I’m sure your accountant has already asked you for your gross and net income when preparing your tax return, right?
But what is gross income and how does it differ from net income?
Keep reading for everything you need to know about gross income and how it applies to you.
What is gross income?
For individuals, your gross income is the total amount of earned income you can find on your paycheck before taxes and deductions are taken.
It takes into account all sources of income from your salary, rental income, interest income and even dividend profits.
Companies calculate gross income slightly differently. Their gross income is also referred to as gross profit, the income they earn from selling their product or service minus the actual cost of those products sold.
Related: These 11 US States Reduce Personal Income Tax | Entrepreneur
How is gross income calculated?
Now that you know what gross income is, how do you calculate it?
You may need to calculate your total gross income to acquire a loan from the bank to satisfy the lender.
Your potential landlord may require it to ensure you can pay the rent.
You can even apply for a credit card, and they need your gross income amount before approving your application.
Keep reading to learn how individuals and businesses can calculate their gross income.
Related: How to Calculate Gross Profit: Formula and Examples | Entrepreneur
Calculation of gross personal income
Since personal gross pay includes many forms of employment income, rental income, interest, and dividends, these must be taken into account when calculating your gross income.
Example:
If Alex earns an annual income of $100,000 a year at his office job and he also earns $70,000 in rental income from real estate he owns, $10,000 in dividend profits and $5,000 into interest income on his savings account, his calculation would be as follows:
Gross income = $100,000 + $70,000 + $10,000 + $5,000 = $185,000
Calculation of gross business income
A company’s gross profit is shown in the company’s income statement.
This is the company’s annual gross margin before deducting overhead, interest and taxes.
This calculation represents business income from the sale of goods or services after deducting any tax deductions for direct costs incurred by the business.
Examples of direct costs may include:
- Employee labor costs.
- Material used in the production phase.
- The cost of supplies.
- The cost of raw materials.
- All shipping charges required.
Example:
If Brian’s Hardware Store’s total revenue was $1,300,000 and its expenses were as follows, what is its gross revenue? :
- Material cost: $150,000
- Supply cost: $60,000
- Equipment cost: $340,000
- Labor cost: $150,000
- Shipping cost: $100,000
To calculate gross margin, revenue less cost of goods sold (COGS), of Brian’s Hardware Store, the calculation is as follows:
Gross revenue = $1,300,000 (COGS) -$150,000 – $60,000 – $340,000 – $150,000 – $100,000 = $500,000
What is net income?
Another question your accountant may ask you is what your net income is.
Your net income is your gross income less taxes and deductions taken by your employer.
Essentially, you can see your net pay on your pay stub on payday.
Net income represents your actual total earnings and is what you can use to give you an idea of how much money you can spend throughout the month.
It’s also a good indicator of how much you might pay in taxes each year.
Related: What exactly does your income statement tell you? | Entrepreneur
How do I calculate my net income?
To calculate your net income, first take your gross income and deduct the following expenses:
- Income taxes.
- Health insurance payments.
- Contributions to retirement account.
- Social security and health insurance taxes.
- Loan payments.
- Child support payments.
- Alimony payments.
- Wage garnishment.
Example:
If Suzanne’s annual salary is $150,000 as a lawyer and she has the following expenses, what is her net income? :
- Income taxes: $8,000.
- Health insurance payments: $2,000.
- Retirement account contributions: $5,000.
- Loan repayment: $10,000.
To calculate Suzanne’s net income, the calculation is as follows:
Net income = $150,000 – $8,000 – $2,000 – $5,000 – $10,000 = $125,000
Related: How to Calculate Net Income: Here’s a Complete Guide | Entrepreneur
What is taxable income?
You will use your gross income when you complete your state and federal income tax paperwork.
Then you can deduct any applicable deductions to determine how much you may owe.
Remember that your gross income is not the same as your taxable income.
This is because some sources of income are not counted in your gross income for tax purposes.
Some sources of income that are not taxable include:
- Life insurance payments.
- Specific Social Security benefits.
- Interest from state or municipal bonds.
- Certain inheritances or donations.
- 401(k) contributions.
- Contributions to the health savings account.
