Even the most well-managed payroll departments can occasionally encounter delays. Whether it's because of shift miscalculations or late raise approvals, there are circumstances where employees might not get the compensation they've rightfully earned.
In these situations, HR and payroll rely on retroactive pay to address wage discrepancies and maintain accountability. This not only supports compliance with labor standards, but also helps preserve employee confidence and promote transparency.
Here’s a guide on what retroactive pay is, when it’s used, and how to calculate it accurately to maintain fair compensation.
What is retro pay?
Often abbreviated as "retro pay," retroactive pay is any compensation owed to an employee for work already performed that wasn't included in their most recent paycheck. It serves to correct discrepancies between what an employee was paid and what they were actually entitled to receive.
There are many reasons why an employee's compensation doesn't include all of their earnings. A few common scenarios include delayed raises, overlooked bonuses, or miscalculations during payroll processing. These situations trigger the need for retroactive pay, and each has nuances in calculating the amount owed.
How does retro pay work, and how do you calculate it?
Since retro pay usually aims to fix an error, it’s essential that calculations are accurate. Here’s how:
1. Identify the rate difference
When a pay discrepancy is identified, the first step is to determine the exact difference between what the employee was paid and what they should have received. While these calculations vary depending on the specific circumstances, they generally involve comparing hourly rates before and after a raise or correcting a salary bonus amount.
As a hypothetical example, assume an hourly employee was paid $18/hour but they got a raise and their new rate is actually $20/hour. If their paycheck wasn’t updated to reflect this new rate, they would be underpaid $2 for every hour worked during the affected period.
2. Multiply by the number of affected hours or pay periods
After identifying the pay difference, multiply the pay rate difference by the number of hours worked or the number of affected pay periods. For instance, with the hourly employee mentioned above, determine the hours worked over the four weeks and multiply by the pay gap. If the total for this employee was 160 hours over this period, the retro pay owed would be $320 (or $2 x 160).
3. Apply any necessary overtime corrections
If the employee worked overtime during the affected period, then the retro pay calculations have to include adjustments based on applicable overtime laws. While these policies vary depending on a company's jurisdiction, they're set at time-and-a-half over 40 hours per week under the
Fair Labor Standards Act (FLSA).
As an example, suppose an employee worked 10 overtime hours during an affected pay period and the quoted overtime pay was $30/hour (which includes time-and-a-half). Instead, this employee received overtime at their current rate of $27 per hour (also including time-and-a-half). So, the difference between the two pay amounts is $3, and the total retro pay is $30 (or $3 x 10).
4. Document the calculation thoroughly
Incorrect retro payments can affect employee trust, so it's important to do the calculations a few times and make sure all calculations are correct. Double checking the work is especially important in multi-jurisdictional payrolls with potentially conflicting laws on minimum wage, overtime, and wage corrections.
During this final stage, attach supporting documents like audit reports or revised wage agreements to the employee's payroll file for transparency and sound recordkeeping.
Is retroactive pay taxable? Retroactive pay laws
Retroactive pay is a form of taxable income subject to the same treatment as regular wages. However, since retro pay gets processed outside the regular payroll schedule, it falls under supplemental wages.
In these cases, federal and state tax withholding depends on the amount of the payment and the employer's payroll system. There are two methods for withholding taxes on supplemental wages:
Flat-rate method. Often used for larger supplemental payments, this method uses a flat percentage for withholding (As of 2025,
this is 22% for federal income tax up to the latest threshold). The benefit of using the flat-rate option is that it simplifies withholding calculations, but it may result in over- or under-withholding depending on the employee's annual income.
Aggregate method. Alternatively, employers who use the aggregate method combine retroactive pay with the employee's regular wages for the current payroll period. Taxes are then withheld from the combined amount as a single payment using the employee's W-4 information. While the aggregate method is more accurate for aligning withholding with an employee's actual tax liability, it may push the employee into a higher tax bracket.
Beyond withholding retro pay for the federal income tax, employers must consider other factors to maintain compliance and avoid penalties. Here are a few:
Social Security and Medicare (FICA) taxes: Both the taxes for Social Security and Medicare have standard rates for withholding (
6.2% for Social Security up to the annual wage base and
1.45% for Medicare, with an additional Medicare tax for high earners).
Federal Unemployment Tax Act (FUTA) and State Unemployment Tax Act (SUTA). Like regular wages, retroactive pay is subject to
FUTA and
SUTA taxes up to the annual wage base limits for each. These are employer-paid taxes that fund unemployment benefits.
State and local income taxes: Some states and municipalities have unique rules on supplemental wages. If this is the case, employers have to understand and abide by these policies when withholding retro pay for taxation. Always review state and local income tax requirements in your area to ensure accurate and compliant payroll processing.
What is back pay? Retro pay versus back pay
The function of back pay is similar to retroactive pay, but there are sharp distinctions between these classifications. The core difference between retroactive pay and back pay lies in why the money is owed.
