Gross vs. net income: what’s the difference?
Every taxpayer should understand the difference between gross income and net income. If you’re not sure what distinguishes one from the other (and when you might need to refer to one or the other), keep reading. We’ve broken down all you need to know below.
What is gross income?
If you’re an individual taxpayer, your gross income is your earnings total before taxes and other deductions have been applied to your paycheck. (Or, in the case of self-employed taxpayers, determined and applied by yourself or your accountant.) Gross income is usually calculated annually at the end of each tax year, and it covers all of your income sources, from wages earned at work to property and investments.
The gross income of a business or company is slightly different. Also described as a business’s ‘gross margin’ or ‘gross profit,’ it’s a pre-tax, pre-admin total for all sources of income, including a business’s revenue from selling products or services. It should be included in the income statements of the business each tax year.
But it differs from an individual taxpayer’s gross income because it subtracts the Cost of Goods Sold (COGS) from the initial figure to reach the final figure. The COGS amount accounts for product manufacturing costs and expenses associated with service provision.
Let’s summarize the key things you need to know about gross income, as you bust tax jargon and get to grips with your finances:
Individual gross income = income from wages, salaries and other sources (pensions, rental properties, dividends, etc.)
Business gross income/margin/profit = total revenue minus COGS
After subtracting ‘above-the-line deductions’ like retirement contributions and healthcare expenses, your individual gross income will be referred to in your tax return as Adjusted Gross Income (AGI)
Businesses often look at gross income rather than net income to understand the true performance of a particular product or service
What is net income?
Individual net income is a person’s income in a certain period (as mentioned, usually a tax year for filing purposes) once deductions and taxes have been accounted for. Take the initial gross figure and reduce it accordingly, and you’ll reach the final net figure.
For a business, net income equals the total revenue, including sales earnings, minus all of the following:
COGS (also subtracted to find the gross income total)
Whether you’re an individual taxpayer or a small business owner finding your feet, you’ll need to be able to determine your net income. Even beyond the necessity of it for tax filing purposes, it will provide you with a clearer sense of the money that will end up in your hands/the hands of your business after deductions.
Here’s a summary of the key things you need to know about net income:
Individual net income = individual gross income minus deductions and taxes
Business net income = total business revenue minus amortization, COGS, depreciation, expenses, interest, and taxes
Net income is often referred to as ‘take-home pay’, for individuals
Businesses calculate earnings per share using net income, but investors are encouraged to do their research regarding reported figures, as some companies will under-report expenses or over-report revenue to paint a more impressive picture
How do I calculate my gross and net incomes?
Calculating gross income as an individual equals adding up your income from all of the following applicable sources:
Some sources of taxable income are not included in the standard gross income calculation—gifts, life insurance payouts and Social Security benefits, to name a few. However, these sources may still be included in calculations done by lenders or creditors, so awareness of them is crucial.
When you’ve determined your gross income, you can then subtract your above-the-line deductions (retirement plan payments, student loan payments, healthcare expenses, alimony payments, etc.) to determine your AGI.
Calculating your individual net income is then just a case of subtracting taxes and below-the-line deductions to reach a final figure. Properly calculated deductions, both above-the-line and below-the-line, are the best way to help reduce your income tax amount fairly and legally.
For business owners, gross income is determined by subtracting COGS from your business’s total revenue. Net income is also a subtraction from your total revenue, but this one includes COGS, expenses, taxes, and more (as outlined above).
When to use gross vs. net income
You might be wondering, ‘Why do I need to know my gross income and my net income?’ You might ask yourself, ‘Which number is more important?’
Put simply, net income is what you receive, while gross income is what you’re paid before expenses and taxes have reduced the total. This means that the answer to the second question above depends hugely on the situation. Overall, neither figure is more essential than the other, as both provide different contexts and tell you different things.
For example, individual net income is the crux of your tax return and the figure that tells you what you’ll actually receive monetarily in a given period. But individual gross income is also a necessity when filing your taxes. Plus, it’s requested and used as a barometer in several situations, including loan applications, salary negotiations, rental housing applications, and credit limit determinations.
In a business sense, net income is known as ‘the bottom line,’ and it’s the strongest and most evident indicator of a company's profitability. It’s used to work out earnings per share. That said, a business’s gross income is a better figure to go by when comparing companies that aren’t alike and analyzing efficiency in revenue generation.
Hopefully, you’re leaving this article with a much stronger idea of both income types and when one might be relevant over the other. If you’re still seeking further financial advice or help with filing your taxes, you’re in the right place.
Keep perusing our articles, or get in touch today, and we’ll connect you with a finance expert who can assist in no time.
Kate has written for leading publications and blue chip companies over the last 20 years.