Gross and net income are similar concepts but represent two very different numbers when it comes to salary. Gross income is the salary you agree to when you accept a job offer and can be helpful when calculating taxes. Net income is your actual take-home amount after taxes, health insurance, paying into a 401(k), and anything else that comes out of your paycheck before it reaches your bank account.
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What Is Gross Income?
Gross income is the total revenue generated from your labor or the total of all of your income from taxable sources. In short, it’s your full salary. This is the amount you accept after accepting a job and/or negotiating a salary. Remember, this number is not your take-home amount; it’s what you will make before any taxes or contributions, like health insurance or a 401(k), are taken into account. For tax purposes, gross income includes:
- Wages or salaries;
- Tips;
- Bonuses;
- Income from self-employment;
- Interest income or dividends;
- Capital gains;
- Income from owning a rental property;
- Royalties;
- Distributions from retirement accounts;
- Unemployment benefits;
- Social Security benefits depending on your income;
- Pensions;
- Annuities.
Gross income has a slightly different meaning for business owners. Instead, it’s the revenue minus the costs of goods sold.
What Is Adjusted Gross Income?
Above-the-line deductions can be taken from your gross income for tax purposes. These adjustments include:
- Tuition and fees;
- Student loan interest;
- Educator expenses;
- Any alimony paid;
- Moving expenses as related to starting a new job;
- Uncollectible debts owed to you;
- Contributions to a traditional IRA.
There are some limitations to deductions, and a few have qualifications or can’t be taken if you use other, similar credits. The result of subtracting these deductions is your adjusted gross income (AGI).
AGI is often used to calculate tax breaks, such as education tax credits or mortgage insurance deductions. When applying for a loan, lenders use your AGI along with your credit score to determine whether you qualify.
What Is Net Income?
Net income, also called taxable income, is your takeaway from your paycheck. It’s what is actually deposited in your bank account after taxes and deductions are resolved. Federal, state, and local taxes, Social Security, Medicare contributions, and any pre-tax deductions for medical and dental insurance are all factored into net income. For example, if you make $50,000 and take the standard individual deduction for 2019 of $12,200, you will have a net income of $37,800.
Net income is typically not listed on your tax return but can be easily calculated by finding the difference between your taxable income and income tax.
For business owners, this is the profits earned after all taxes and expenses are deducted from revenue.
Difference Between Net and Gross Income for Personal Finances
As mentioned above, it’s important to know the difference between gross and net income when it comes time to submit your taxes. Gross can help you calculate what you made in a year and what you will pay taxes on. This is the compensation amount, before any perks or benefits, that you will agree to during a salary negotiation for a new job.
Net income will tell you how much you actually see in your bank account after taxes, health insurance, 401(k) contributions, and anything else that comes out of your paycheck. This can help you negotiate for better benefits, given the disparity between gross and net incomes. For example, if company-paid healthcare only covers a portion of the cost, and the rest comes from your paycheck, you can negotiate a higher gross to compensate, leading to a higher net income.
It can also be helpful to know what your net income is for every paycheck in order to help create a budget. While you may think you are getting the full salary of the gross income, you are only getting net income. The difference can be significant when deciding how to live within your means.
It’s important to know both numbers for different reasons. A higher gross will lead to a higher net and can be used to offset the costs of health insurance and taxes. They can also help when it comes to calculating taxes or creating a budget.
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