You finally land your dream job with a salary you can hardly believe – $70,000 a year, and every dollar is yours!
Or so you thought.
$70,000 gross income morphs into about $52,000 net income, depending on your state taxes. How is it possible for such a seemingly high annual salary to dip nearly $20,000? And what is the difference between gross vs. net income?
One word: taxes.
What Is Gross Income?
Your gross income is defined as the amount of income you receive each week, month, or year before any taxes, deductions, and withholdings are removed from your paycheck.
Gross income can also come from passive sources, which is rent on a property you own, interest on any loans you may have given or dividends on stock investments. You also get gross income from a side gig that doesn’t withhold taxes. That income goes straight to your pocket.
Keep in mind that your gross income is always larger than the amount you actually pocket and take home. If you need at least $60,000 in take-home pay a year to keep your budget alive, then you need a job that actually pays $80,000 or $85,000 a year in gross income.
If you apply for a personal loan, mortgage, rental property, or new car, you’ll be asked to disclose your gross income. Keep in mind that all of the following sources of money count toward your gross income:
- Hourly wages
- Self-employment income
- Passive income
What Is Net Income?
Net income is your take-home pay. It’s the money you can actually spend on bills, groceries, and gas. The government automatically takes certain taxes from your gross income in order to satisfy your financial obligations as an American citizen. Required tax withholdings on every paycheck include:
- Federal Income Tax
- Social Security Tax
- Medicare Tax
- State and Local Income Tax
Depending on the benefits offered by your employer, you might also elect to have optional deductions taken from your gross pay for:
- Health Insurance
- Dental Insurance
- 401k Savings
Though allowing these deductibles will lower your net income, you’ll receive other benefits instead, like affordable medical care and future retirement funds.
What About Gross vs Net Income for Businesses?
Businesses also have gross and net income, but it’s calculated differently than personal income.
A company’s gross income equals sales minus the cost of goods sold. In other words, it’s the amount that a business earns from the sale of goods or services before other administrative costs and taxes are calculated. For example, if a company sells $1,000,000 worth of products but the cost of those products totaled $600,000, then the company’s gross income is $400,000.
A company’s net income, meanwhile, is the residual amount of earnings after all expenses have been deducted. Think of this as the final amount of profit a company truly earns. Let’s use the same example of the company that sold $1,000,000 worth of products and grossed $400,000. Say that company posted $250,000 in expenses. Its net income would be $150,000.
It’s important to note that gross and net income can’t always accurately reflect the financial status of a business. There are many other elements that come into consideration, including non-operational expenses, gains, and losses.
Overall, gross and net income offer two different financial pictures. Make sure you calculate your budget using net income so that you’re not counting on money the government has earmarked for your taxes!
Read about micro-investing and how to get started with our complete guide: Micro-Investing: What It Is, Why It’s for You and How to Start.