“Surely your accountant has asked you for your gross and net income in the past when preparing your income statement, right? But do you really understand the difference between gross income and net income? Keep reading to learn all about gross income and how it applies to you.
What is gross income?
Gross income refers to the total amount of earned income you receive before taxes and deductions are taken out. This includes income from your salary, rental income, interest income, and dividend earnings. Businesses calculate their gross income, also known as gross profit, by subtracting the cost of products sold from the income generated from selling their products or services.
How is gross income calculated?
Calculating gross income depends on whether you are an individual or a business. For individuals, you need to consider all sources of income mentioned earlier and add them up. For example, if you earn $100,000 from your job, $70,000 from rental income, $10,000 from dividends, and $5,000 from interest income, your gross income would be $185,000.
For businesses, gross income is calculated by subtracting the cost of goods sold (COGS) from the total income generated. This includes costs such as employee labor, equipment, supplies, raw materials, and shipping. For example, if a hardware store has a total income of $1,300,000 and the COGS is $750,000, the gross income would be $500,000.
What is net income?
Net income is the amount of income you have left after deducting taxes and other deductions. It represents your final take-home pay and is what you can use to determine your spending power and potential tax liability.
How do I calculate my net income?
To calculate net income, you start with your gross income and subtract expenses such as income taxes, health insurance payments, retirement contributions, loan payments, and other deductions. For example, if your gross income is $150,000 and you have expenses totaling $25,000, your net income would be $125,000.
What is taxable income?
Taxable income is the income that is used to calculate the taxes you owe. It is based on your gross income but may exclude certain types of income that are not subject to taxation, such as life insurance payments, specific Social Security benefits, and contributions to retirement accounts and health savings accounts.
What is adjusted gross income?
Adjusted gross income (AGI) is your gross income minus any applicable adjustments. It is used to calculate your taxes for the year and determine your eligibility for tax credits and deductions.
What are tax brackets?
Tax brackets are different income ranges that determine the tax rate you are subject to. The higher your income, the higher your tax rate. Your marital status and taxable income determine which tax bracket you fall into.
What are capital gains?
Capital gains refer to the profit made from selling capital assets, such as stocks, businesses, real estate, or artwork. Capital gains are included in taxable income but are generally taxed at a lower rate. Short-term capital gains are taxed at your regular income tax rate, while long-term capital gains have their own tax rates.
What is modified adjusted gross income?
Modified adjusted gross income (MAGI) is used to determine eligibility for specific deductions, contributions, and tax credits. For example, it helps determine if you qualify for a Roth IRA contribution or certain education tax benefits.
Understanding gross income and net income, along with other related concepts like taxable income and capital gains, is important for managing your finances and ensuring proper tax compliance. Consult with your accountant for personalized advice based on your specific financial situation.”
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Surely your accountant has asked you your gross and net income before when preparing your income statement, right?
But what exactly is gross income, and how is it different from net income?
Read on to learn 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 in your paycheck before taxes and deductions are taken out.
Consider all sources of income from your salary, rental income, interest income, and even dividend earnings.
Businesses calculate gross income slightly differently. Their gross income is also called gross profit, the income they earn from the sale of your product or service minus the actual cost of those products sold.
Related: These 11 US states are cutting personal income taxes | Entrepreneur
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 acquire a loan from the bank to satisfy the lender.
Your potential landlord may require it to make sure you can pay your rent.
You may even be applying for a credit card, and they require the amount of your gross income before they will approve your application.
Read on to learn how both individuals and businesses can calculate their gross receipts.
Related: How to calculate gross profit: formula and examples | Entrepreneur
Calculation of gross income for individuals
Since people’s gross pay includes many forms of income from employment, rental income, interest income, and dividend payments, this must be taken into account when calculating your gross income.
Example:
If Alex earns an annual income of $100,000 per year from his office job and also earns $70,000 in rental income from real estate he owns, $10,000 in dividend earnings, and $5,000 in interest income in his savings account, Your calculation would be as follows:
Gross income = $100,000 + $70,000 + $10,000 + $5,000 = $185,000
Calculation of gross income for companies.
A company’s gross profit is on the company’s income statement.
It is the annual gross margin of the company before discounting indirect expenses, interest and taxes.
This calculation represents business income earned from the sale of goods or services after deducting tax deductions with respect to direct costs incurred by the business.
Examples of direct costs may include:
- Employee labor costs.
- Equipment used in the production phase.
- The cost of supplies.
- The cost of raw materials.
- Any required shipping costs.
Example:
If the total income from Brian’s hardware store was $1,300,000 and his expenses were as follows, what is his gross income:
- Materials Cost: $150,000
- Supply Cost: $60,000
- Equipment Cost: $340,000
- Labor cost: $150,000
- Shipping Cost: $100,000
To calculate gross profit, revenue less cost of goods sold (COGS), for 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 is what your net income is.
His net income it is your gross income minus taxes and deductions deducted by your employer.
Essentially, you can see your take-home pay on your pay stub on payday.
Net income represents your actual total earnings and is what you can use to give you an idea of how much money you can spend throughout the month.
