Doing everything correctly when running a small business is a misconception and nearly impossible to follow – all small business owners know it. Along the way to success, there will be mistakes and setbacks. For instance, employee retention and turnover can have a significant financial and emotional effect on your business.

There can be errors in payroll processes. This could happen due to a variety of reasons and can be rectified in a number of ways. One such method is retroactive pay.

What Is Retro Pay?

Talking about what retroactive pay is, these bonuses make up the difference between what an employer should pay an employee and what they do.

Payment owed to an employee for work already completed but paying at a reduced rate is known as retroactive compensation. It’s most often associated with late performance appraisals. These signify that the employee was given a pay raise that took place in a previous pay period.

Let’s say George, one of your employees, works as both a sales representative and a developer. For each of the two jobs, you compensate him differently. As a customer service agent, he earns thirty dollars per hour, and he earns forty dollars per hour as an engineer.

Perhaps you paid for ten hours of developer work using the lower customer service rate, and George’s most recent paycheck stated that he received three hundred dollars. You’ll have to pay him the difference because he should have made four hundred dollars. That a hundred dollars in retroactive pay. This is the pay that George will receive if the employer measures his paycheck correctly.

What Is Back Pay?

Back pay is the difference between an employee’s due compensation and the sum paid. It’s possible that a company owes a worker back pay for hours worked. It could also be due to a wage raise, promotions, or bonuses. Back pay refers to the amount an employer owes an employee if he did not pay them the entire amount earlier.

It is a method for an employer to make up for an unintentional payment error or wage infraction. Back pay is due to salaried employees, hourly employees, freelancers, and contractors alike.

If your employer withholds a part of your salary without your permission, you are eligible for back pay.

If you fire an employee from a job, you will still have to pay them for the hours they worked. The employer must do this no later than the normal payment date for the last pay period worked.

What Is The Distinction Between Retroactive Pay And Back Pay?

Before learning how back pay is calculated, you should first be aware that back wages compensate the employee for the disparity between what the employer should pay them and what they actually do. Unpaid bonuses, missed overtime compensation, or failing to pay an employee in full for the time they worked are examples of this.

The difference between what an employer paid and what they owed is retroactive pay. On the other hand, back pay is payment for work completed in the past but for which the employee received no payment.

Yes, these two phrases can be confusing. A simple way to differentiate between them is:

  • Employers use retroactive compensation to correct a past period’s rate of pay or wage
  • When learning how to track your back pay, you must remember that back pay is used to make up for missed bonuses, missed normal hours, or skipped extra hours

You will owe the retroactive employee compensation if you gave them a raise but failed to record it in the system. You would owe back pay if you failed to pay them in full for a day’s work. 

What Are Some Examples Of Payroll Errors That Necessitate Retroactive Pay?

Compensation shortfalls usually occur when compensation adjustments don’t reflect in the next payroll run. Listed below are the most common situations:

  • Overtime: Not multiplying overtime hours by one and a half is a common mistake
  • Shift Differentials: Paying an extra rate for hours working outside an employee’s regularly scheduled shift, known as shift differentials
  • Commissions: Depending on the accounting system used, a late-paying client can cause funds to be held back for commission payments
  • Pay Raises: Not adjusting an employee’s pay rate after a pay increase

What Is The Correct Method Of Calculating Retroactive Pay?

Fortunately, this isn’t too dissimilar to calculating your regular pay period payments. You’ll need to know the fundamentals, such as:

  • The pay period’s start and end dates
  • How many hours a week did the hourly employee work? 
  • The total sum of money you paid them in the pay period
  • The correct amount that you should have given them

Simply deduct the amount paid from the amount due. You’ll now have the amount you owe in retroactive pay to your employee.


State Laws for Retroactive Pay

The state law governs Retroactive compensation in some cases. Consider the following:

  • Employees of state agencies or institutions of higher education in Texas cannot receive retroactive compensation. This is possible only if they were contractually or legally bound to higher salaries that they were not paying.
  • Employees in California have the right to sue their employers if their salary statements do not contain the exact dates when an employer is paying them. Employers must ensure that they clearly note the payroll dates on the pay statement, whether they’re paying retroactive or back pay. California also does not authorize any public official, employee, or contractor to receive retroactive pay after providing service or completing the contract.

Review your state’s laws and make sure you’re aware of any local regulations. You’ll want to double-check that there aren’t any city or other municipal codes that limit how (or even if) you can issue retroactive pay.

How to Pay Out Retroactive Pay?

If it was a clerical mistake that resulted in less pay or a raise that was supposed to occur in the middle of the pay cycle, all you have to do now is cut a check for the discrepancy. You have the option of issuing a separate check or incorporating it into the employee’s next regularly scheduled payment — the choice is yours.

Once you’ve realized your mistake, there are three options to pay your workers what you owe them.

