I’m sure your accountant has previously asked you about your gross and net income when preparing your tax return, right?
But what exactly is gross income and how does it differ from net income?
Read on for everything you need to know about gross income and how it applies to you.
What is Gross Income?
For individuals, your gross income is the total amount of earned income you can find on your pay stub before taxes and deductions are deducted.
It takes into account all sources of income from your wages, rental income, interest income and even dividend earnings.
Companies calculate gross income slightly differently. Their gross income is also known as gross profit, which is the income they earn from selling their product or service minus the actual cost of those products sold.
Related: These 11 US States Lower Individual Income Tax | australiabusinessblog.com
How is gross income calculated?
Now that you know what gross income is, how do you calculate it?
You may need to calculate your total gross income to get a loan from the bank to satisfy the lender.
Your potential landlord may need it to make sure you can pay the rent.
You may even be applying for a credit card and they need your gross income amount before approving your application.
Read more about how both individuals and companies can calculate their gross income.
Related: How to Calculate Gross Profit: Formula and Examples | australiabusinessblog.com
Gross income calculation for individuals
Since gross pay for individuals includes numerous income from employment, rental income, interest income, and dividend payments, this must be taken into account when calculating your gross income.
If Alex earns an annual income of $100,000 a year from his office job and he also earns $70,000 in rental income from properties he owns, $10,000 in dividend earnings, and $5,000 in interest income from his savings account, his calculation would be as follows :
Gross Income = $100,000 + $70,000 + $10,000 + $5,000 = $185,000
Gross Income Calculation for Businesses
A company’s gross profit is shown on the company’s income statement.
It is the company’s annual gross margin before deducting any indirect costs, interest and taxes.
This calculation represents the business income earned from the sale of goods or services net of any tax deductions related to the direct costs incurred by the business.
Examples of direct costs can be:
- Employee labor costs.
- Equipment used in the production phase.
- The cost of supplies.
- The cost of the raw materials.
- Any shipping costs required.
If Brian’s Hardware Store sales totaled $1,300,000 and their expenses were as follows, what is their gross income?:
- Material cost: $150,000
- Delivery cost: $60,000
- Equipment cost: $340,000
- Labor Cost: $150,000
- Shipping cost: $100,000
To calculate gross profit, sales minus cost of goods sold (COGS), of Brian’s Hardware Store, the calculation is as follows:
Gross Income = $1,300,000 (COGS) – $150,000 – $60,000 – $340,000 – $150,000 – $100,000 = $500,000
What is Net Income?
Another question your accountant may ask you is what your net income is.
Your net income is your gross income minus any taxes and deductions withheld by your employer.
Essentially, you can see your net pay on your pay stub on payday.
Net income represents your actual total income and is what you can use to give yourself an idea of the amount of money you can spend during the month.
It’s also a good indicator of how much you could be paying in taxes annually.
Related: What exactly does your income statement tell you? | australiabusinessblog.com
How do I calculate my net income?
To calculate your net income, first take your gross income and subtract the following expenses:
- Income taxes.
- Health insurance payments.
- Retirement account contributions.
- Social Security and Medicare taxes.
- Loan payments.
- Child support payments.
- Alimony payments.
- Wage garnishment.
If Susan’s annual salary is $150,000 per year as a lawyer, and she has the following expenses, what is her net income?:
- Income Tax: $8,000.
- Health Insurance: $2,000.
- Retirement account contributions: $5,000.
- Loan Payments: $10,000.
To calculate Susan’s net income, the calculation goes like this:
Net Income = $150,000 – $8,000 – $2,000 – $5,000 – $10,000 = $125,000
Related: How to Calculate Net Income: Here’s a Comprehensive Guide | australiabusinessblog.com
What is Taxable Income?
When completing your tax return, you use your gross income as a basis state and federal income tax papers.
You can then subtract any deductions to determine how much you may owe.
Remember that your gross income is not the same as your taxable income.
This is because some sources of income are not included in your gross income for tax purposes.
Some sources of income that are not taxable include:
- Life insurance payouts.
- Specific Social Security Benefits.
- State or municipal bond interest.
