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What is gross income?
Gross income refers to the total earnings a person receives before paying for taxes and other deductions. The amount that remains after taxes are deducted is called net income. When looking at a pay stub, net income is what’s shown after taxes and deductions. Net income is always lower than gross income unless the person is exempt from paying taxes and has no deductions.
How gross income works
Gross income typically comes from a paycheck, which can comprise a combination of hourly wages, salary, commission and bonuses. But gross income can come from other sources such as annuities, alimony, pension, capital gains, rental income, royalties and income from self-employment. These forms of income are often only partly subject to taxation. Other sources of gross income subject to taxation are:
- Alternative compensation for services rendered
- Business income
- Dividends
- Gambling winnings
- Gas, oil, or mineral rights
- Income from discharged debt
- Income from a decedent or as an interest of an estate or trust
- Interest from bank accounts, certificates of deposit (CDs), etc.
- Selling goods online or in-person
- Tips
Some examples of nontaxable income include inheritance, municipal or state bonds, workers’ compensation payments and life insurance proceeds.
Employers withhold state and federal income taxes, Medicare and Social Security taxes from your paycheck before you receive it. For business owners, self-employed and independent contractors/freelancers, payment is received as gross income and it is their responsibility to pay their share of taxes. A business’s gross income is calculated as gross revenue minus the cost of goods sold (COGS) and may be referred to as gross margin or gross profit margin as a percentage.
Example of gross income
Here is an example of what gross income looks like for an individual on a weekly basis:
- 45 hours worked at $15 per hour = $675
- Commission = $150
- Bonus = $500
- Gross income = $1,325
Here is an example of what gross income might look like on an annual basis:
- Annual salary: $55,000
- Annual bonus: $5,000
- Rental income: $10,000
- Interest: $675
- Stock dividends: $500
- Side business income: $10,000
- Selling goods online: $1,300
- Total annual gross income: $82,475
To determine a business’s annual gross income, here is an example:
- Gross revenue: $250,000
- Cost of goods sold: $200,000
- Total annual gross business income: $50,000
Why understanding gross income is so important
Gross income is what is used by lenders to determine how much they will allow someone to borrow for a loan, like an auto loan or mortgage. The lender will determine how much to lend based on the individual’s debt-to-income ratio, or DTI. The DTI is determined by dividing monthly debt payments by monthly gross income.
The higher someone’s DTI, the less likely a lender will want to loan money and the higher the interest rate on the loan will be. Ideally, DTI should be no higher than 36 percent; however, some lenders will lend as high as 50 percent DTI.
Gross income vs. net income
The total amount of pay received is the gross income, while the net income is the remaining amount after taxes and deductions are removed.
Deductions could include:
- Health insurance premiums
- Life insurance premiums
- Voluntary benefits (accident, sickness, critical injury, disability, etc.)
- Flexible spending account contributions
- Health savings account contributions
- Job-related expenses (uniforms, union dues, meals, travel, etc.)
- Retirement contributions
- Wage garnishments
- Child support payments
Most deductions lower taxable income. These are known as pretax deductions. Other deductions, such as contributions to a Roth IRA and certain voluntary benefits, do not lower taxable income. These are known as post-tax deductions.
Net income is often called take-home pay or disposable income. Net income is what is leftover to spend and can be used to make a budget. Living expenses, bills, debt payments and other obligations should be budgeted out of net income rather than gross income. Making a budget based on gross income will likely cause the budget to be short each month, because the amount required for the budget is reduced by the deductions and taxes taken.
Here’s an example of why a budget should not be based on gross income without accounting for deductions and taxes. Sally has a monthly gross income of $4,000 and a net income of $3,000. She creates a budget with her gross income amount with total expenses equalling $3,500. Because Sally only brings home $3,000, she is short $500 on the monthly budget. Sally will either have to adjust her budget to account for the $500 or find a way to increase her net income by $500 to cover the remaining expenses.
You can sign up for Bankrate’s myMoney tool to categorize your spending transactions, identify ways to cut back and improve your financial health.
Learn more:
- What is net income?
- Gross vs. net income
- When are taxes due?
FAQs
Yes, gross income is the total amount of income a person or company has earned before deductions against that income. Gross income is calculated as the total amount of revenue earned before subtracting expenses like costs, interest, and taxes.
