What are scenarios where you need to calculate retro pay?

The following scenarios may necessitate retro pay.

• Pay raises. You give an employee a pay raise but don’t update the pay rate before running payroll.
• Miscalculated wages. You make an error, such as entering the incorrect number of hours worked or the wrong pay rate, when calculating wages.
• Miscalculated overtime earnings. You forget to multiply by 1.5 when calculating an employee’s overtime pay.
• Per diem rates. You failed to include per diem rates when calculating an employee’s compensation.
• Shift differentials. You forget to account for shift differentials when calculating an employee’s wages. Shift differentials refer to the different pay rates for shifts that occur at different times of day, such as night or evening shifts.
• Pay rates that depend on position. You enter incorrect rates when calculating the wages of an employee who works in more than one position at different agreed-upon rates.

How do you calculate retro pay for salaried employees and hourly employees?

You calculate retro pay by subtracting the amount that you paid the employee from the amount that you should have paid the employee. You base the calculations on gross and withhold the taxes afterward.

How to calculate retro pay for salaried employees

Let’s work with an example. You pay your employee $40,000 per year. You give them a $5,000 pay raise, which brings their salary to $45,000 per year. The next pay period, you forget to use the new pay rate when you run payroll. You pay the employee biweekly, so there are 26 pay periods in a year.

The first step is to calculate the employee’s gross pay per period before you gave them the pay raise. The employee earned $1,538.46 per pay period ($40,000/26) before the pay raise. The next step is to calculate the amount you should pay the employee after the raise. The amount should be $1,730 ($45,000/26).

Finally, calculate the retro pay by subtracting the amount you paid the employee from the amount you should pay them. The retro pay amount is $191.54. Now, let’s say you forget to enter the new pay rate in 3 payrolls. In this case, the retro pay amount is $574.62.

Keep in mind that employment taxes apply to retro pay, so the amount your employee will take home is not the amount of gross wages you owe them.

How to calculate retro pay for hourly employees

Let’s use another example. You pay your employee $15 per hour and the frequency of payment is weekly. During one week, your employee worked 48 hours. You paid the employee the regular $15/hour rate for the eight hours of overtime instead of paying the overtime rate.

Start by calculating the gross wages you paid the employee that week. The amount of gross pay the employee earned that week was $720 ($15 × 48). Next, determine the amount of overtime wages that you should have paid the employee. Overtime rates are 1.5 times the normal rate, so the employee’s overtime wage amount is $180 ($15 × 1.5 × 8). Therefore, you should have paid the employee $780 ($15 × 40 + $180).

Finally, subtract the amount you paid the employee ($720) from the amount you should have paid them ($780). You owe the employee $60 in retro pay. Again, keep in mind that employment taxes apply to retro pay.

How should you pay retro pay?

Two methods are available for paying retro pay to an employee. The first method involves adding the retro payment to the regular wages of an employee. The second method involves treating the retro pay as a standalone payment.

Whichever method you prefer, you must make it clear to the employee why you are paying them the retro pay. They need to know you’re paying them for work that they did and that you are not offering additional wages.

For the sake of clarity, include the word “retro” on the employee’s pay stub to ensure the adjustment reflects on the employee’s records. Also important to note is that the tax withholding will be based on your method of paying retro pay.

How do taxes factor into retro pay?

Retro pay is subject to payroll and income taxes. Employers are required to pay their portion of payroll taxes. Withhold the following taxes before you pay retro pay:

• Federal income tax
• Social Security and Medicare (FICA)
• Local income tax (where applicable)
• State income tax (where applicable)

Retro pay is a form of supplement wages, which refers to compensation you give an employee over and above the employee’s regular wages. In a case where you pay retro pay on its own, use the percentage method. Set aside 22% of the retro pay amount to remit for federal income taxes.

Alternatively, you can use the aggregate method, whereby you include the retro pay in the employee’s regular compensation for the next period. When using this method, use the income tax withholding tables to determine the amount to set aside for taxes. You can find the tables in IRS Publication 15. If you use payroll software, these numbers are probably calculated for you.

Be sure to withhold FICA tax. Find out the local and state income taxes on the retro pay amount by consulting your state’s tax authority.