Gross vs. net income—what’s the difference?
When it comes to personal finance, you’ve got a lot of numbers to keep track of. But there’s one number that should be obvious: your income. But, wait—are we talking gross income or net income? What’s the difference, really? And are they calculated the same way for everyone?
Read on to learn the difference between gross income and net income, when to use each, and how they’re calculated for employees, businesses, and independent contractors. Trust us: This will help you with your personal budget!
Table of contentsWhat is the difference between gross income and net income?How to calculate gross incomeWhat is adjusted gross income?How to calculate net income
What is the difference between gross income and net income?
For individuals, gross income is your pre-tax income, or the total amount that you are paid before taxes and deductions have been taken out. Net income, also known as take-home pay, is a smaller number: Your net income is the amount of money you make after taxes and deductions have been taken out. Most employees receive their net pay in a paycheck that has taxes deducted from it, while most self-employed people receive gross pay from clients and then must deduct and pay the taxes themselves.
For businesses that sell goods, gross and net income are calculated a little differently. (More on that later.)
How to calculate gross income
You can think of your gross income as the total amount of money that others pay you. If you’re an hourly or salaried employee, not all of this money will make it into your checking account, but your gross income is still a handy number to know. Gross income is the number you’ll use when negotiating a new salary or applying for a loan or credit card.
For salaried employees: If you work for an employer who takes taxes out of each paycheck, you might know your gross income corresponds to your hourly rate or yearly salary. You can find your gross pay in your contract and on your paystubs—it should be the highest number, before taxes and other deductions are taken out of your paycheck. If you have additional sources of income, such as investments, rental income, or a side business, these will all be considered part of your gross income when you file taxes.
For independent contractors: If you’re an individual independent contractor (someone who is hired for their services, but not an employee) you’re considered a “sole proprietor,” or a one-person business, in the eyes of the IRS. Your gross income is probably the number you’re most familiar with: It’s your full rate, or the total amount of money you receive from clients when you invoice. Once you receive payment for your services, it’s your job as an independent contractor to pay taxes on this income. Most independent contractors like to set aside a portion of their gross income for taxes, so they don’t get too comfortable with having their entire gross pay available in a checking account.
For businesses: Gross income can mean different things for businesses, but typically company gross income refers to gross profit. Gross profit is the total revenue generated by sales minus the cost of goods sold. This number doesn’t take into account any other costs associated with running the business, just the cost of the goods. Gross profit can then be used to calculate gross margin, which is gross profit divided by revenue, expressed as a percentage. Gross margin is used to calculate what percentage of the selling price of an item is profit.
What is adjusted gross income?
When filing taxes as an individual, you’ll probably come across a number called adjusted gross income (AGI). AGI is your total taxable income, and it’s usually less than your gross income. Your AGI is your gross income minus deductible expenses, such as student loan interest and some retirement account contributions. You can think of AGI as a step in between your gross income and your net income. AGI usually isn’t used outside of filing taxes, but it’s an important number to know if you’re an independent contractor calculating your own tax payments.
How to calculate net income
As an individual, your net income is the more important number: It’s the amount of money you actually have to spend, once taxes and other deductions are taken out of your pay. Your net income is the number you’ll use to make budgets and plan for financial goals.
For employees: If you’re a salaried or hourly employee, you can use your paystub to find your net income. Your net income is simply your gross income minus federal and state income taxes, FICA taxes (Social Security and Medicare), and any other local taxes you may have to pay. Other deductions might include contributions to an employer-sponsored retirement plan, pension plan, or health insurance. You might see this number labeled “net pay” or “check amount.”
For independent contractors: If you’re self-employed, your paychecks won't have taxes taken out. Instead, you may have to make your own estimated quarterly tax payments, based on your AGI. To calculate your AGI and how much you’ll have to pay in taxes each quarter, fill out form 1040-ES from the IRS website. For the purpose of budgeting, a quick way to roughly estimate your net income is to multiply your gross income by 0.7. If you were an independent contractor last year, you can find your actual net income on your Schedule C tax return form, under “net profit.”
For businesses: Net income for businesses, also known as “the bottom line,” refers to the profit a business has leftover after all expenses have been taken out, including taxes; selling, general, and administrative (SG&A) costs; loan interest; and other operating expenses. You can use net income to calculate net margin, also known as profit margin: net profit divided by revenue, expressed as a percentage. This number is typically used internally as a measure of business health.
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