Knowing the difference between your gross income and your net income can help you create a budget and a long-term financial plan.
Your net income is the best number to focus on when creating a budget, while your gross income will determine your taxes.
Let’s take a closer look at gross vs net income for individuals.
What is Gross Income?
Your gross income is made up of all your sources of income, including your wages, salaries, tips, commissions, bonuses, profits, rents, and any other form of earnings — before any taxes or other deductions are taken out.
Therefore, when you look at gross vs net income, your gross income is likely to be the highest estimated income figure.
Examples of Gross Income
Gross income for individuals can include:
- Rental income
- Alimony
- Dividends and interest
- Pension plans
If you are an independent contractor, gross income can include all payments you’ve received from clients for work completed in a given calendar year.
Interestingly, both gifts and inheritances are not considered income (though they may be taxed under separate guidelines).
Certain categories of income may be excluded from your gross income figure if you do not wish for them to be considered as part of an application for credit. These include income such as alimony or spousal support, child support, and public assistance programs.
Gross Income in Loan Applications
Surprisingly, mortgage lenders and home equity lenders will often consider your gross income when reviewing and underwriting your loan application.
They will compare your monthly debts, including the new loan, with your gross monthly income to come up with a debt-to-income ratio.
What is Net Income?
Your net income is also referred to as your “take-home” income because it’s what you literally take home after income taxes and other deductions are made.
Knowing your net income can help you determine a realistic and affordable monthly budget before taking on debt (and the subsequent monthly payments).
Examples of Net Income
As an example, let’s say Susan earns $50,000 per year working as a teacher.
After deducting taxes, retirement fund contributions, and insurance payments, her annual income is closer to $40,000. This is her take-home pay or net.
It is worth noting that net income has an alternative meaning if you are self-employed or running a business. In these cases, net income refers to profitability or revenue minus total costs.
What about Income Taxes and Net vs Gross Income?
You may see both gross income and net income on your income tax filings. In this case, gross income refers to your total taxable income, which may exclude different types of nontaxable income.
In contrast, your adjusted gross income or AGI is calculated based on your gross income minus certain adjustments.
Your net income when filing income taxes is calculated by taking your taxable income and subtracting your total tax liability. The result is your net income (based on your tax return).
Gross Profit vs Net Income
In business, gross profit and net income are two crucial metrics when measuring profitability. Gross profit refers to the income or the profit that remains after the production costs have been subtracted from the revenue.
Net income is what remains after all expenses or costs have been subtracted from the revenue of the business.
Understanding the differences between gross profit vs net income can help investors determine whether a business is profitable, or losing money.
The Bottom Line
Gross income and net income can mean different things in different situations. You may see these terms in many places, including loan applications.
The easiest way to remember the difference between gross income and net income is straightforward. Gross income is usually the larger income number while net income is usually the smaller income number.
Sources
- Indeedaccessed on July 13, 2022
- Corporate Finance Instituteaccessed on July 13, 2022
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