How to manage retro pay and backdating

If you owe pay to an employee due to a miscalculation, an overlooked salary increase, or another reason, you need to issue them a retroactive payment right away.

However, if you have team members in different countries, the rules around retro pay and back pay may be different. Therefore, you should know how to manage this process in every location you hire in.

In this article, we’ll cover retro pay and back pay, and explain how you can minimize mistakes to ensure you’re paying everyone accurately and on time.

So let’s jump straight in.

Retro pay vs back pay

Retro pay and back pay are both issued in instances of payroll discrepancies. However, there are some differences between the two.

What is retro pay?

Retro (or retroactive) pay is money you owe an employee for work they completed during a previous payroll period — but weren’t correctly paid for at the time. Retro pay makes up for the difference between what you should have paid, and the actual payment they received.

You might have to issue retro pay for:

• Errors in payroll

• Missed commissions and bonuses

• Forgotten salary raises

• Miscalculations

It’s important to note that retro pay may be calculated differently depending on whether your employee is salaried, or has an hourly rate.

What is back pay?

Back (or backdated) pay is the payment of wages or salary owed to an employee for previous unpaid work. It differs from retro pay in that it is the money owed to an employee for a missed payment.

You might be required to issue back pay for:

• Payroll processing delays

• Unpaid wages such as bonuses or commissions

• Missed hours and overtime wages

In most cases, the standard practice for determining back pay is to use the employee’s regular rate for the relevant pay period. 

How to calculate retro pay and back pay

Payroll calculations for retro pay and back pay rely on several variables. Retro pay calculation for salaried and hourly employees differs slightly, and you’ll need to determine the length of time that the disparity existed. 

Legal guidelines dictating pay periods can also impact your calculations in certain situations.

Calculating retro pay

For salaried employees: First, calculate the portion of the worker’s salary you should have paid them. Then, determine the incorrect pay rate. Find the difference between the new and old salaries, then divide that amount by the number of pay periods. The resulting figure will be the amount to be paid retroactively.

For example, suppose your employee received a pay raise from $74,000 to $85,000. The difference between these two amounts is $11,000. Assuming the employee is paid monthly, divide $11,000 by 12 pay periods. You will owe $917 in retroactive wages for each month you missed paying your employee.

For hourly employees: First, determine the agreed-upon rate you should have paid the employee for the specified payroll period. Next, note the difference between the incorrect hourly rate and the correct one. Then, evaluate the number of hours worked and multiply that by the hourly rate difference.

For example, let’s say you’ve decided to ramp up your employee’s hourly rate from $15 to $20, but failed to reflect this raise in previous pay periods. The difference between the two rates is $5. So, if your employee worked for 40 hours within that pay period, the amount owed as retro pay would be $200 (i.e., $5 x 40).

How to calculate back pay

Determining back pay is more straightforward. For example, say your employee qualified for a bonus of $500 last month, but you forgot to add it to their payroll. Simply add the value of the bonus to their next payroll (you may also want to issue an apology if the employee was expecting the bonus).

You can issue retro and back pay on separate checks, or incorporate them into your employee’s next paycheck.

Also, keep in mind that supplemental wages are extra income that employees receive on top of their regular pay. Thus, in most cases, retro pay and back pay are considered supplemental wages for tax purposes.

Tax withholding for retro pay and backdating

In many locations, there are different rules for withholding taxes from supplemental wages because, as mentioned, they are not considered regular wages.

In the US, for instance, you will still need to withhold federal income taxes, Medicare, and Social Security (FICA taxes), as well as state and local income taxes. However, your method of paying the employee back will affect how much income tax you need to withhold.

In Australia, as per federal tax rules, back pay may be taxed since it is part of an employee’s income. The amount that is taxed depends on when the money is received. If you pay out a lump sum of money outside of the year it was due, you may be able to use the Delayed Income Tax Offset to help lower your tax liabilities.

In Canada, meanwhile, retro pay increases attract employment insurance (EI) premiums, income tax, and Canada Pension Plan (CPP) contributions. However, you are not obligated to withhold CPP contributions from an employee's paycheck if you have already deducted the annual maximum.

If you have employees in different countries, it’s highly advisable to consult with a local tax advisor — or work with a global HR partner, like Remote. We can calculate and manage payroll, deductions, and tax withholding for you, ensuring that you’re fully compliant and accurate wherever you hire.

To learn more, speak to one of our friendly payroll experts today.

Retro pay and backdating best practices

If you do make payroll mistakes, here are some best practices to follow to ensure the impact on both you and your employees is minimized.

Keep accurate data

Maintain a detailed record of all corrections and adjustments made to an employee’s salary, including the rationale behind the change and if any retro pay or backdating was issued.

Double-check calculations

Double-check your calculations. Automated payroll systems can simplify this and significantly improve the accuracy of your payroll processing. Automation can also help ensure compliance with any applicable local tax regulations that govern payroll processing.

Resolve issues quickly

Once a payroll error occurs and you need to issue back pay or retro pay, your company needs to address the issue promptly. Not taking action may result in dissatisfaction among your affected team members, or even potentially costly legal issues.

Communicate regularly

Be transparent and communicate any adjustments made to your employees’ pay rates. Be quick to address any issues, and reassure them that they are being fixed as a priority. Nobody likes to be paid incorrectly, but open and honest communication can salvage trust and foster a more positive relationship in the long run.

Minimize payroll errors with Remote

While most payroll errors are unintentional, they do happen occasionally. The best way to quickly solve them — and to minimize them altogether — is to use an automated, centralized payroll automation system like Remote.

Our platform provides a single source of truth for all your employee and payroll data, making it simple to find records, make the correct calculations, and ensure that everything is handled in full accordance with the relevant tax withholding laws. 

To learn how we can simplify and streamline your entire payroll process — wherever your team members are based — speak to one of our friendly experts or book a demo today!

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