Gross income and net income can mean different things depending on the situation. In general, gross income is the total income you earn on your paycheck, and net income is the amount you receive after deductions are taken out.
Gross income and net income are fairly easy to understand, but the terms can have different meanings depending on the situation.
Gross and net income are two terms you’ll commonly see in reference to your personal finances, a business’s finances and sometimes your taxes. It’s important to know how gross and net income are different in each circumstance.
Gross income is typically the larger number, because in most cases it’s the total income before accounting for deductions. Net income is usually the smaller number, as that’s what left after accounting for deductions or withholding.
Your paycheck and personal income
The most common place you’ll see references to gross and net income is your paycheck. Your gross income, often called gross pay, is the total amount you’re paid before deductions and withholding. If you aren’t paid an annual salary, your gross pay for a paycheck will be equal to the number of hours you worked multiplied by your hourly pay rate. When you add up all your gross pay for a year, you should get your annual gross income. If you’re salaried, the annual salary your employer pays you is the same as your annual gross income.
Does a mortgage lender care about my gross income or my net income?
Typically, mortgage lenders use your gross income to calculate how much home you can afford. Even so, you’ll benefit by making sure you can afford the payment using your net income instead.
Net income is your gross pay minus deductions and withholding from your paycheck. Your net income, sometimes called net pay or take-home pay, is the amount that the paycheck is written for. It’s the amount you’d get if you cashed the check, or if you use direct deposit, it’s the amount deposited in your bank account.
What types of deductions do I subtract from my gross income to reach my net income?
Many types of deductions and withholdings could reduce your gross income to net income. Here are some common deductions and withholdings.
- Health insurance premiums
- Dental insurance premiums
- Vision insurance premiums
- 401(k) contributions
- Health savings account contributions
- Flexible savings account contributions
- Union dues
- Social Security and Medicare taxes
- Federal income tax withholding
- State, city and/or local income tax withholding
Businesses can also use the terms gross and net income. Within the business realm, gross and net income can mean different things from business to business, depending on the type of business.
In general, gross income, also referred to as gross profit, is a business’s revenue minus the cost of the goods it sells. This type of income shows how much money a company has left over, after selling its products and accounting for the cost of goods, to pay the rest of its expenses.
On the other hand, a business’s net income, also referred to as net profit, is normally the amount of money left over after accounting for operating expenses a company incurs.
Your personal income taxes
You may see the term “gross income” come up when filing your income taxes.
In this case, most people use the term gross income to refer to your total income, which you can find on Form 1040. That said, nontaxable types of income aren’t included in total income. Nontaxable income can include gift income and income used for certain retirement contributions.
One term the IRS does use that you might want to know when it comes to taxes and your income is adjusted gross income. Adjusted gross income is your gross income minus certain adjustments.
You may also see the term “net income” when filing income taxes. You can calculate it using information from your federal tax return. Take your taxable income listed on your Form 1040 (Line 10 for 2018) and then subtract your total tax (Line 15). The result is your net income based on your tax return.
Gross income and net income can have different meanings depending on the situation. You could see these terms in many places, including loan applications.
An easy way to keep these terms straight is by using a simple rule of thumb. Usually, gross income is the bigger number and net income is the smaller number.
Article courtesy of Lance Cothern – Credit Karma
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please contact your tax professional for advice.