With retro pay, the employee received a payment but was underpaid. Back pay happens when an employee wasn't paid at all for work they performed due to an employer's unlawful action (e.g., wrongful termination).
| Retroactive Pay | Back Pay |
Definition | Compensation for a past period where an employee was underpaid | Compensation for wages an employee should have earned but did not receive at all |
Reason | Correction of an underpayment to an employee due to internal payroll issues, delayed raises, or structural changes | Remedial payment for wages lost due to an employer's unlawful action or omission, often stemming from a legal judgment, settlement, or government agency ruling |
Timing | Work was already completed and paid, but at the wrong rate | Work was completed but not paid at all |
Cause | Typically a payroll administration issue like an oversight or delayed implementation of a valid pay change | Usually a legal or compliance issue, sometimes involving wage and hour disputes or wrongful termination cases |
Resolution | Resolved internally by the employer through a payroll adjustment, often initiated by the payroll department or HR | |
Taxes | Primarily governed by general wage and hour laws regarding timely and accurate payment of wages | Heavily influenced by specific labor laws, anti-discrimination statutes, and court precedents related to unlawful employment practices |
Since each of these compensation types uses different regulatory frameworks, they have significantly different implications from a compliance standpoint. While retro pay typically involves a simple payroll adjustment, back pay usually involves legal disputes and potentially court-ordered settlements or actions from the Department of Labor.
If employers aren't careful when making this distinction, misclassifying retroactive and back pay could trigger fines or penalties. Clearly defining these terms makes for accurate tracking and timely resolutions, maintaining transparency and consistency throughout payroll operations.
Support financial flexibility with EarnIn
Retroactive pay is a necessary tool for correcting compensation errors, but HR and payroll should strive to use it sparingly. Consistency in payroll accuracy is what fosters lasting employee trust and minimizes financial stress across the workforce.
With more employees living
paycheck to paycheck, even minor payroll delays can have a significant impact on their
financial wellness. But even when payroll is accurate and on time, employers have a unique opportunity to support employee well-being through proactive financial wellness benefits.
EarnIn is one solution. With no payroll or HRIS integration required, EarnIn offers a suite of tools that empower employees with greater financial flexibility. Using
on-demand pay,
employees can access up to $150 per day, with a max of $750 between paydays
— and get paid in minutes, starting at just $3.99 or in 1-3 business days at no cost. Employees also have access to other tools, including free
Credit Monitoring and
Balance Shield,
which helps protect against overdraft fees.
Book an
EarnIn demo today and strengthen your employees’ financial positioning by giving them the flexibility to access their pay as they work.
Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.
This Blog was sponsored by EarnIn. While the author received compensation, the information shared is grounded in independent research and intended to provide helpful and accurate guidance to readers.
EarnIn is a financial technology company not a bank.Banking services are provided by our bank partners on certain products other than Cash Out.
Lightning Speed is an optional service that allows you to expedite the transfer of funds for a fee. Depending on the product, the fee may be charged by EarnIn or its banking partner. Lightning Speed is not available in all states. Restrictions and terms apply. See the
Lightning Speed Fee Table and
Cash Out User Agreement for details.
A pay period is the time between your paychecks, such as weekly, biweekly, or monthly. EarnIn determines your daily and pay period limits (“Daily Max” and “Pay Period Max”) based on your income and financial risk factors as outlined in the Cash Out Maxes section of our Cash Out User Agreement. EarnIn reserves the right to adjust the Daily Max and Pay Period Max at its discretion. Your actual Daily Max will be displayed in your EarnIn account before each Cash Out. EarnIn does not charge interest on Cash Outs or mandatory fees for standard transfers, which usually take 1–2 business days. For faster transfers, you can choose the Lightning Speed option and pay a fee to receive funds within 30 minutes. Lightning Speed is not available in all states. Restrictions and terms apply; see the
Lightning Speed Fee Table and
Cash Out User Agreement for details and eligibility requirements. Tips are optional and do not affect the quality or availability of services.
Calculated on the VantageScore® 3.0 model. Your VantageScore 3.0 from Experian® indicates your credit risk level and is not used by all lenders, so don’t be surprised if your lender uses a score that’s different from your VantageScore 3.0.
Learn more.
Balance Shield provides free alerts when your bank account balance drops below the threshold you set in your EarnIn account. You can also enable automatic transfers (up to $100/day -subject to your available earnings- with a limit of $750/pay period), if your bank account balance falls below your set threshold. You choose the speed of these automatic transfers. Standard speed is available at no cost and the transfer typically takes 1-2 business days. Lightning Speed is available for a fee [see LS Fee Table] and the transfer typically takes less than 30 minutes. You will also have the option to set a tip for automatic transfers. Tips are optional and can be $0; however, if you choose to set a tip, it will be applied to each automatic transfer. Whether you tip, how much, and how often you tip does not impact the quality and availability of services. You can cancel the alerts and/or transfers at any time in your EarnIn account settings. See the
Cash Out User Agreement for more details. While Balance Shield can help you avoid overdrafts, it does not guarantee protection from third-party fees, and its effectiveness depends on your usage and bank activity.
