Retroactive (or retro) pay is compensation an employee receives for work they’ve already completed but were not correctly paid for at the time. There are a variety of reasons for the discrepancy, such as an increase in wages, a missed bonus, or incorrect hours tracked. This guide walks you through how to calculate retro pay—we also provided a free calculator for you to use.
The 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. Also, note that retro pay still gets taxed—all calculations in this article compute gross retro pay.
Calculating Retro Pay for Employees
If you need to calculate retro pay while doing payroll, answer a few key questions, such as:
- 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 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 the methods for calculating retroactive pay for non-exempt hourly employees and for salaried employees:
Processing Retro Pay
To process retro pay, you can either:
- Use a payroll software: The best practice to manage payroll payment errors like retroactive pay is to process a separate off-cycle payroll run using software like Gusto to ensure accurate calculation. Learn more about it in our Gusto review.
- Calculate the amount manually: The ultimate goal is to pay the employee as soon as you realize the error.
Regardless of which method you use, retro pay is taxable, so make sure to deduct the correct payroll taxes from the payment.
Retroactive Pay Laws
When it comes to retroactive pay, you’ll need to pay attention to your state’s labor laws to ensure that you remain in compliance with any laws. If an employee is terminated, your state may require you to submit retroactive pay immediately.
In cases when the error resulted in an overpay, you may not be allowed to correct it. However, if you pay an employee less than what they’re owed, it can lead to government fines and penalties or worse, a lawsuit.
Besides these issues, underpaying employees—especially if it becomes routine—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 to act swiftly and keep the employee informed of the actions you’re taking. Transparency is key in sensitive matters like this.
Federal 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.
State Payroll Directory
Click on the map below to see more detailed information on each state law regarding retro pay.
State Payroll Directory
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. Here’s a table to explain their differences:
Regular Pay | Retro Pay | Back Pay | |
|---|---|---|---|
Definition | Standard wages paid for work performed in the current pay period | Wages owed to employees for work completed in a previous pay period typically due to a payroll error. | A legal term, these are wages owed for work already performed but never paid, typically as restitution for the employee. |
Causes/Triggers |
|
|
|
Time Frame | Current pay period only | Specific past period when new rate should have been applied | Any period where wages were unpaid |
Legal Requirements | Must meet minimum wage and overtime laws | Must be calculated at the correct rate for the applicable time period | Required following legal proceedings; may include penalties and interest |
Payment Timing | Regular payroll schedule | Usually paid as soon as the correction is identified | May be paid as lump sum or installments based on agreement or court order |
Tax Implications | Normal payroll taxes in the current period | Taxed based on the year it’s paid, not when it is earned | May have special tax considerations depending on size and nature of payment |
Documentation Needed | Standard payroll records | Requires detailed records showing rate changes and effective dates | Requires extensive documentation of unpaid wages and calculations |
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 from 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.
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:
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.
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. However, this is different if it’s a non-discretionary bonus due during a week with overtime pay.
Other Payroll Calculators
For more calculators to make pay processing easier, check out our articles:
- Gross Pay Calculator
- Overtime Pay Calculator
- FICA Tax Calculator
- FUTA Tax Calculator
- Time Card Calculator
- Employee Mileage Reimbursement Calculator
Retro Pay Frequently Asked Questions (FAQs)
State laws significantly impact how employers must handle retro pay, with variations in timing requirements, documentation needs, and calculation rules. They also differ on retention periods, penalties for late payment, and statutes of limitations, making it essential for employers to understand their specific states’ regulations while processing retro pay.
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.
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.
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.
