Updated: Mar 18, 2020
Have you ever wondered how your payroll is calculated? Your pay stub shows your gross pay, deductions, and your net pay; the smaller amount that goes into your bank account.
Payroll can be very complex and complicated due to the number of rules there are to follow, but I will run through a simple example so you can get the basic idea of how your payroll is calculated. After you read through this, you may want to decipher your own pay stub. Grab a coffee and take some notes, you will find this interesting.
First the employer calculates your gross pay. This is the total of all your earnings from the period. For this example, we need a victim, lets call him Bert. Bert is paid weekly, every Thursday like clockwork. His pay on Thursday consists of the earnings from the previous week, Sunday to Saturday. We are going to calculate Bert’s pay for this Thursday.
Last week Bert worked 8 hours a day from Monday to Friday. Bert has an hourly wage of $28. His gross pay is calculated as 40 hours x $28/hour = $1120. Now that we know his gross pay is $1120, we can begin to calculate his net pay.
There are certain deductions that happen during the payroll process. Canada Pension Plan (CPP), Employment Insurance (EI) and Federal and Provincial income tax. These deductions are then remitted to the Government on your behalf by your employer. We will work through how these deductions are calculated for Bert.
Canada Pension Plan (CPP)
CPP deductions are calculated on the gross pay, but you are allowed to make $3500 annually that you are not required to pay CPP on, this is known as an exemption. We need to calculate what the CPP exemption will be for Bert. Because Bert is paid weekly, he has 52 pay periods a year. So, we simply take the allowable exemption of $3500 and divide it by 52. Here’s the math, $3500 / 52 = $67.30. Bert’s CPP exemption will be $67.30. Just a note, no rounding takes place for this calculation.
We are now able to calculate Bert’s CPP. We will take his gross pay of $1120 and subtract the exemption of $67.30, then multiply it by the 2020 CPP rate of 5.25%. Here’s the math, $1120 -$67.30 x .0525 = $55.27. We now know Bert’s CCP deduction will be $55.27. If you are trying to calculate the CPP on your own pay stub, you will have to keep in mind not all sources of income are pensionable. Bert’s pay is a simple payroll for explanation purposes, his total gross pay is pensionable.
The EI calculation is much simpler. We just need to take Bert’s gross amount and multiply it by the 2020 EI rate of 1.58%. Here’s the math, $1120 x .0158 = $17.70. We now know Bert’s EI deduction will be $17.70. If you are trying to calculate the EI on your own pay stub, you will have to keep in mind not all sources of income are insurable. Bert’s pay is a simple payroll for explanation purposes, his total gross pay is insurable.
We now need to calculate how much tax would be deducted from Bert’s gross pay. There are two sides to income tax; Federal and Provincial. For demonstration purposes we will use the 2020 tax deduction tables for Ontario. Tax deduction tables aren’t used much anymore as most businesses use software to calculate payroll, but this gives you a clear understanding of how tax deductions are derived. We will also assume Bert falls under claim code 1 (based on TD1 completion) for this example.
First, we will calculate the Federal tax. Looking at the tax table, Bert’s gross income falls between $1112 and $1124, based on this, his Federal tax deduction will be $125.35.
Now we will calculate the Provincial Ontario tax. Looking at the tax table, Bert’s gross income falls between $1114 and $1126, based on this, his Provincial tax deduction will be $64.65.
Please visit https://www.canada.ca/content/dam/cra-arc/migration/cra-arc/tx/bsnss/tpcs/pyrll/t4032/2020/t4032-on-1-52pp-20eng.pdf to view the complete tables.
If you are following along with your pay stub and are calculating your own tax deductions, please refer to this link: https://www.canada.ca/en/revenue-agency/services/forms-publications/payroll/t4032-payroll-deductions-tables.html. You will need to select your province and the appropriate tax deduction table based on your payroll frequency (weekly, bi-weekly, semi-monthly and monthly). Due to the intervals in the table, you may produce a different tax amount than what is on your pay stub, so don’t panic if you are off by a few cents.
Bert’s net pay is now easily calculated by taking the gross pay, subtracting the CPP amount, subtracting the EI amount, and then subtracting the Federal and Provincial taxes. Here’s the math, $1120 - $55.27 - $17.70 - $125.35 - $64.65 = $857.03. Based on the calculation, Bert’s Net pay is $857.03. This is the amount that will be deposited into his bank account.
How Expensive Are You?
Now that you understand how your payroll is calculated, have you ever wondered how much you cost the company you work for? Your gross pay is not the total impact you have on the company. There are other associated costs to having employees that come out of the company’s pocket. If you have CPP deducted from your pay, your employer also must match your CPP deduction. Your company pays/remits the same amount of CPP that you have deducted. It doesn’t stop there. Your EI deductions are also matched, but at a greater value. Your employer pays/remits 1.4 times the amount you have deducted for EI.
Let’s review Bert’s pay. Bert’s CPP deduction is $55.27, which means, his employer will also pay/remit the same amount of $55.27. Bert’s EI deduction is $17.70, which means, his employer will pay/remit 1.4 times that amount, totaling $24.78. In conclusion, Bert’s payroll cost his company $1120 in gross pay, plus the additional $72.97 for the employer portion of CPP and EI.
This is a basic explanation as there are also several other expenses that a company incurs on your behalf, such as, accrued vacation pay, health benefits, workplace safety, and health taxes depending on the province you work in.
You now know how Bert’s pay is calculated, and how much it cost his company. I encourage you to review your pay stub and understand how you are being paid. Also keep an eye open for errors. Payroll is complicated and often involves several people or departments relaying information back and forth. Sometimes something might get missed and it is always best to catch it early. The only other advice I have is this, when in doubt, ask. Your payroll person or department should always be able to explain your payroll to you.
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