Understanding the Difference Between Gross and Net Income
10 MIN READ
Published August 15, 2023 | Updated December 16, 2023
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Key Takeaways
Gross income on your pay stub is the total income you earn, while net income is what you’re left with after taxes and deductions are taken out. Other items that may be deducted from your gross income include employee benefit premiums, taxes, wage garnishments, and other deductions.
Understanding Gross vs. Net Income
Your pay stub will state your gross pay and your net pay, whether you earn hourly wages or an annual salary. Understanding the difference between gross vs. net income will help you know how much money you’ll get each pay period.
In this article, we’ll explain what gross pay means, how it differs from net income, and how to calculate both so you can better budget for your variable and fixed expenses.
What Is Gross Income?
Gross income is the total amount of money you receive before taking out taxes and deductions. You’ll see it on your pay stub as “gross pay.” It reflects the amount your employer pays based on your hourly wage or salary.
For example, if your employer agrees to pay you an annual salary of $50,000, your gross pay is $50,000 annually.
What Is Net Income?
Net income is the amount of income you receive after paying taxes and other paycheck deductions. This is the amount that an employer will actually deposit into your account. Your pay stub will specify your net pay.
For example, if your gross pay is $50,000 and the total taxes, deductions, and contributions each year amount to $15,000, your net pay or take-home pay will be $35,000.
Calculating Gross and Net Income
Knowing how to calculate your gross and net pay will give you a realistic idea of how much money you’ll have available for your expenses. This allows you to make an accurate budget each month, which is one of the most important money management skills to master.
Teresa Dodson, debt expert and founder of Greenbacks Consulting LLC, encourages individuals to “look at your expenses and make sure you’re budgeting for net income.” She also advises job seekers to think carefully after receiving a salary offer. “When they give you an annual rate of pay, deduct taxes, etc., to see what your net income will be to ensure you’re taking home enough money.”
Gross Income Calculation
Your gross income includes your salary and any other income sources, such as interest, dividends, pension plans, rental income, child support, and alimony. If you work a single job and get an annual salary from your employer, your gross salary equals your annual salary.
If you're an hourly worker, your gross income for a pay period will be your hourly pay multiplied by the number of hours you worked during that period. For example, if your hourly pay is $15 and you worked 35 hours a week, your gross pay for that week will be $525.
Net Income Calculation
To calculate your net income, you’ll need to begin with your total gross income, including your wages, tips, and income from other sources such as investments. Next, you’ll need to calculate the total of your income taxes, Medicare and Social Security taxes, retirement contributions, insurance payments, and any other deductions. Subtract this from your gross income to calculate your net income.
For example, if you earn $40,000 per year as gross income and another $5,000 from investments, your gross income will be $45,000. If your total taxes and deductions for the year are $12,000, your net income will be $33,000.
Factors Affecting Net Pay
Your net pay will depend on a number of factors, including:
- Federal income tax withholdings
- State income tax withholdings
- Medicare and Social Security taxes
- Retirement savings
- Health insurance premiums
- Wage garnishments
- Your filing status (single, head of household, or married)
Differences Between Gross and Net Income
Understanding the main differences between gross vs. net income will help you understand your tax liability, the deductions that impact your net income, and how much money you’ll have available each month to pay towards necessities, discretionary spending, and debt payments. Your gross and net income will also help you determine how much mortgage debt you may qualify for.
Impact of Taxes on Gross and Net Income
As discussed earlier, the main difference between gross and net income is that gross income is your income before deductions, while net income is the actual paycheck amount you’ll receive after those deductions.
The higher your gross income is, the higher taxes you’ll generally pay, depending on qualifying credits, deductions, and marital status. Your gross income is the starting point when you file your state and federal income tax. It’s also important to remember that gross income is not the same as taxable income. Certain types of income are counted as your gross income when filing taxes, such as inheritance, gifts, and life insurance payouts.
Taxable income is adjusted gross income or AGI, which accounts for deductions that will lower your gross income for tax purposes. Based on your taxable income, you’ll be able to determine how much in taxes you’ll owe on your income. The amount of taxes you’ll pay will have a huge impact on your net pay.
