If you are hearing about back pay for the first time, you might be wondering: What is back pay? It is the money that an employer owes an employee for work they completed but were not paid for. It can arise from payroll errors, incorrect pay rates, delayed payments, or other underpayments.
Back pay can also result from a retrospective pay increase or adjustments following issues such as equal-pay reviews or the National Minimum Wage. In some cases, arrears may arise following an employment dispute or legal decision.
This blog explains what back pay is and how it is calculated. It also discusses how managing it correctly is essential for an effective payroll process.
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What Is Back Pay?
Back pay, often referred to as arrears of pay, is money an employer owes an employee because they did not receive the full amount they were entitled to at the correct time.
For instance, an employee may receive backdated pay when a payment increase is agreed and applied retrospectively to an earlier period.
Another example of back pay is a miscalculation that led to workers being paid less than they earned.
Back pay can also arise from legal decisions or certain employment disputes, including cases involving equal-pay claims or unpaid wages.
Handling payroll in-house can be stressful, and that is why it is better to work with professionals who specialise in payroll services for small businesses.
Now that you know “what is back pay”, let’s move forward and discuss its reasons.
What Are the Common Reasons for Back Pay?
Back pay or arrears of pay may arise when an employee does not receive the full amount they are entitled to at the correct time. Some reasons for back pay are:
Delayed or Backdated Pay Rises
A retrospective pay rise may result in backdated pay for an earlier period. Whether the employee is entitled to the higher rate for that period depends on the terms and effective date of the pay award.
Unpaid Overtime
If an employee is entitled to payment for overtime but the payment or hours were incorrectly recorded, the outstanding amount may need to be paid as arrears.
National Minimum Wage Underpayments
If an employer pays a worker less than the applicable National Living Wage or National Minimum Wage, the employer must pay the resulting arrears.
Payroll Errors
Payroll or HR errors can result in an employee receiving less than they were entitled to under their employment terms. Then, the employer may need to calculate and pay the outstanding arrears.
Equal Pay Claims
Arrears can arise when an employee has been underpaid in an equal-pay case or following a relevant legal decision.
Bonuses or Unpaid Commissions
A commission or bonus may result in additional pay when the employee is entitled to it under their employment contract or applicable payment scheme. The timing and entitlement depend on the relevant terms.
Why Back Pay Matters?
Learning the importance of back pay is a part of understanding what is back pay. Back pay helps ensure employees receive the wages they are legally or contractually entitled to when payment has been delayed, or they have been underpaid.
Moreover, it can help correct issues such as payroll errors, National Minimum Wage underpayments, or unpaid overtime, while supporting compliance with UK employment laws.
For example, in 2022/23, HMRC identified around £5.8 million in National Minimum Wage arrears owed to 25,200 workers. This shows the importance of identifying and correcting underpayments.
How Is Back Pay Taxed?
Generally, back pay is treated as employment income and subject to PAYE. The tax treatment depends on when the employee became entitled to the payment, not simply when the money reaches their bank account.
For arrears of pay, the earnings typically relate to the tax year in which the employee was entitled to them. In contrast, backdated pay from a retrospective pay rise is usually taxable when the employee becomes entitled to the additional amount. So, employers must apply the appropriate PAYE rules based on the type of payment.
What Does Back Pay Mean on a Payslip?
Identifying back pay on payslips is an essential part of a transparent and compliant payroll process. Usually, back pay on a payslip appears as a separate payment or adjustment showing the additional amount paid to the employee. The payslip should show the employee’s gross pay and relevant deductions, such as Income Tax and National Insurance (NI).
Remember, back pay is taxable income, so National Insurance Contributions (NICs) and income tax can be deducted where applicable.
How to Calculate Back Pay?
Knowing what is back pay can help you know how to calculate it. Calculating back pay involves:
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Identify the Correct Pay Rate
Start by identifying the correct pay rate. Check the employee’s contract, applicable minimum wage, agreed rate, overtime entitlement, or other relevant terms for the period concerned.
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Calculate the Amount That Should Have Been Paid
Then, multiply the correct hourly rate by the hours worked, or calculate the correct salary or other payment due.