Why is the gross total income important? ›
The gross income of an individual is often a figure required by lenders when deciding whether or not to advance credit to an individual. The same applies to landlords when determining whether a potential tenant will be able to pay the rent on time.
How does gross income affect taxes? ›
Gross income
All of the taxable income you receive for the year. You'll report it on your tax return (Form 1040). It includes all of your earned income, unearned income, and other taxable income before any deductions, credits, or other adjustments are subtracted.
Why do companies go by gross income? ›
In managing a business, companies often use gross income to: Evaluate whether their cost of goods sold is well controlled. Determine whether the pricing of their products or services is sound and allows them to properly pass along the cost of goods sold to the customer. Understand a business's profitability.
Why do we use gross income instead of net? ›
That's because net income represents the amount of money you have available to spend from each paycheck. If you use gross income instead, you might end up spending money that's already been allocated elsewhere. But gross income can be a more accurate figure if you use a budgeting tool that calls for it.
What does gross income mean? ›
For individuals, gross income is all the money you earn before taxes and other deductions are subtracted. Your earned income can come in many forms: salary, bonuses, tips, hourly wages, rental income, dividends from stocks and bonds, and savings account interest.
What is the purpose of gross? ›
Differences Between Gross vs. Net Income
| Gross Income | Net Income |
|---|
| Practical Use | Used to assess the profitability of core business activities and set pricing strategies. | Critical for evaluating overall business performance, making strategic decisions, and assessing fiscal stability. |
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Gross income includes all income you receive that isn't explicitly exempt from taxation under the Internal Revenue Code (IRC). Taxable income is the portion of your gross income that's actually subject to taxation. Allowable deductions are subtracted from gross income to arrive at your taxable income.
What's my gross income? ›
What is gross income? In short, gross income is a person's total earnings prior to taxes or other deductions. It includes all income received from all sources: including money, property, and the value of services received. Gross income is reduced by adjustments and deductions before taxes are calculated.
What is the difference between earned income and gross income? ›
Gross income is all income an individual earns during the year both as a worker and as an investor. Gross income is derived from income sources beyond those related to employment. Earned income only includes wages, commissions, bonuses, and business income minus expenses, if the person is self-employed.
What you earn (based on your wages or salary) is called your gross income. Employers withhold (or deduct) some of their employees' pay in order to cover payroll taxes and income tax. Money may also be deducted, or subtracted, from a paycheck to pay for retirement or health benefits.
What does gross revenue tell you? ›
Gross revenue is the dollar value of the total sales made by a company in one period before deduction expenses. This means it is not the same as profit because profit is what is left after all expenses are accounted for.
Why is my gross pay so high? ›
Your gross annual income will always be larger than your net income because it does not include any deductions. Some deductions are mandatory and others are voluntary choices you have made about savings or benefits. Required deductions can include but are not limited to: Federal, state and local income or payroll taxes.
Why does gross pay matter? ›
Your personal gross pay amount can: Contribute to your financial success when and if you receive a promotion or negotiate a salary. Confirm your hourly rate based on the number of hours worked (in addition to overtime pay) Allow you to see how much house you can afford when pre-applying for a new mortgage.
Why do lenders look at gross income? ›
While your net income accounts for your taxes and other deductions, your gross income does not. Lenders look at your gross income when determining how much of a monthly payment you can afford.
Why do places go by gross income? ›
Gross income is a financial measure that helps assess an entity's revenue, profitability, and potential for expansion and is the starting point for any form of financial analysis. It refers to a company's full earnings generated from sales or services before taking into account deductions, costs or taxes.
What is the significance of gross national income? ›
Gross National Income (GNI) is the total amount of money earned by a nation's people and businesses. It is used to measure and track a nation's wealth from year to year. The number includes the nation's gross domestic product (GDP) plus the income it receives from overseas sources.
Why do banks use gross income? ›
While your net income accounts for your taxes and other deductions, your gross income does not. Lenders look at your gross income when determining how much of a monthly payment you can afford.
Why is it important to calculate your income? ›
Calculating your monthly net income is an important part of budgeting and financial planning. It allows you to keep track of your income and expenses, as well as plan for the future. It also helps to identify areas where you may be spending too much or areas where you could save more.
Why is adjusted gross income important? ›
AGI is an important figure because it is what's used to determine your eligibility for certain deductions and tax credits.