Importance of Deductions
Your gross income is always larger because it doesn’t account for the deductions and taxes you’ll pay. Some deductions are mandatory, while others are voluntary. Mandatory deductions may include:
- Form W4 elections
- Wage garnishments
- Retirement plan
- Health insurance premiums
- Social Security and Medicare taxes
- Federal and state taxes
There may be voluntary deductions from your pay for pension plans, union dues, and uniforms. These deductions are not federally mandated, but depending on your employer contract, you may not be able to opt out of them.
You’ll also see deductions on your pay stub for your 401k, health plan, flexible savings account, and other benefits offered by your employer. There are separate accounts to house such deductions related to savings. This means that the money is yours, but you may be able to access it only under certain circumstances. Typically, you’ll be able to determine the amount for these deductions personally.
Gross Vs. Net Income in Different Industries
Your gross vs. net income will be calculated differently based on whether you are employed or a business owner. Let’s take a closer look at how each of them is calculated.
Personal Gross Vs. Net Income
When your employer discusses compensation with you, they’re talking about your gross pay, such as $50,000 a year or $20 per hour. This is also what is used to determine your federal and state tax bracket.
You can calculate your gross wages based on how you’re paid. For example, if you’re a salaried employee with an annual salary of $50,000 and you’re paid monthly, then your gross income each month will be $50,000 divided by 12, which is $4,167.
If you’re employed at an hourly wage, multiply your hourly rate by the number of hours you worked during a given period. For example, if you worked 35 hours in a week at $15 an hour, your gross pay will be $525 for the week.
Your net pay will depend on your taxes and payroll deductions. Once your gross income is calculated, you’ll need to deduct pre-tax contributions such as 401k and health insurance premiums. Next, you’ll need to deduct all taxes. If there are any court-ordered payments, those will also be deducted from your income to calculate your final net pay.
Business Gross Vs. Net Income
Your gross vs. net business income is an important profitability metric to determine the financial health of a business. For business owners, your gross profit or income is the profit that remains after deducting the cost of goods sold (COGS) from revenue. This will help you determine how much profit you earn from selling your products and services through your small business.
Your net income for the business is the profit remaining after deducting all costs and business expenses. This will help you determine your overall profitability. For example, let’s say your business generated a gross profit of $400,000 after deducting production costs from total revenue. If you had additional expenses such as operating expenses, tax debt, and other debt payments of $235,000, then your net profit would be $165,000.
Gross Annual Income Vs. Net Annual Income
Your gross annual income vs. net will give you a better idea of how much you’re earning each year. This is crucial to determine so you’ll know exactly how much income to expect each year and how to budget for certain expenses and savings.
Gross Annual Income Calculation
If you receive an annual salary and have an employment contract, you can look there to find your gross annual income. You can also calculate your gross annual income using your pay statements if you don’t have a contract. For example, if you receive $4,000 in gross pay each month from your employer, your gross annual income is $48,000 ($4,000 x 12 months).
If you receive any additional income through your employer, such as bonuses, you’ll need to include that when you calculate your gross annual income. It’s important to note that the taxes you’ll pay on bonuses are usually at a different rate than your regular income.
Net Annual Income Calculation
To calculate your net annual income, you’ll first have to know your gross income. Next, take a look at your paycheck to see which deductions are taken out from your pay each pay period. These may include union dues, taxes, health plan expenses, and more. Add all of these deductions.
Once you know your total deductions, subtract the deductions from your gross pay to calculate your net pay. Once you know your monthly net pay, multiply it by 12 to calculate your annual net income. It’s important to note that your net pay may fluctuate under several circumstances. For example, when union dues decrease, or taxes increase. These will impact your final net pay for the year.
Bottom Line: Gross Vs. Net Income
Once you understand the key differences between gross vs. net income, it’s important to create a budget using these figures. The best number to use for your budget is your net income because that’s what you’ll receive each month when you get paid. This will allow you to get an accurate understanding of your financial situation. You’ll know how much money you have available for your expenses so you don’t rack up credit card debt.
Another way to improve your financial situation is by reducing your debt load so you can free up money to allocate toward savings. If you have over $10,000 in unsecured debt, TurboDebt can help you pay it off. Contact TurboDebt today to take advantage of our free consultation and see how we can help you find the right debt relief option for your needs.