How to Calculate & Process Retro Pay (+ Free Calculator)

Prior Period Hourly Pay Rate Expected

Prior Period Hourly Pay Rate Paid

Number of Hours Paid Incorrectly

Annual Salary Pay Rate Expected

Annual Salary Pay Rate Paid

Number of Pay Days Per Year

Number of Days Paid Incorrectly

Total Paid for Prior Period

Correct Amount for Prior Period

Retroactive pay, commonly known as retro pay, is compensation owed to an employee for work they’ve already completed but were not correctly paid for at the time. This discrepancy can occur for a variety of reasons such as an increase in wages, a missed bonus, or incorrect hours tracked. This guide walks you through how to calculate retro pay—we even provide a free calculator you can use to make it easy and stress-free.

Our retro pay calculator can quickly compute retroactive pay for hourly employees, salaried employees, and even flat-rate amounts. Keep in mind that the calculator cannot calculate payroll with the impact of overtime in prior pay periods.

Calculating Retro Pay for Hourly & Salaried Employees

If you need to calculate retro pay while doing payroll, you need to first ask a few questions. These include:

How long was the employee paid incorrectly?
What rate were they paid during that time?
Is the employee hourly or salaried? (So that you know which pay rate to use.)
Is the employee exempt from overtime, or do overtime hours have to be considered?
Does the retroactive pay affect only one pay period or more? Will you need to fix payroll accounting on the back end?
Was the retroactive pay caused by missed hours, which may affect overtime calculations and need to be paid at overtime rates, or was there a discrepancy only in the pay rate itself?

Here are two simple methods for calculating retroactive pay:

Calculating Retro Pay for Hourly Employees
Calculating Retro Pay for Salaried Employees

Establish the correct hourly rate. Determine the correct hourly wage that should have been paid to the employee during the specific pay period.
Identify the incorrect hourly rate. Find out what hourly rate was actually paid to the employee during the same pay period.
Calculate the difference. Subtract the incorrect hourly rate from the correct one. This gives you the amount that was underpaid per hour.
Determine the number of hours worked. Identify the total number of hours worked by the employee during the pay period in question.
Multiply the difference by hours worked. Multiply the amount that was underpaid per hour (step 3) by the total number of hours worked (step 4). The result is the total retroactive pay due to the employee.

Establish the correct salary. Determine the correct salary that should have been paid to the employee for the specific pay period. Make sure you’re taking into consideration the pay frequency for your salaried employees (monthly, twice monthly, every two weeks, or weekly).
Identify the incorrect salary. Find out what salary was actually paid to the employee during the same period.
Calculate the difference. Subtract the incorrect salary from the correct one. This gives you the amount that was underpaid.
Determine the number of pay periods. Identify the total number of pay periods during the period in question, as referenced in step 1.
Divide the difference by the pay periods. Divide the amount that was underpaid (step 3) by the total number of pay periods (step 4). The result is the total retroactive pay due to the employee for the pay period.

Processing Retro Pay

The best practice to manage payroll payment errors like retroactive pay is to process a separate off-cycle payroll run using software like Gusto. It is a highly robust payroll software that can ensure you calculate your employee’s pay correctly. Learn more about it in our Gusto review. Otherwise, you can calculate the amount manually. The ultimate goal is to pay the employee as soon as you realize the error.

Retro pay is taxable, whether paid as a lump sum or added to the next payroll in your existing payroll software. Regardless, you’ll need to make sure you deduct the correct payroll taxes from the retroactive payment.

Processing a special payroll run costs extra with providers that charge a fee for each payroll generated (this is not the case with Gusto). In most states, it’s acceptable to wait and add the additional amount to the employee’s check during the next pay cycle. Keep in mind, however, that if overtime is involved in the pay period in which the mistake was made, you’ll need to adjust for overtime hours and/or use an overtime pay rate when calculating retroactive pay.

Retroactive Pay Laws

Once your company establishes a pay cycle, you should pay employees consistently. When it comes to retroactive pay, you’ll need to pay attention to your state’s labor laws to ensure that you remain in payroll compliance. If an employee is terminated, your state may require you to submit retroactive pay immediately. And, in cases when the error resulted in an overpay, you may not be allowed to correct it.

Paying an employee less than what they’re owed can lead to a variety of legal consequences, including lawsuits. Underpaying an employee can result in the employee suing the company for back pay if the issue is not promptly resolved. Underpayment can also result in government fines and penalties.

Besides these issues, underpaying employees can also lead to distress and inconvenience to employees. If the issue occurs more than once—especially if it becomes routine—then it can lead to a drop in employee morale and an increase in employee turnover.

