Retroactive pay (retro pay) is a payment made to an employee to make up the difference between what was paid and what should’ve been. It can occur when salary is increased in the middle of the pay cycle or a bonus was earned in the prior pay period.
You can use our simple calculator below to quickly calculate retroactive pay for hourly employees, salaried employees, and even for flat rate amounts. Keep in mind that the calculator cannot calculate payroll with the impact of overtime in prior pay periods.
Disclaimer: Fit Small Business does not provide legal or tax advice. Be sure to confirm your retro pay calculations with your payroll provider or tax consultant.
Retro Pay Calculator
Retro Pay Calculations
Here are two simple ways to calculate retroactive pay:
To determine retro pay for an hourly employee, you’ll need to know how many hours were paid at the wrong rate so that you can determine the correct rate to pay. You’ll multiply the differential rate by the hours paid incorrectly to calculate the gross retroactive pay amount. Taxes should be deducted from the gross amount to determine the net amount the employee should receive.
Calculating retroactive pay for salaried staff is a little more difficult than calculating for hourly workers. You’ll need to know the difference between the annual salary the employee was paid and the salary that should have been. In addition, you should be able to verify the number of payroll days in the year (this is the number of days worked—making sure to deduct any holidays, weekends, and days off).
If you need to calculate retro pay while doing payroll, you need to first ask a few questions. For example, how long the employee was paid incorrectly, the pay rate they were paid for the time frame in question, and the rate of pay they should’ve received for the work.
Other questions to ask are:
- 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?
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 or to 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 some providers (unlike Gusto) that charge a fee for each payroll generated. 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.
Payroll Rules Regarding Retro Pay
The Department of Labor (DOL) Wage and Hour Division states that employees must be paid each pay period and no later than 12 days from the end of the pay period.
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 paying them the retro pay due on the very next pay period.
It’s important to know what the laws are for your specific state before issuing payments outside of your regular pay schedule to ensure that you are staying compliant. For more help, check out our comprehensive guide to running payroll in your state. (If your state is missing, then check back as we release new state guides weekly.)
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.
Retroactive pay isn’t the same as back pay, although some people mistakenly use the terms interchangeably. To reiterate, retroactive pay is the difference between what was supposed to be paid and what was paid. Back pay is paying someone for time worked in the past that was never paid in the first place.
Back pay is typically court-ordered, subject to damages (which doubles the amount of back pay due), and less common. Similar to regular pay, it’s a simple calculation of the number of hours worked multiplied by the pay rate. Retro pay, however, is the number of hours worked multiplied by the difference between what was paid and what should’ve been.
Regular pay is the wage you pay your employees per pay period, typically based on an annual salary (salary/number of pay periods) or hourly rate (hours worked x pay rate). Retroactive pay is the difference between the regular pay you should’ve disbursed and the regular pay you disbursed.
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 or a raise is given but not communicated to the person running payroll.
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 shift differential = $4 gross retro pay due
Overtime: An employee whose regular pay rate is $18 an hour worked 43 hours last week, but work time was added to the payroll as 40 hours. The additional three hours of retro pay not only need to be paid but paid at 1.5 times the regular pay rate as they are calculated as overtime in the prior pay period.
$18 regular pay rate x 1.5 overtime rate = $27 overtime pay rate
$27 overtime pay rate x three hours paid incorrectly = $81 gross retro pay due
Bonuses: The employee earned a $300 bonus but did not receive the bonus on the pay period. 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.
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 onto the next pay period’s earnings.
The best way to avoid retro pay issues is to use software like Gusto, a full-service payroll system that helps you calculate and pay your employees—plus payroll taxes. It also has a simple time tracking system you can use to ensure employee work hours are accurate, which helps to prevent the need for retro pay. It can handle retro pay and any taxes you need to pay on it. Sign up for a free trial.