  • Make a new payroll run- Make sure you clearly label the word “RETRO” on the pay stub so it doesn’t confuse your employee.
  • Include the retroactive compensation in the employee’s next paycheck, and make sure you mark it clearly. Mark the retroactive pay accordingly once more.
  • On the employee’s next paycheck, combine retroactive compensation with normal pay. There is no need to use the RETRO label for this alternative. Do confirm with your payroll provider or accountant whether this choice is available in your state. Many states demand that you give the exact dates of the employee’s pay period too.

How is Backpay Calculated?

Backpay Calculation for Hourly Employees

Let’s say you pay an employee ten dollars per hour and pay them weekly. During one week, the employee worked forty-five hours. You processed their payment at a rate of ten dollars per hour instead of the overtime rate for the five hours of overtime.

To begin, figure out how much you paid the employee in gross wages for the previous week. Let’s assume that you paid the employee a total of four hundred and fifty dollars.

Figure out how much overtime pay you should have given the employee. Multiply their hourly pay rate by one and a half, and multiply by the number of overtime hours worked to get their overtime rate. You owe the employee seventy-five dollars in overtime.

Now add the employee’s overtime and daily pay together to figure out how much you should have paid them during the week. The employee’s daily pay is four hundred dollars. You should have paid the employee a total of four hundred and seventy-five dollars.

Finally, calculate the retro pay by subtracting what you paid the employee from what they should have got. You owe the employee twenty-five dollars in back wages. Remember that the employee’s twenty-five dollars in retro compensation are still subject to payroll taxes.

Backpay Calculation for Salaried Employees

Assume a yearly salary of thirty-five thousand dollars for an employee. You raise their annual salary to forty-two thousand dollars by giving them a seven thousand dollars raise. You forget to run payroll using their new pay rate the next pay period. The employer pays the employee every two months. In a semi-monthly pay cycle, there are twenty-four cycles.

Before the increase, you must first determine the employee’s gross compensation per year.

Next, decide how much you should pay the employee as a result of the raise. Divide their new forty-two thousand dollars annual salary by twenty-four. The semi-monthly salary for the employee could now be one thousand seven hundred and fifty dollars.

Finally, deduct the amount you paid in gross salaries from the amount you should have paid them. Keep in mind that back pay is subject to employment taxes. 

Retroactive Pay And Taxes

When it comes to income tax, things are a bit different with retroactive payments. The IRS refers to retroactive salaries as “supplemental wages”. In other words, it is the money that an employer pays an employee in addition to their regular salary.

You must withhold applicable payroll taxes, like any other form of payment, ranging from state-mandated withholdings to the major ones like Social Security, Medicare, and the like. However, depending on the type of payment system you use, retroactive pay follows a slightly different path when it comes to income tax.

If you use individual checks, the IRS will consider this supplemental compensation or a payment made to workers in addition to their regular wages. Even though retroactive pay might be included in regular payments, the IRS will not see it that way. Consider withholding a fixed amount from the total payment if you go this path.

You’ll use the same tax withholding policies for the entire sum of the check if you roll retroactive pay into an upcoming paycheck, and don’t label any of it as retroactive pay. Suppose you roll it into one payment but mark a part of it as retroactive compensation. In that case, you’ll have to do some calculations to figure out what was already withheld and what needs to be withheld from both the retroactive portion and the “regular” payment portion of the check.

Can a Court Order Retroactive Payment?

In certain cases, an employee will be able to sue their employer in court for back pay. 


  • Discrimination: An inclusive and diverse workspace is one in which everyone feels equally active and respected in all aspects of work, irrespective of who they are or what they do for the business. When an employer pays one group of workers more than another because of their race, gender (violating the Equal Pay Act), age, or other protected status, it results in discrimination.
  • Retaliation: When an employer fires an employee due to whistleblowing or being the victim of harassment.
  • Breach of Contract: When an employer fails to pay an employee or contractor at the agreed-upon rate.
  • Overtime Violations: When an employer fails to account for overtime.
  • Minimum Wage Violations: When an employer pays employees less than the federally-mandated minimum wage. This could be both on the books or under the table.

FAQs on Retroactive Payment 

What does being paid retroactively mean?

Income due to an employee from a former pay period is referred to as retroactive pay. Reasons for retro pay could include erroneous salary payments or earnings for hours worked, or even a pay raise. Whatever the case may be the employer is responsible for ensuring that the appropriate amount of retroactive pay is given to the employee. 

In essence, all compensation dues being cleared means being paid retroactively.

What is disability back pay?

Disability back pay is the sum of money the employer is obligated to give an employee during the time they were disabled. There is sometimes a gap between the beginning of disability and authorization of disability pay. Once the employee receives authorization for benefits, they’ll be able to recover back wages in the form of disability back pay.

Some errors are more costly than others. Without proper care, frequent retroactive payment errors can lead to employee dissatisfaction and noncompliance with US labor laws.