Gross Vs. Net Pay

It happens many a time that when a person receives his first salary, after joining a new organization, the amount of salary is much lesser than what was communicated to him, by the human resources department, during the interview. If this has happened to you, you too must have wondered, "why is the amount less than what was promised?". Well, this happens because all companies, when they give an advertisement for a job or when they tell the salary to a new employee, give the gross salary figures or the amount known as the Cost to Company (CTC). So, when the employee actually gets the salary, what he receives is the net salary. The following Buzzle article further brings forth the difference between gross and net pay...

Gross Vs. Net Pay: Difference
A salary or pay is the payment made by the employer to an employee for the services rendered by the latter. It is a mutually acceptable periodic payment which in most cases is mentioned in the employment contract, signed by the two, at the time when the employee joins the organization. A salary can also be paid to an employee on hourly basis. Gross pay is the total salary including the standard deductions which includes bonuses, commissions and all other allowances. For example, if a person before joining an organization is told that his salary would be USD 45,000, then this is his gross pay or salary. Net pay on the other hand is the salary after all the deductions have been made. The deductions include the taxes, social security contributions, health benefits, insurance and sometimes trade union dues. Net pay is the salary in hand. So a person with a gross salary of USD 45,000 may get a net pay of USD 35,000, after all the deductions have been made.

Gross Salary vs Net Salary: Calculation
For understanding gross vs net salary, let's learn how to calculate the net salary. Net salary is also known as the adjusted gross income or AGI. AGI is used to find out the tax bracket of the individual. In order to calculate AGI, a few deductions are made from the gross salary. Deductions made from the gross salary to calculate AGI include health insurance contributions, individual retirement account (IRA) contributions, contributions to simple IRA, contributions to 'Simplified Employee Pension' plan, contributions for any other retirement plans, alimony payments, interest paid on education loan (wherever applicable) and others depending on individual cases. Here is the mathematical formula for calculating net salary or net pay:

Net Pay = Gross Pay - Standard Deductions (tax deductions + social security + state / local taxes)

Some of the deductions are compulsory while others are voluntarily taken up by the employee. According to the law, the employer is supposed to give a copy to the employees at the end of the year, mentioning all the deductions that have been made by the employer in the employee's salary. Income tax is calculated as per the Subtitle A of the Internal Revenue Code of 1986.

Gross Vs Net Income
In business, gross income is calculated as the difference between the total revenue generated and the total cost incurred to generate that revenue. If it's a product that the company manufactures, total cost will include all the costs right from the raw material cost to the manufacturing cost to the marketing cost i.e., all costs incurred till the product is sold in the market. Net income is calculated by subtracting taxes, overheads, payroll and interest payments from the gross income. Net income is the net profit of a business in a particular time period. Read more on gross income vs net income.

Companies, while signing the employment contract, out of gross wages vs net wages, prefer to mention the gross wages or the gross pay. This is because it remains unaffected by the change in laws pertaining to the various deductions used to calculate the net income.