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Deduct the Amount Already Paid
The next step is to subtract the amount the employee actually received to determine the basic back pay owed.
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Check Other Relevant Payments
Last but not least, consider whether overtime, commissions, bonuses, or other contractual payments also need to be included.
For Example
If a worker is entitled to the £12.71 National Living Wage from 1 April 2026 but is paid £11.71 for 100 hours, the basic underpayment would be £100 (£12.71 − £11.71 × 100). Note that the actual calculation may differ where other pay elements or National Minimum Wage rules apply.
Is Back Pay Considered Taxable Income?
Yes, in the UK, back pay is considered taxable income because it is part of the employee’s gross earnings. It is subject to the same statutory deductions as employees’ regular salary.
Pay As You Earn (PAYE)
Deductions for National Insurance (NI) and income tax are usually applied when money is received.
Generally, for arrears of pay, Income Tax relates to the tax year in which the employee was originally entitled to the earnings, while NICs are usually calculated when the arrears are paid.
Pensions
Understanding what is back pay is important for both employees and employers because the pension contributions must be recalculated based on the new total earnings.
Back pay may affect pension contributions where the employee is enrolled in a workplace pension scheme. However, the impact depends on the pension scheme rules and how the payment is treated for pension purposes.
Higher Tax
If you receive a large lump sum of back pay, you may temporarily appear to move into a higher tax band for that pay period. This occurs because the system thinks you have moved into a higher tax bracket. However, it usually balances out over the tax year.
Is Back Pay the Same as a Bonus?
No, a bonus is an additional payment made by an employer, often based on performance, company results, or an agreed arrangement. On the other hand, Back pay relates to unpaid or underpaid earnings or a retrospective pay adjustment.
Here is an example to understand it properly:
A £1,000 performance bonus is an additional reward, while a £1,000 correction of previously underpaid wages may be back pay or arrears. A £1,000 difference resulting from a retrospective salary increase may be backdated pay. The payroll and tax treatment depends on the circumstances of the payment.
Does Back Pay Have National Insurance Contributions?
Back pay can be subject to NICS. Usually, for arrears of pay, HMRC treats the arrears as part of the employee’s earnings in the pay period when they are paid.
For instance, £1,800 in normal monthly earnings plus £1,000 in arrears gives total earnings of £2,800 for that pay period when calculating NICs. The actual NI contributions depend on the applicable thresholds and the employee’s circumstances.
What Are the Best Legal Practices for Back Pay?
While back pay represents a liability for employers, you might also wonder what back pay is in a legal sense, right?
Employers should handle back pay accurately and promptly because employees have legal protections against unauthorised deductions from wages under the Employment Rights Act 1996.
- Keep accurate payroll records, including wage deductions, hours, and relevant employment information.
- Check the employment contract, pay rate, hours worked, and applicable minimum wage rules.
- Calculate the arrears correctly by comparing the amount actually paid with the amount the employee was entitled to receive.
- Pay any confirmed arrears and make the appropriate payroll adjustments.
- Check payroll procedures after an error to reduce the risk of similar underpayments happening again.
You can use suitable payroll software or seek professional payroll support to help maintain accurate records and calculations.
To know more about the top payroll software, read our guide: Best Payroll Software for Small Businesses in the UK.
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The Bottom Line
Understanding what is back pay, how it is calculated, and how it should be handled is essential for both employees and employers. Employers should ensure employees receive the pay they are legally or contractually entitled to and maintain accurate payroll records.
Back pay generally refers to unpaid or underpaid earnings owed to an employee. Employers should pay any wages the employee is legally or contractually entitled to and comply with applicable payroll and tax requirements. Moreover, employees should check for backdated pay or arrears to ensure they are receiving their full entitlement.
Still confused and need help with back pay or payroll? At Micro Entity Accounts, we have the best accountants who can help you calculate back pay correctly and handle the relevant payroll requirements. Contact us now for expert support!
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Disclaimer: The content provided on Micro-Entity Accounts, including our blog and articles, is for general informational purposes only. It does not constitute financial, accounting, or legal advice.
