Gross wages are the total amount of financial compensation owed to an employee before any deductions are made. Gross wages include the employee’s base rate of pay plus any variable additions, such as overtime pay, incentives, or bonuses.
Why Do You Need To Understand Gross Wages?
Calculating gross wages is the first step in determining an employee’s net wages, often known to employees as take-home pay. Getting this calculation right is critical to ensure that deductions are made appropriately, and later tax adjustment filings are not required.
New employees are sometimes disappointed to learn that their gross wages do not match the final amount in their paychecks. Gross wages are subject to deductions before the employee receives their paycheck, which may lead to some employee questions on how the calculation works.
Understanding gross wages and how they differ from net wages will ensure you process payroll accurately and can help employees understand how their pay was calculated.
Where Can Employees Find Their Gross Wages?
Gross wages are displayed on the pay stub that accompanies an employee’s paycheck and on the employee’s W-2 tax form. Gross wages will generally be listed near the top of a pay stub, followed by a list of deductions.
On a W-2 form, gross wages appear in Box 1, labeled “wages, tips, and other compensation.”
What Is the Difference Between Gross Wages and Net Wages?
Gross wages are the total financial compensation earned by an employee prior to any deductions. Net wages refer to the employee’s actual take-home pay or the amount paid to the employee in their paycheck after deductions have been processed.
What Is Included in Gross Wages?
Since gross wages reflect the total financial compensation earned by an employee, this includes more than just their salary or hourly wage. The following types of earnings are included in an employee’s gross wages:
- Hourly wage
- Piece rate pay
- Holiday pay
- Paid time off, including vacation and sick pay
How Do You Calculate Gross Wages?
Gross wages are calculated differently for employees paid a salary versus those paid an hourly wage. Follow these steps for each employee type.
Calculating gross wages for hourly employees
Start by multiplying the employee’s hourly wage by the number of hours worked in the week. Then calculate any additional pay earned and add it to the hourly wage.
Example: Employee A earns $15 per hour and worked 42 hours in the pay week. Overtime in this state applies to all hours worked over 40 hours in a week and is paid at 1.5 times the hourly wage ($15 x 1.5 = $22.50 overtime rate).
Week 1 base earnings: $15 x 40 hours = $600
Week 1 overtime: $22.50 x 2 hours = $45
A’s hourly wages for the week are $645.
You will need to calculate hourly wages for the full length of the pay period. For instance, a bi-weekly pay period requires calculating hourly wages for two weeks and adding them together.
Example: Employee A works 37 hours in the second week of a two-week pay period.
Week 1 hourly wages: $645 (see calculation above)
Week 2 base earnings: $15 x 37 hours = $555
Week 2 overtime: $0 (no hours worked over 40 hours)
A’s hourly wages for the two-week pay period are $1,200 (week 1 + week 2).
Finally, remember to add in any other earnings from commissions, bonuses, or other forms of additional pay, if applicable.
Example: Employee A earns a bonus of $200 during the two-week pay period.
A’s gross wages are $1,400 (hourly wages + bonus payment).
Calculating gross wages for salaried employees
Calculating gross wages for salaried employees is usually more straightforward. If they are paid a salary because they are exempt from the Federal Labor Standards Act (FLSA), as is often the case, then you only need to divide their salary by the number of pay periods in the year.
Example: Employee B earns an annual salary of $50,000 and is FLSA-exempt. B is paid biweekly. To calculate B’s salary wages, divide the annual salary by 26 pay periods.
B’s salary wages are $1923.08 ($50,000 / 26 pay periods).
As with hourly wage employees, bonuses or other forms of incentive pay will be added to the salary wages for the pay period when they are earned.
Example: B earns a bonus of $1,000 during this biweekly pay period.
B’s gross wages are $2923.08 (salary wages + bonus payment).
Impact of Reimbursements on Gross Wages
Some payments made by employers to employees are excluded from gross wages. Common excluded payments include employee discounts, awards or prizes, and expenses from business travel. These are limited in scope and set out in full by the IRS in its Fringe Benefit Guide.
As an example, reimbursing an employee for travel expenses after they take a week-long work trip on behalf of the business would likely not be included in the employee’s gross wages.
In general, reimbursements must be made under an “accountable plan” (see Chapter 6 of the Fringe Benefit Guide), which requires that the expense be business related, be reported to the business, and that any amount paid to the employee beyond the expense amount be promptly returned to the business.
Amounts to be returned to the business sometimes occur when a business opts to pay the employee in advance based on an estimate of what the expenses will total. If this estimate turns out to be more than the actual expense, then the employee must promptly return the difference.
Required Deductions From Gross Wages
When discussing the differences between gross wages and net wages with an employee, it is helpful to explain that some deductions from their gross wages are required by law.
State and federal income taxes
Income taxes are required to be paid to the federal government via the IRS and may also be due to the state government, depending on the employee’s state of residence. Federal taxes are calculated based on a number of factors, including:
- Amount of gross wages
- Filing status (single or married)
- Withholding allowances
- The applicable IRS withholding method
State income tax information can be found by checking with the state revenue or tax board.
Federal Insurance Contributions Act (FICA) deductions are also required and are used to contribute to Social Security and Medicare.
Other deductions required by law
While less common, additional deductions may be required from an employee’s gross wages. Examples of these are court-ordered wage garnishments such as child support payments.
Optional Deductions From Gross Wages
After required tax deductions, employees may also have further optional deductions from their gross wages.
If offered by the company, employees can opt to have deductions from their gross wages placed into a qualified retirement plan. The most common plan type offered is a 401(k) plan. This is a tax-advantaged plan recognized by the IRS, which allows for contributions from employees and matching contributions from employers. In order to offer a 401(k) plan, the company must design their plan to meet IRS qualification requirements. This is accomplished by taking steps such as preventing plan money from being diverted to other company uses and restricting overall contributions to the limits set for that tax year ($20,500 in 2022).
Healthcare and life insurance
Company-supported health, dental, and vision insurance plans typically require deductions depending on the plan chosen by the employee. Employees sometimes opt out of these plans entirely when they already have insurance coverage outside of their employment.
Companies may also offer tax-favored healthcare plans or health savings accounts, which take deductions from gross wages when employees opt into them.
Other optional insurance plans, such as life insurance or short-term disability plans, would also result in deductions from gross wages.
Importance of Understanding Gross Wages
Many employees like to have a sense of what their pay will be before they receive it. It is important for HR professionals to understand how gross wages are calculated and what deductions employees should expect from these wages when they receive their paycheck. This way, HR can help clear any misunderstandings and double-check that employees are being paid appropriately.
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