Gross income and net income mean different things. The former is the total income you earn each paycheck, while the latter reflects the amount you receive after all deductions and taxes are taken out. Here’s a comprehensive look at gross income vs net income.
What Is Gross vs net income?
The terms themselves are easy to understand, however, depending on the situation, they can have vastly different meanings. You will often see these terms when referencing your personal finances, business finances, or even in your own taxes.
Differentiating between the different types of income is important to understand your personal finances. For budgeting purposes, or just so you better understand the total amount of money that will be a part of your home pay.
Gross income is your total income before deductions are taken out (in business terms this is total revenue.) This means that your gross income is typically the larger amount you see. Since net income is the leftover amount after all federal and state income taxes, as well as other deductions, have been taken out, it is usually the smaller monetary amount.
Thinking of this as a business helps some people to better understand the principles in a simpler fashion. A business like an independent contractor separates out more than just its revenue from its expenses. To calculate net income, they will parse the cost of the goods they sell as well as the cost of goods sold (COGS.) For example, a business has more costs than just the item, there’s a cost to process transactions, rent, advertising, etc. When considering gross vs net income, thinking of costs like the sale of goods will help one to consider their total expenses on their financial statements.
Understanding the numbers on your paycheck
The most common place you tend to see these terms is on your paycheck and pay stubs.
Understanding gross vs net income is important for your long term financial needs and financial success. Also, often applying for a new line of credit, such as when you apply for a credit card, requires access to these numbers.
Gross income
Often called gross pay, your gross income is the total amount you are paid before withholdings and deductions. You may also see this as “adjusted gross income,” which in layman’s terms, simply refers to your taxable income.
Gross pay is equal to the number of hours you have worked multiplied by your hourly pay rate. However, if you are a salaried employee, it may be different.
Yearly gross income is the amount of pay you receive when you add up your gross pay for the year. If you are paid a salary, this is the same as your annual gross income.
Net income
Net income, known as take-home pay or net pay, subtracts your deductions and withholdings from your gross pay. There are many different types of deductions that can be taken from your paycheck for tax purposes in the future. These can include income tax, 401(k) deductions and deductions made due to student loan interest.
This is the actual amount that you directly receive from your company – the amount that will be written on your check or, if you use direct deposit, is the amount deposited into your checking or savings account.
Gross and net income. income tax
Gross income is another term that you will often see when you are filing income taxes. In the realm of taxes, your gross income refers to your total income, however, nontaxable income will not be included in your total income. Your gross income can be found on Form 1040.
In addition to gross income, you may also be aware of a line on your taxes that notes your “net income.” To find this number, you take your taxable income (line 10) and subtract your total tax (line 15).
Gross and net pay regarding businesses
You may also see businesses refer to net and gross income. However, in the business world, these terms are usually stated as “gross profit” and “net profit” instead.
A business’s gross profit is calculated by taking company revenue and subtracting the cost of the goods it sells. Revenue is a term used to describe the amount of income generated from selling goods and services to consumers. Gross income for a business shows how much money a company has after selling its products. It accounts for the cost of goods and shows the amount of money left to pay for any additional company expenses.
Net income, similarly to how it works in personal finances, is different from gross income. Net income, or net profit, is the amount of money left over after accounting for any operating expenses the company has. For a company, net profits will help investors determine if a company is profitable and reflects the effectiveness of company management. This number may also be expressed as a company’s “bottom line.”
The takeaway
As a rule of thumb, your gross income should be larger than your net income. But, remember that these numbers can mean different things depending on the context. Other places you may see these terms are in loan applications to help lenders determine how much debt you will be able to pay back.
The easiest way to keep these numbers straight is to remember the following. Gross income is usually the bigger number, while net income is typically the smaller number.
If you are still experiencing confusion when it comes to your income, or need more information about what number is needed for a certain form, you can always reread any instructions provided or inquire with customer service or a trusted friend for additional help.
