Payroll: from gross to net pay

Payroll is the business calculation that most people meet first: the check or deposit that arrives every pay period. For an employer, payroll is also one of the largest costs and one of the most regulated. Amounts must be withheld correctly, sent to the government on time and reported at year end, and mistakes bring penalties and interest. This lesson works through the arithmetic of a pay period, from the hours or salary that make up gross pay to the deductions that leave net pay, and then looks at what the employer pays on top.

Payroll rules in the United States come from three levels: federal law for Social Security, Medicare and federal income tax withholding, plus the Fair Labor Standards Act (FLSA) for minimum wage and overtime; state law for state income tax, state unemployment insurance and often a higher minimum wage; and sometimes city or county law for local income taxes. The figures in this lesson are the 2026 rates at the time of writing (October 2026). They change every January, so always check the current IRS Publication 15 and 15-T and your state's tables before running a real payroll.

Gross pay

Gross pay is what an employee earns before anything is taken off. It is calculated in one of several ways, depending on how the employee is paid.

The number of pay periods matters. Weekly pay gives 52 periods a year, biweekly (every two weeks) gives 26, semi-monthly (twice a month) gives 24 and monthly gives 12. Biweekly and semi-monthly are easy to confuse: a biweekly payroll occasionally has 27 pay dates in a calendar year, while semi-monthly always has exactly 24. To convert an hourly wage to an annual equivalent, a common assumption is 2,080 hours (40 hours × 52 weeks).

Overtime

In the United States, the Fair Labor Standards Act requires overtime of at least one and a half times the regular rate for hours over 40 in a workweek for non-exempt employees. Some states go further: California, for example, requires overtime after 8 hours in a day and double time after 12 hours in a day. Salaried employees can be exempt from overtime if they meet the duties tests and earn above a salary threshold; the thresholds have been the subject of rule changes and court decisions, so check the current federal and state levels. When federal and state rules differ, the rule that is better for the employee applies.

Statutory deductions

US employers must withhold federal income tax and FICA taxes (Social Security and Medicare) from most employees' pay, together with state income tax in the states that have one and local income tax in the cities and counties that levy it. A few states also require employee contributions to state disability or paid family leave programs.

Social Security is withheld at 6.2 % of every dollar of wages until the employee's year-to-date wages reach the wage base of $184,500; after that, Social Security withholding stops for the year. Medicare has no ceiling, and an extra 0.9 % is withheld on wages above $200,000. Higher earners therefore see their take-home pay rise late in the year once the wage base is passed.

Income tax withholding

Federal income tax is progressive: each rate applies only to the slice of taxable income within its bracket. For 2026, the rates for a single filer are 10 % on taxable income up to $12,400, 12 % up to $50,400, 22 % up to $105,700, 24 % up to $201,775, 32 % up to $256,225, 35 % up to $640,600 and 37 % above that. The standard deduction for a single filer is $16,100. Employers calculate withholding from the employee's Form W-4 using the wage bracket or percentage method tables in IRS Publication 15-T.

A useful approximation of the IRS method is to annualize: multiply the period's gross by the number of periods, subtract the standard deduction, apply the brackets and divide back by the number of periods. The official percentage method uses adjusted annual wages and slightly different table figures, so actual withholding will differ by a few dollars, but the approximation shows how withholding is built.

# Simplified biweekly payroll, 2026 rates (illustration only)
def brackets(income, table):
    tax, lower = 0.0, 0.0
    for upper, rate in table:
        if income > lower:
            tax += (min(income, upper) - lower) * rate
        lower = upper
    return tax

gross, periods = 2400.00, 26
annual = gross * periods
# Canada (Ontario)
cpp = round((gross - 3500 / periods) * 0.0595, 2)
ei = round(gross * 0.0163, 2)
fed = brackets(annual, [(58523, .14), (117045, .205), (181440, .26), (258482, .29), (1e12, .33)]) - .14 * 16452
on = brackets(annual, [(53891, .0505), (1e12, .0915)]) - .0505 * 12989 + 750
ca = [cpp, ei, round(fed / periods, 2), round(on / periods, 2)]
print("Canada (ON):", ca, "net", round(gross - sum(ca), 2))
# United States (Pennsylvania)
fit = brackets(annual - 16100, [(12400, .10), (50400, .12), (105700, .22), (1e12, .24)])
us = [round(gross * .062, 2), round(gross * .0145, 2), round(fit / periods, 2), round(gross * .0307, 2)]
print("US (PA):", us, "net", round(gross - sum(us), 2))

Canada (ON): [134.79, 39.12, 257.1, 138.24] net 1830.75
US (PA): [148.8, 34.8, 204.15, 73.68] net 1938.57

Other deductions

Beyond the statutory deductions, an employee's pay may carry voluntary or contractual deductions. Some reduce taxable income, because they are taken before tax is calculated; others are taken after tax.

The employer's cost

The cost of an employee is more than gross pay. US employers match the employee's Social Security and Medicare taxes (the employer does not match the Additional Medicare Tax), pay federal unemployment tax (FUTA) of 6.0 % on the first $7,000 of each employee's wages, usually reduced to 0.6 % by a credit for state unemployment taxes, and pay state unemployment insurance (SUTA) at a rate based on their layoff history. Workers' compensation insurance is required in almost every state. On top of these come benefits such as health insurance, which for many employers is the largest addition.

Remitting and reporting

Withheld amounts are held in trust for the government. Employers deposit federal income tax, Social Security and Medicare, together with their own share, on a monthly or semi-weekly schedule set by the IRS, and report them quarterly on Form 941. At year end the employer issues each employee a Form W-2 and files copies with the Social Security Administration. Independent contractors are not on payroll; payments to them of $2,000 or more in 2026 are reported on Form 1099-NEC. Responsible persons can be held personally liable for unpaid trust fund taxes.