form. Use software to avoid errors and safeguard payroll compliance.

Learn more from the IRS about the W-4 and federal tax withholding methods.

Why gross and net pay matter for your business

Employers need to understand gross and net pay because of how these numbers affect their business's budget, recruitment efforts, and employee satisfaction.

Gross pay and employer costs

Gross pay shows how much your business pays out in wages and taxable non-cash benefits. It also gives you a starting point for calculating the employer's portion of payroll taxes, state and federal unemployment taxes, and other employment-related expenses. According to the Bureau of Labor Statistics, total employer compensation costs for private industry workers averaged $46.60 per hour worked in March 2026, with wages and salaries accounting for $32.60 of that total.

When thinking about employee raises and rates for new employees, consider how gross pay plus all other costs from benefits to office supplies affect your bottom line.

Gross pay and recruitment

Gross pay is the headline number for recruitment efforts. It affects who applies to your job listings and which candidates are likely to accept your offers. Benefits, business culture, and work-life balance also play a key role.

Net pay and employee satisfaction

Net pay directly affects employee satisfaction and retention rates. Employees are more likely to look for other jobs if their net pay is too low.

You can't do anything about tax deductions, as that's based on each employee's personal situation, but you should consider how benefits affect both your costs and employee satisfaction rates.

Say you contribute to employee retirement accounts. That increases your costs and builds up retirement savings for employees. For some workers, that's great news. But others may prefer extra pay instead of retirement account contributions, especially if their net pay isn't enough to cover their cost of living expenses.

To strike the right balance, consider everything: gross pay, net pay, your costs, and how it all affects your employees.

Run payroll with confidence in Xero

Employers should understand gross and net pay, but they don't need to calculate them. There's software for that. Xero accounting software syncs with easy-to-use payroll software like Gusto, and many other popular options are also available in the app store.

Let payroll software calculate gross pay, deductions, and net pay. It can also file payroll returns and make payments. Best of all, the numbers get ported into your Xero accounting records, making it easy to run real-time reports on employee costs.

Running payroll is easy with Xero, get one month free.

FAQs on gross pay and net pay

Here are answers to common questions about gross pay and net pay.

How do I gross up a bonus?

Divide the desired take-home bonus by (1 minus the tax rate). For example, if you want an employee to take home a $500 bonus and their effective tax rate is 30%, the formula is $500 / (1 - 0.30) = $714.29. You'd pay a gross bonus of $714.29 so the employee receives the full $500 after taxes.

How do overtime and tips affect net pay?

Overtime and tips increase both gross and net pay, but a higher-than-usual paycheck can trigger a larger income tax withholding for that pay period. Most payroll software calculates income tax as if the worker receives that same pay every period during the year. If employees notice a bigger-than-expected withholding, they'll typically get the difference back as a refund when they file their annual tax return.

What is gross income vs net income?

In a business context, gross income is total revenue minus the cost of goods sold, while net income is what's left after subtracting all operating expenses, taxes, and interest. For individual employees, gross income is total earnings before deductions, and net income is take-home pay.