- Certain legacies or gifts.
- 401(k) contributions.
- Contributions to health savings account.
- Teacher costs.
Your taxable income may also be used to determine which tax bracket you fall into.
Related: Is it taxable income if a company reimburses an employee’s health insurance premium? | australiabusinessblog.com
What is not considered taxable income?
While most sources of income are considered taxable, there are some instances where income is not taxed.
Usually, a partnership is not considered a taxable entity.
The distributive portion of the partnership income, such as the gains, losses, deductions or credits, is usually based on the partnership agreement.
You must declare these in your tax return, regardless of whether they have been paid out.
While a partnership typically pays no taxes, it is still required to file an information return.
S corporate income
Typically, one S company does not have to pay taxes on his income.
Instead, the income, losses, deductions and credits are passed on to shareholders based on each of their pro rata shares.
Again, although an S corporation does not normally pay taxes, it is still required to file a return.
Related: Tax basics for entrepreneurs | australiabusinessblog.com
What is Adjusted Gross Income?
The IRS defines your adjusted gross income (AGI) as your gross income minus any adjustments.
Your adjusted gross income will never exceed your total gross income and may be less.
Your accountant will use your adjusted gross income as a starting point to calculate your taxes for the year and to help determine your eligibility for any tax credits and deductions to help lower your overall tax bill.
Related: What is Adjusted Gross Income? Everything you need to know. | australiabusinessblog.com
What are tax brackets?
There are different tax brackets that you can fall under for income tax purposes.
Federal income tax rates are divided into seven sections called tax brackets.
As your income rises, so does the tax rate you must pay.
To find out what your marginal tax rate is or what your highest federal tax bracket is, you may need to know the following:
- You need to know your filing status. The options are single, married filing jointly, married filing separately, head of household, or qualified widow.
- You also need to know your taxable income, as described above.
Knowing these two things can help you figure out which tax bracket you fall into.
Keep in mind that not all of your income will be taxed at that rate. The reason is that the US income tax system operates on a graduated system, so that individuals pay an increasing rate as their income rises.
Related: Think you’re running into a tax bracket? Here’s what to do | australiabusinessblog.com
What are capital gains?
You may have heard someone talk about capital gains before, but what exactly are they and how do they apply to you?
Capital gains include the profit from the sale of a capital asset.
You can think of the sale of:
- Sale of a company.
- Sale of a plot of land.
- Sell a work of art.
Capital gains are for the most part included in your taxable income, but are normally taxed at a lower rate.
To apply capital gains, the asset must be sold at a higher price than it was purchased for.
On the other hand, a capital loss occurs when an asset is sold for less than it was previously purchased for.
Both capital gains and losses are taxed as short-term or long-term gains. Short term is classified as owned for a year or less and long term is if the asset was owned for more than a year.
Typically, short-term capital gains are taxed at a maximum of 37% and long-term gains are taxed at a maximum of 20%.
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What is Adjusted Adjusted Gross Income?
Your adjusted adjusted gross income (MAGI) is how the IRS determines whether you qualify for certain deductions or contributions to a Roth IRA.
The IRA will also use MAGI to help determine a taxpayer’s eligibility for specific educational tax credits and other tax credits.
To calculate your MAGI, the following calculation is used:
MAGI = adjusted gross income + qualifying tax deductions
Your modified adjusted gross income is calculated by taking your adjusted gross income and adding the following deductions:
- Passive income or losses.
- Loss of rental properties.
- Interest earned on EE savings bonds.
- Excluding foreign income.
- Half of the self-employment tax.
- Any deductions for IRA contributions.
- Deduction of interest on student loans.
Related: What is Adjusted Adjusted Gross Income (MAGI)? | australiabusinessblog.com
Gross income takeaways
Basically, your gross income as an individual is any income you receive, including your salary, interest earned, dividend income, rental income, and money you receive for retirement.
If you’re a business owner, this is your total revenue minus cost of goods sold.
Individuals will provide their gross income at the time of income tax, which after certain deductions and exceptions will become their adjusted gross income and taxable income.
If you want to calculate your gross and net income to better understand your finances and create a good budget, do the above calculations.
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