Finally! Your first paycheck. You see a breakdown of how much you earn during the pay period. What is gross income? What is net income? How does my adjusted gross income affect my tax return? What do all these taxes mean? Is gross income before or after taxes? How can I calculate my gross annual income? How is my net income different from gross income?
These are probably just some of the few questions you’re asking yourself right now.
To a finance industry novice, or maybe to you, a young professional or entrepreneur who has just started setting personal financial goals, or is wanting to learn how to save money and make investments, all the financial jargon can be pretty daunting.
We have good news for you – you’re off to a good start! In this article, we will attempt to simplify gross income: its definition, how it differs from other related accounting terms – such as net income – how to calculate your gross annual and monthly income, and why understanding it is important. We will also take a look at adjusted gross income, how to calculate it, and how it affects your tax bill.
In the simplest terms, gross income is the total earnings over a set period, before any deductions, including taxes, are applied. Understanding this concept will help you assess your financial health and, ultimately, formulate financial strategies based on your actual calculations.
If you are looking to get a loan or if you are soliciting investments for your business, chances are, companies, banks, and investors look at your gross income as one of the key factors in measuring projected financial gains before making their decision.
What is Gross Income?
So, what is it really? The implications of gross income can slightly differ for a business and an individual.
If you are self-employed or a salaried employee, your total earnings before any deductions or taxes are applied is your gross income. Your earnings can come from one or several income streams. When calculating your total gross income, you should also consider dividend payouts, salaries, commissions, and income from selling or renting goods. In terms of utilization, your gross income information can be used to assess your eligibility to apply for credit cards – like a Home Depot credit card – or a bank loan.
On the other hand, this might be slightly different if you have a business or a company. Your gross income will be the total revenue generated from sales minus the overall direct costs of goods that you sold.
You can formulate gross income as follows:
Gross Income = Total Revenue – Overall Direct Cost of Goods
This is the amount you get before subtracting any tax, deductions, and expenses. You can find this amount at the top of your business income statement. It is the starting figure after accounting for the sales revenue and the costs of goods sold figures.
For example, if you have a cupcake business making a total of $1,000 in sales, and the cost of baking the cupcakes is $400, this means that your business gross income is $600.
The gross income of your business can communicate profitability and can either attract or discourage potential investors. You can also calculate your gross income over a specified time frame – this can be annual (gross annual income), monthly (gross monthly income), or even, weekly.
Once you apply the necessary deductions to the gross income, you get the net income. We will further discuss net income shortly in this article.
What is Gross Annual Income?
The gross annual income is gross income for one year, which can be based on a calendar year. This is from the first day of January to the last day of December of the same year. Or, it can also be based on the fiscal year, which is the accounting period designated by the U.S. Federal Government. This starts on the first day of October of the previous year and ends on the last day of September of the next year. For example, October 1, 2019, to September 30, 2020, is one fiscal year. However, a company can still set its own non-calendar fiscal year – that is any consecutive 12-month period – based on the nature of the business.
It is important to define the period when calculating the gross annual income, especially when submitting annual income statements for audit, taxation, and other financial purposes. Usually, gross annual income calculations for businesses follow the fiscal year.
How To Calculate Gross Annual Income?
If you are a salaried employee, you might be wondering how to calculate your gross annual income. To do so, start with converting any of your hourly, daily, weekly, or monthly rates using the following applicable formula:
Gross Annual Income =
|Rate Per Given Period||Multiply By Frequency in a Year||Details|
|Monthly Rate||Multiply by 12||12 Months in a Year|
|Weekly Rate||Multiply by 50||Average Number of Work Weeks in a Year|
|Daily Rate||Multiply by 250||Average Number of Work Days in a Year (5 Days Per Week)|
|Hourly Rate||Multiply by 2,000||Assuming 8 Work Hours Per Work Day|
The figures are based off on the average number per year through an accounting process called calendarization. This process allows a standardized period when reporting income or any financial information.