If you spot an underpayment or an employee brings an underpayment to your attention, it’s vital that you act swiftly and keep the employee informed of the actions you’re taking. Transparency here is key.

Payroll Rules Regarding Retro Pay

There are no federal laws governing how often employees must be paid specifically—only that the schedule should be regular and predictable. Many states do however have specific requirements.

Take note of state guidelines regarding labor laws, like minimum wage, the frequency and length of pay periods, records retention, and whether or not a paycheck must be provided immediately upon termination. Similar to regular pay, retroactive pay needs to be paid as soon as possible to ensure federal and state labor law compliance. In most states, this means cutting the employee a separate check or including the retro pay due in the very next pay period.

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Regular Pay vs Retro Pay vs Back Pay

It’s easy to confuse regular, retro, and back pay as they are all payments made to employees; however, different rules govern when and how you should pay each.

This is the standard compensation that employees receive in exchange for the services they provide during a regular pay period. It is often based on an hourly wage or a set salary and is the most common form of employee compensation.

As we’ve noted, this is compensation owed to an employee for work done in a previous pay period at a higher rate than was initially paid. It typically occurs when an employee receives a pay increase, but the increase takes effect from a past date.

For example, if an employee gets a raise starting from the first of the month, but the payroll for that month has already been processed, the employer would owe retro pay for the difference between the old and new wage rates for the days worked in that month.

This is paying someone for time worked in the past that was never paid in the first place. It’s often associated with the resolution of a dispute or legal judgment.

Situations When Retro Pay Might Be Needed

There are common situations when retro pay might occur in a small business, though it’s usually an accident that typically happens as a data entry or communications error. For example, incorrect information is entered on the time card.

Here are some more examples of situations in which you may need to calculate retroactive pay:

Pay Raises: An employee received a pay raise of $1.15 an hour by the owner, but the owner forgot to inform the payroll department; payroll runs the employee’s last paycheck using the old pay rate to calculate earnings. The employee will need the difference paid as retro pay for the 40 hours in the prior period back to the date the raise should have taken effect.

$1.15 per hour x 40 hours paid at the wrong rate = $46 gross retro pay due

Shift Differentials: An employee typically works as a server, but one shift a week they work as a supervisor with a shift differential of 50 cents extra per hour. The employee was paid for all hours, but eight of those hours were paid using their regular pay rate, not the supervisor pay rate—so their next check has to be adjusted with $4 miscellaneous income added as retro pay:

Eight hours paid incorrectly x 50 cents shift differential = $4 gross retro pay due

Overtime: Suppose an employee is paid $15 per hour. One week, this employee works 50 hours, but his employer mistakenly pays him his regular hourly rate for all 50 hours, instead of paying the overtime rate of 1.5 times the regular rate of pay. The overtime rate for this employee is $22.50 per hour, but the employer has already paid this employee $15 per hour ($150 for 10 hours). In this case, they only need to pay the difference of $75.

($22.50 x 10 hours) – $150 = $75 gross retro pay due

Bonuses: The employee earned a $300 bonus but did not receive it. The bonus can be paid with a separate $300 check as retro pay. You will need to deduct taxes, though you do have the option to gross up the bonus calculation to ensure your employee receives a certain amount after taxes, if you’d prefer.

There’s no retro pay calculation for this because it’s a flat amount.

Other Payroll Calculators

Retro Pay Frequently Asked Questions (FAQs)

Are there any legal obligations related to retro pay?

Yes, employers have legal obligations to correct any underpayments or mistakes in pay, including providing retro pay when necessary. Violations can result in penalties under labor laws, such as the Fair Labor Standards Act (FLSA).

How should retro pay be communicated to employees?

Transparency is key. Employers should clearly communicate the reason for the retro pay, how it was calculated, and when it will be paid. This can be done through a letter, email, or face-to-face meeting.

How should retro pay be recorded in payroll?

Retro pay should be recorded separately in your payroll system to keep clear records. This can help avoid confusion and ensure accurate tax and benefit calculations. Some payroll systems have specific features for recording retro pay.

Is retro pay taxable?

Yes, retro pay is subject to the same federal, state, and local income taxes as regular pay. It’s also subject to Social Security, Medicare, and unemployment taxes.

How does retro pay affect overtime calculations?

If an employee’s pay rate is increased retroactively, you’ll need to recalculate overtime pay based on the new rate for any overtime hours worked during the retroactive period.

Bottom Line

Retro pay situations happen, and you must address the problem sooner rather than later. A best practice is to pay the employee with a separate payment as soon as you discover they’ve been paid incorrectly. However, in most states, you’re allowed to wait and add the retro pay amount to the next pay period’s earnings.