How to Calculate & Process Retro Pay (+ Free Calculator)
This article is part of a larger series on How to Do Payroll.
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:
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.