To calculate your gross annual income, simply convert your applicable rate by using the formulas mentioned above.
For example, let’s say you have an hourly wage of $30. You work a regular eight-hour workday, on all the work weekdays. You can calculate your gross annual income as follows:
|Rate||Period||Multiply By||Gross Annual Income|
|$240||Daily (Hourly Rate x 8)||250||$60,000|
|$1200||Weekly (Daily Rate x 5)||50||$60,000|
This means that at your current hourly rate with the required number of working hours, you have a gross annual income of $60,000.
How To Calculate Gross Monthly Income?
As with gross annual income, the same principles apply when calculating your gross monthly income, although it might differ a bit depending on the conditions of your pay.
If you are a salaried employee and are paid annually, and you have your gross annual income information, simply divide that number by 12 – corresponding to the number of months in a year.
Gross Monthly Income = Gross Annual Salary / 12
For example, if you have an annual gross salary of $60,000, dividing that amount by 12, you will get a gross monthly income amount of $5,000.
Calculating Gross Monthly Income When Paid Hourly
On the other hand, if you are paid on an hourly basis, you can perform the following calculations. First, identify how many hours on average you work in a week, multiply that number by 52 – which is the number of weeks in a year – then finally, divide it by 12. This is simplified through the following formula:
Gross Monthly Income = ([Hourly Rate] x [Number of Hours Weekly] x ) / 12
Consider yourself an hourly paid employee earning $35 per hour working 40 hours per week. To determine your gross monthly income, take your hourly rate, and multiply it by 40 (number of hours in a week) and 52 (number of weeks in a year). In digits, that would be $35 x 40 hours per week, which is equals to $1,400. After multiplying this amount by 52, you will get your gross annual income amount of $72,800. Divide this by 12 to get the gross monthly income.
Gross Monthly Income = ([$35] x [40 hours] x [52 weeks]) / 12
= $72, 800 / 12
This means that you are earning a gross monthly income of $6,066.67.
The examples above only factored in salaries. In reality, you may have multiple sources of income. When calculating gross incomes, either on an annual or monthly basis, it is important to account for all income sources.
Now you may be living with your family or spouse, or other housemates. In such scenarios, it might also be useful to calculate the household income. The household income accounts for the total gross income of all the earning household members who are 15 years or older. The household income is usually calculated to gauge the economic context of a region. It is also useful for the household members in cases of loan applications.
Gross VS Net Income
What, then, is a net income? And why is your net income lower than your gross income?
We have briefly talked about net income at the beginning of this article. Essentially, net income is the total earnings after subtracting taxes, expenses, and other necessary deductions. Simply put, your net income is your gross income after taxes.
For a business, these deductions can include depreciation, administrative expenses, and other costs of operations like business insurance, as well as professional and legal fees. Tracking the net income of the business means tracking its profitability and financial health. It provides insight into its overall business performance.
You can usually find the net income information in the company’s income statements. The income statement details the total revenue for a period (generally, for a year or over a quarter) and overall expenses, as well as losses, to demonstrate how the net income figures were arrived at. This is why the income statement is one of the primary bases for business analysts and accountants to measure the financial soundness of the company.
Why is Knowing My Net Income Important?
In terms of salaries, the net income is the take-home pay or the amount from the salary available to you after all the deductions have been taken, such as payroll taxes and other contributions, like Social Security and Medicare contributions. Your net income is the amount highlighted in your paycheck that you can withdraw or transfer to a bank account.
For example, you are earning a gross monthly income of $1,000. You will still have to subtract a total of about $400 for taxes, contributions, and other deductions. This would translate to a net income of $600 for that specific time frame.
Knowing your net income allows you to create monthly budgets, and overall manage your finances more effectively. When creating budget plans, your starting amount will be your take-home pay. This means that being mindful of your net income will enable you to efficiently allot a budget for your expenses.
That’s not all. You can even allocate money for both your short-term and long-term financial goals – be it for your savings, for emergency and retirement funds, or your investments.