It’s also a good indicator of how much you might pay in taxes each year.
Related: What exactly does your income statement tell you? | Entrepreneur
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.
- Contributions to the retirement account.
- Social Security and Medicare taxes.
- Loan payments.
- Child support payments.
- Alimony payments.
- Wage garnishments.
Example:
If Susan’s annual salary is $150,000 a year as a lawyer and she has the following expenses, what is her net income:
- Income taxes: $8,000.
- Health insurance payments: $2,000.
- Contributions to the retirement account: $5,000.
- Loan payments: $10,000.
To calculate Susan’s net income, the calculation is as follows:
Net income = $150,000 – $8,000 – $2,000 – $5,000 – $10,000 = $125,000
Related: How to Calculate Net Income: Here’s a Complete Guide | Entrepreneur
What is taxable income?
You will use your gross income when you fill out your state and federal tax papers.
You can then deduct any applicable deductions to determine how much you owe.
Remember that your gross income is not the same as your taxable income.
This is because some sources of income are not counted as part of your gross income for tax purposes.
Some sources of income that are not subject to tax include:
- Life insurance payments.
- Specific Social Security benefits.
- Interest from state or municipal bonds.
- Certain inheritances or donations.
- 401(k) contributions.
- Contributions to health savings accounts.
- Educator expenses.
Your taxable income is also what can be used to determine what tax bracket you fall into.
What is not considered taxable income?
While most sources of income are considered taxable, there are some cases where income is not taxable.
partnership income
Generally, a partnership is not considered a taxable entity.
The distributive portion of the partnership’s income, such as profits, losses, deductions, or credits, is generally based on the partnership agreement.
You must report them on your tax return, regardless of whether they have been distributed.
Although a partnership generally does not pay tax, it is still required to file an information return.
S corporation income
Typically, a S-Corporation You do not have to pay any tax on your income.
Instead, income, losses, deductions, and credits are passed through to shareholders based on each of their prorated shares.
Again, even though an S corporation doesn’t normally pay taxes, you still need to file a return.
Related: Tax Basics for Business Owners | Entrepreneur
What is adjusted gross income?
The IRS defines your adjusted gross income (AGI) as your gross income less any applicable adjustments.
Your adjusted gross income will never be more than 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 help determine your eligibility for any tax credits and deductions to help reduce your overall tax bill.
Related: What is adjusted gross income? All you need to know. | Entrepreneur
What are tax brackets?
There are several different tax brackets that you can fall into at income tax time.
Federal income tax rates They are divided into seven sections called tax brackets.
As your income increases, so does the tax rate you will 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 will need to know your marital status for filing purposes. The choices are single, married filing jointly, married filing separately, head of household, or qualifying widow(er).
- You will also need to know your taxable income as described above.
Once you know these two things, you can figure out what tax bracket you are in.
Remember that not all your income will be taxed at that rate. The reason is that the US income tax system works on a graduated system, so people pay an increasing rate as their income increases.
Related: Do you think you will increase a tax bracket? This is what you should do | Entrepreneur
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 gain from the sale of any capital goods.
These may include the sale of:
- Of actions.
- Sale of a business.
- I am selling a lot of land.
- I am selling a work of art.
For the most part, capital gains are included in your taxable income, but are typically taxed at a lower rate.
For capital gains to apply, the asset must sell for a higher price than it was purchased for.
On the other hand, a capital loss occurs when an asset is sold for less than what was previously purchased.
Both capital gains and losses are taxed as short-term or long-term gains. The short term is classified as owned for one year or less and the long term is if the asset was held for more than one year.
Generally, short-term capital gains are taxed up to 37% and long-term capital gains are taxed up to 20%.
Related: Capital Gains: How Digital Entrepreneurs Can Master the Essential Art of Fundraising
What is modified adjusted gross income?
Your modified adjusted gross income (MAGI) is how the IRS determines if you are eligible for certain deductions or contributions to a Roth IRA.
The IRA will also use MAGI to help determine if a taxpayer is eligible for specific education tax benefits and other tax credits.
To calculate your MAGI, the following calculation is used:
MAGI = Adjusted Gross Income + Qualified Tax Deductions
Your modified adjusted gross income is calculated by taking your adjusted gross income and adding the following deductions:
- Passive income or losses.
- Losses from rental properties.
- Interest earned on US savings bonds.
- Foreign income excluded.
- Half of the self-employment tax.
- Any deduction for IRA contributions.
- Student loan interest deductions.
Related: What is Modified Adjusted Gross Income (MAGI)? | Entrepreneur
Gross Income Findings
In short, your gross income as an individual is any income you receive, including your salary, interest earned, dividend income, rental income, and money you receive from your pension.
If you own a business, this is your total revenue minus your cost of goods sold.
Individuals will provide their gross income at the time of income tax, which will become their adjusted gross income and taxable income after certain deductions and exceptions.
If you want to calculate your gross and net income to better understand your finances and create a proper budget, use the above calculations.
Verify Other entrepreneur articles for more information about gross income and other financial issues.
https://www.entrepreneur.com/money-finance/what-is-gross-income-heres-everything-to-know/453591
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