Retro pay
Summary definition: Wages added to an employee’s paycheck to correct a shortage from a prior pay period.
What is retroactive pay?
Retroactive pay (a.k.a. retro pay) is additional compensation issued after an employee receives insufficient wages on their paycheck for the work they’ve performed. In other words, retro pay is intended to make an employee whole by providing the full compensation they’re owed for their work.
Employers who need to pay an employee retroactively often add the missing difference to the next regular paycheck. However, those wishing to resolve the situation sooner can instead run an off-cycle payroll to issue a retro check.
Key takeaways
- Retro pay is additional compensation given to correct underpaid wages from previous pay periods.
- Retroactive payments are usually caused by payroll errors ranging from missed overtime hours to incorrect or outdated pay rates.
- Other compliance-based aspects for employers to consider include federal and state taxes, labor laws, and documentation practices.
How does retro pay differ from back pay?
The distinction between retro pay vs. back pay centers around the nature and amount of wages that weren’t initially paid. Simply put, retroactive pay fixes an incorrect wage amount, while back pay provides wages that weren’t paid in the first place.
| Retro pay | Back pay | |
|---|---|---|
| Purpose | To correct miscalculations in an employee’s paycheck | To compensate an employee for wages that were never received |
| Amount | The difference between what the employee was paid and what they should’ve been paid | The full amount of wages the employee didn’t receive |
If, for example, an employee’s paycheck is $1,200 when it should be $1,400, their employer owes them $200 in retro pay. Conversely, if the employee didn’t receive a paycheck at all, they’re owed $1,400 in back pay.
How does retro pay work?
Despite its simple purpose, retroactive pay can involve a range of situational nuances that lead to drastically different outcomes. Employers and HR teams should understand the basic mechanisms for retroactive payments.
When to use retroactive payments
A retro payment is most commonly used when an employer needs to correct a payroll error from the prior pay period, such as:
- The employer didn’t include an employee’s supplemental income.
- The employee’s overtime pay was missed.
- The employer forgot to apply the worker’s new salary retroactive to their promotion.
- The system failed to include a shift differential.
How to calculate retroactive pay
The biggest factor in determining retroactive payment amounts is whether the employee is salaried or hourly. With this in mind, the process is straightforward.
- Find the difference between the gross pay the employee received and the gross pay they should’ve received.
- Determine how many pay periods or worked hours the discrepancy affected.
- Multiply the pay difference by the number of impacted pay periods or worked hours.
- Apply all necessary withholdings and deductions to the retro payment amount.
- Add the retroactive payment amount to the employee’s next paycheck or process a standalone retro check.
Payroll software or a retro pay calculator can help reduce manual errors, especially when multiple periods, overtime rates, or deductions are involved.
Are there retroactive payment taxes?
Although it’s used to restore underpaid wages, the IRS still applies taxes to retroactive pay, meaning employers must withhold federal, state, and possibly local taxes from every retro payment.
For that reason, employers who need to determine retro pay amounts should use gross wages rather than net wages in their calculations.
Other retro pay compliance topics
In addition to tax laws, employers should also consider several other compliance requirements when handling retro payments.
| Consideration | Details |
|---|---|
| Timeliness | While it only specifically addresses back pay requirements, the Fair Labor Standards Act (FLSA) requires employers to correct wage errors promptly, often by the next regular payday. Corresponding state and local labor laws may impose stricter standards, making this consideration especially important for multi-state employers. |
| Documentation | To prepare for potential future audits or claims of unfair treatment, employers should keep detailed records documenting the nature of the error, the effective date of the correction, the calculation method, the amount of the retroactive payment, and the date it was paid. |
| Court orders | Failure to provide a corrected payment retroactive to the prior period can sometimes result in (or be added to) legal action against the employer for claims of discrimination, retaliation, breach of contract, overtime violations, or minimum wage noncompliance. |
Retroactive pay example
Employee A earns an annual salary of $50,000 and is paid biweekly (i.e., 26 times a year). Her gross pay for each pay period is $1,923 ($50,000 ÷ 26).
During her recent review, Employee A learned she’s getting a $3,000 annual raise for her performance over the last year. This would increase her gross pay to $2,038 per pay period ($53,000 ÷ 26).
However, during the first pay period after receiving this raise, the accounting team accidentally forgot to include that raise when calculating Employee A’s paycheck. As a result, her gross pay remained $1,923 rather than $2,038.
At the end of the next pay period, Employee A received her normal gross pay ($2,038) as well as $115 in retro pay ($2,038 - $1,923) for a total of $2,153 ($115 + $2,038).
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