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Gross income refers to the total amount of money you receive in a given period, while net income is the portion of those funds left over after taxes and other payroll deductions are subtracted. In other words, gross income is your total earnings, while net income is your take-home pay.
What Is Gross Income?
Gross income includes all the money you make. It can come from any source, including:
- Work compensation (including any side businesses you may have)
- Interest earned on savings or bond holdings
- Returns on real estate or other investments
- Payments you receive from pension or retirement funds
- Social Security and other government benefits
- Gifts, inheritance and prize winnings
If you have a single source of income through a job, you can determine your gross income by checking your pay stub. Your gross earnings usually are listed on the stub, along with details on deductions taken out for taxes, Social Security and other purposes.
Gross income is typically stated on an annual basis, capturing the amount of money you collect over the course of a calendar year. (Annual gross income is the starting point for calculating your federal income tax, for example.) To calculate your gross annual income using a pay stub, multiply the gross pay amount listed on the stub by the number of paychecks you receive per year—52 if you're paid weekly, 26 if you're paid bi-weekly, 24 if you're paid twice a month or 12 if you're paid monthly.
Your gross annual income for the previous calendar year is also summarized for you in various places:
- Your employer-provided W-2
- The 1099 form you receive for contract or freelance work
- If you receive Social Security benefits, you will receive a Form SSA-1099 summarizing the amount of benefits you received in the past year.
- If you have taxable income from interest-bearing accounts or bonds, stock dividends or distributions from your retirement accounts, you will typically receive a year-end statement.
Unless you have sources of income that aren't automatically reported to you, such as gifts or inheritance, you can determine your gross annual income by adding up the total amounts listed on whichever of these documents apply to you.
For example, consider Joe, a single high school teacher whose salary is $45,000 annually. He receives two paychecks per month (24 times per year), and his pay stub reflects gross pay of $45,000/24 or $1,875.
When you're applying for a mortgage or other large loan, your lender may use your monthly gross income to calculate your debt-to-income (DTI) ratio. You can determine your monthly gross income by dividing your most recent annual gross income by 12, or by adding up gross earnings from your paychecks (and any other income sources) for the last full month.
Joe's monthly gross income can be determined by doubling his twice-monthly gross pay: $1,875 x 2 = $3,750.
What Is Net Income?
Net income is the amount of money you take home after deductions including federal withholding taxes as well as contributions to Social Security, Medicare, health insurance benefits and retirement savings are subtracted from your gross pay.
If you have a single source of income, you can start determining your net income by looking at your paycheck. The amount it's written out for, or that's deposited in your account each payday, is your net income for that pay period. To calculate your annual net income, start by multiplying that amount by the number of paychecks you receive annually. To that total, you must then factor in any additional taxes you pay or refunds you receive.
Consider Joe from our previous example. Let's assume he lives in a city and state with no income taxes. Recall that his annual gross pay is $45,000 and that he's paid twice monthly, or 24 times per year, for gross pay of $1,875 per pay period.
His deductions are as follows:
- Joe has a total of $6,500 withheld annually for his retirement savings, health insurance premium and health savings account. Dividing that amount by 24 yields a deduction of about $271 per paycheck.
- Joe's employer withholds an additional $8,925 annually to cover his federal income tax, Social Security and Medicare costs. Dividing that by 24 yields an additional deduction of about $372 per paycheck.
Joe's net income per paycheck is his gross pay minus his deductions: $1,875 - ($271 + $372), or $1,232.
To calculate his annual net income, Joe must multiply his net pay per paycheck by his number of pay periods, then add in the $200 refund he'll receive this year on his federal income taxes: ($1,232 x 24) + $200 = $29,768
How Gross Income and Net Income Can Affect Your Budget
Joe's example may or may not mirror your own—he's a single person with relatively aggressive retirement-savings goals—but it shows the potential for significant differences between gross and net incomes and underscores the need to plan accordingly.
For example, let's say Joe budgets 30% of his income to cover his rent. If he used his gross monthly income of $3,750 as the basis for that, he'd set aside $1,125 per month for rent—an amount that's very close to a full paycheck of $1,232, or half his monthly take-home pay of $2,464.
With careful juggling, Joe might be able to make ends meet, but it'd be much less of a reach if he started his calculations using his net monthly income: 30% of $2,464 is $739, which won't cover apartment rents in many locations, but it gives Joe a better idea of how he might need to rethink his rent allocation—upping the portion of his budget devoted to rent, or perhaps finding some housemates to share expenses.
In general, budgeting using net income is wiser and more realistic than planning using your gross income.
The Bottom Line
Calculating your net and gross incomes is relatively simple when a single employer is your only source of money and working with net income as the basis for budgeting and planning will help you avoid financial overreach.
Multiple jobs, one-time financial gains such as inheritances or contest winnings, or income-generating real estate and investments can complicate the math—and the tax implications—considerably. If your income picture is complex, consider consulting a financial professional to assist in determining your tax liabilities and its impact on your net income.
When managing your personal finances, it's also important to keep a close eye on your credit report and credit score, which you can do for free through Experian.