Gross Income VS Adjusted Gross Income: What is Adjusted Gross Income? And What’s In It For Me?
There are specific adjustments that you can apply when reporting the gross income amount to calculate your actual taxable income. This directly affects the amount of tax you will be liable to pay.
Adjusted gross income (AGI) is the amount that remains once certain necessary deductions are subtracted from your gross income. These adjustments are referred to as ‘above-the-line’ deductions or items. These include student loan payments, retirement plan contributions, and educator expenses, among others.
You might be wondering – what does adjusted gross income mean to me? Once applied or adjusted, your gross income would reduce, which consequently means reduced taxable income. In principle, after factoring in deductions and credits into the overall income, the lesser your adjusted gross income, the lesser your income tax liability.
As briefly mentioned, there are allowable deductions, identified in the Internal Revenue Service website, that can be considered when calculating the adjusted gross income.
How to Calculate Adjusted Gross Income?
To calculate adjusted gross income, start with identifying your income streams – such as salaries, capital gains, and interest income – and its corresponding total earnings. The sum will yield your gross income.
Gross Income = All Income Sources
After which, subtract all applicable deductions from your gross income. Some of the most common income adjustments are:
- Retirement Contributions: Individuals with contributions to eligible retirement plans, like Individual Retirement Arrangements (IRAs) and Simplified Employee Pension Plan (SEP IRAs), are also qualified for gross income deductions.
- Alimony and Separate Maintenance: Alimony payments may be tax-deductible for the paying spouse.
- Student Loan Interest Deduction: Eligible students, parents, or spouses can avail of a tax break for qualified student loan interest payments.
- Educator Expense Deduction: This is for qualified educators to deduct out-of-pocket and unreimbursed expenses incurred for education purposes, such as classroom materials, from their gross income.
- Moving Expenses for Members of the Armed Forces: Active-duty Armed Forces members who have moved or have to move due to official order are qualified to get a tax break for the expenses incurred during moving.
Adjusted Gross Income = Gross Income – Above the Line Deductions
After factoring in the applicable deductions, you will get your adjusted gross income, which also determines your income tax bill.
Modified Adjusted Gross Income
There are scenarios in which some adjustments, such as tax-exempt interests, are added back to your adjusted gross income. This is referred to as the modified adjusted gross income (MAGI). Some of the usual items adjusted back to your gross income include Education-related expenses and retirement plan contributions.
If you have retirement plan coverage at work, your deductions will also affect your modified adjusted gross income. For example, if you are single with a modified adjusted gross income between $66,000 to $76,000, you will be qualified for a partial deduction.
Your modified adjusted gross income will help in identifying your eligibility for certain credits, deductions, and retirement plans, as well as allow you to take full benefit of specific tax perks.
If you’re looking to qualify for Advanced Premium Tax Credits (APTCs), your eligibility will be determined using your modified adjusted gross income. You may be eligible for more credit, the lower your modified adjusted gross income. If your modified adjusted gross income is below a certain threshold, it can be the basis for you and your household to qualify for coverage on subsidized health insurance programs like Children’s Health Insurance Program (CHIP) and Medicaid.
Getting a better understanding of the concept of adjusted gross income and its different conditions and requirements will enable you to identify different areas where you can qualify for tax breaks and tax credits. All of these can translate to better long-term financial gains, reduced tax liabilities, and greater opportunities for savings.
Why Is Knowing All of These Important To Me?
We’ve heard it before, and for sure, this won’t be the last time we’ll hear of it: ‘Knowledge is Power.’
Ultimately, being equipped with the basic knowledge of the concept of gross income, how it works, along with the awareness of other related financial concepts and how they’re interconnected, allows you to become more strategic and effective with how you manage and grow your finances.
Whether you’re a business owner looking to grow your company or an employee looking to be smarter with your money by saving and investing more, it all starts with awareness of what you currently have. As such, knowing your gross income should be your starting point.