- Educator’s expenses.
Your taxable income is also what can be used to determine which tax bracket you fall into.
Related: Is it taxable income if a company reimburses an employee for health insurance premiums? | Entrepreneur
What is not considered taxable income?
Although most sources of income are considered taxable, there are a few instances where income is not taxed.
Partnership income
Generally, a partnership is not considered a taxable entity.
The distributive portion of partnership income, such as gains, losses, deductions, or credits, is generally based on the partnership agreement.
You must report them on your tax return whether or not they have been distributed.
Although a partnership generally does not pay tax, it is still required to file an information return.
Income of corporation S
Generally, an S corporation does not have to pay tax on its income.
Instead, income, losses, deductions and credits flow through to shareholders based on each of their shares on a pro rata basis.
Again, even though an S corporation does not normally pay tax, it is still required to file a return.
Related: Tax Basics for Business Owners | Entrepreneur
What is Adjusted Gross Income?
The IRS defines your adjusted gross income (AGI) as your gross income minus any applicable adjustments.
Your Adjusted Gross Income will never be greater than your Total Gross Income and may be less.
Your accountant will use your adjusted gross income as a starting point to calculate your taxes for the year and help you determine your eligibility for tax credits and deductions to help lower your overall tax bill.
Related: What is Adjusted Gross Income? Everything you need to know. | Entrepreneur
What are the tax brackets?
There are several different tax brackets you can fall into when it comes to income tax.
Federal income tax rates are divided into seven sections called tax brackets.
As your income increases, the tax rate you will pay also increases.
To determine what your marginal tax rate is or what your highest federal tax bracket is, you may need to know the following:
- You will need to know your filing status. The options are single, married filing jointly, married filing separately, head of household, or qualified widow.
- You will also need to know your taxable income as described above.
Once you know these two things, you can determine which tax bracket you are in.
Remember that not all of your income will be taxed at this rate. The reason for this is that the United States income tax system works on a progressive system, so individuals pay an increasing rate as their income increases.
Related: Thinking of increasing a tax bracket? Here’s what to do | Entrepreneur
What are capital gains?
You may have heard someone talk about capital gains before, but what exactly are they and how do they apply to you?
Capital gains include profit from the sale of any fixed assets.
These may include the sale of:
- Shares of shares.
- Sale of a business.
- Sale of a plot of land.
- Sell a work of art.
For the most part, capital gains are included in your taxable income, but are normally taxed at a lower rate.
For capital gains to apply, the asset must be sold at a higher price than it was purchased for.
On the other hand, a capital loss occurs when an asset is sold at a lower price than it was purchased before.
Capital gains and losses are taxed either as short-term or long-term gains. Short term is classified as being held for one year or less and long term if the asset has been held for more than one year.
Generally, short-term capital gains are taxed at up to 37% and long-term gains at up to 20%.
Related: Capital Gains: How Digital Entrepreneurs Can Master the Essential Art of Fundraising
What is Modified Adjusted Gross Income?
Your modified adjusted gross income (MAGI) is how the IRS determines whether you are eligible for certain deductions or contributions to a Roth IRA.
The IRA will also use MAGI to help determine if a taxpayer is eligible for specific education tax benefits and other income tax credits.
To calculate your MAGI, the following calculation is used:
MAGI = Adjusted gross income + Eligible tax deductions
Your adjusted adjusted gross income is calculated by taking your adjusted gross income and adding the following deductions:
- Passive income or losses.
- Losses of rental properties.
- Interest earned on EE Savings Bonds.
- Foreign income excluded.
- Half of the self-employment tax.
- All deductions for IRA contributions.
- Student loan interest deductions.
Related: What is Modified Adjusted Gross Income (MAGI)? | Entrepreneur
Gross take-out revenue
In summary, your gross income as an individual is any income you receive, including your salary, interest earned, dividend income, rental income, and money you receive for your pension.
If you are a business owner, this is your total revenue minus the cost of goods sold.
Individuals will provide their gross income at income tax time, which will become their adjusted gross income and taxable income after certain deductions and exceptions.
If you want to calculate your gross and net income to better understand your finances and create an appropriate budget, implement the above calculations.
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