Gross Vs. Net Pay: Important to Know the Major Differences

Gross Vs. Net Pay
A student fresh out of college appears for a job interview and in due course comes across terms such as gross pay, net pay and cost to company.
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 an hourly basis too. It occurs many a time that on joining an organization a new employee is confused regarding the pay promised to him. Is it gross pay, or cost to company (CTC), or net pay?
Difference between Gross and Net Pay
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 $45,000, then this is his gross pay. 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.
For understanding gross and net salary, let's learn 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 employee at the end of each 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.

Companies, while signing the employment contract, 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.