The initial step to mastering your personal finances and going through tax season with ease is to understand gross income. In simple terms, it is the amount of money you make all in one place; that is, your salary plus additional income or side jobs and investments prior to any deductions or taxes being deducted.
Gross income refers to the amount of money an individual or an enterprise earns from all sources, but does not include any taxes, health insurance payments, or any other form of deductions. It reflects what you make in total, and it is the point of departure when it comes to calculating your tax liability and point of departure in terms of creditworthiness.
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Key takeaways
- What Is Gross Income? At its core, gross income is everything you earn: wages, salaries, profits, interest, rent, and any other source of money coming your way.
- It means different things depending on who you are. For individuals, it’s your total pay before any deductions are taken out. For businesses, it’s revenue minus the cost of goods sold, essentially what’s left after covering production expenses.
- The IRS uses it as a starting point. Before calculating your adjusted gross income or taxable income, the IRS begins with this number, so it sets the tone for your entire tax picture.
- Lenders pay close attention to it too. When you apply for a loan or mortgage, this is one of the first figures banks look at to gauge whether you can realistically handle repayments.
Table of Contents
The Definition of Gross Income
At its core, the gross income definition encompasses every dollar you receive during a specific period, usually a calendar year, that isn’t explicitly excluded by law. For most employees, this is the “big number” at the top of a pay stub before the “shrinking” process of taxes and benefits begins.
IRS records indicate that 1 percent of the earning population in the United States took about 26 percent of the total adjusted gross income reported during the last tax season. Going a notch higher, when it comes to filing your taxes, the first thing that you need to know is your total earnings, as it determines your tax bracket. It not only includes your W-2 income, but also tips, bonuses, gambling winnings, and the fair market value of bartered goods or services.
How to Calculate Gross Income
To calculate gross income, you must aggregate all streams of revenue. For an individual, this process is relatively straightforward, whereas for a business, it requires distinguishing between top-line revenue and the direct costs of production.
Gross income formula
For an individual, the gross income formula is:
Gross Income = Annual Salary + Bonuses + Self-Employment Income + Investment Income + Other Revenue
For a business, the formula focuses on gross profit:
Business Gross Income = Total Revenue – Cost of Goods Sold (COGS)
Gross income calculation example
Let’s look at a practical example of how these numbers add up:
Imagine Sarah, a marketing manager who also runs a small craft business on the side.
- Annual Salary: $75,000
- Annual Bonus: $5,000
- Freelance/Self-Employment Profit: $10,000
- Dividends from Stocks: $2,000
Using the calculation above, Sarah’s total gross income for the year is $92,000. Note that this is the amount before she pays a single cent in federal or state taxes. If Sarah wants to know how much to save from your paycheck, she must first identify this baseline.
Types of Gross Income
Income isn’t always a steady paycheck. The IRS categorizes earnings into three main buckets to ensure everything is accounted for.
Employment income
This is the most common type, often referred to as gross pay. It includes your hourly wages or set salary, overtime pay, commissions, and bonuses. If you receive a W-2 at the end of the year, your total earnings are listed in Box 1.
Self-employment income
As a freelancer, contractor, or small business owner, your gross income is the total gross receipts that you are granted by your clients. But unlike a regular worker, you are in many cases able to claim off the business expenses to come up with your net self-employment profit, which is added to your personal gross.
Investment and passive income
Passive income includes money earned from sources where you are not actively involved on a daily basis. This includes:
- Interest: From savings accounts or CDs.
- Dividends: Payments made to shareholders of a company.
- Rental Income: Money collected from tenants.
- Capital Gains: Profit from selling assets like stocks or real estate.
Gross Income vs Net Income
The primary difference between gross income vs net income is the impact of deductions. Although both gross and net income are important numbers, the one that directly hits your bank account is the net income (often referred to as the take-home pay).
| Feature | Gross Income | Net Income |
| Definition | Total earnings before any deductions. | Earnings remaining after all deductions. |
| Deductions | None. | Taxes, 401(k), health insurance, etc. |
| Purpose | Used by lenders and for tax starting points. | Used for personal budgeting and spending. |
| Calculation | Sum of all revenue sources. | Gross Income – Total Deductions. |
This gap is what one needs to know when learning how to budget. Using your gross amount to cover bills will result in a substantial shortage, as about 20 percent to 30 percent of your gross amount is usually used to cover taxes and benefits.
Why Gross Income Matters
The amount of gross income is a yardstick of your financial capability.
- Debt-to-Income ratio (DTI). Lenders compare what you earn each month to what you owe. Most mortgage lenders want to see a DTI of 36% or lower, meaning your debts shouldn’t eat up more than a third of your gross monthly income.
- Tax obligations. When you file your taxes, gross income is where everything starts. From that top-line figure, you subtract above-the-line deductions to arrive at your adjusted gross income (AGI), which then shapes how much you actually owe.
- Renting an apartment. Landlords use it too. A common rule of thumb is that your gross monthly income should be at least three times the monthly rent, a quick way for landlords to screen whether you can comfortably cover the cost.
A budget calculator or a 50/30/20 calculator can be used to have a visual representation of how your gross pay translates to real-life spending.
Final Thoughts
The basis of your financial life is gross income. Although it is not the amount you will be spending, it is the amount that determines your tax bracket, power to borrow and your general earning capacity. When you are able to precisely record all forms of income, such as your main salary and passive investments, you will be in a better position to decide how to utilize your financial future.
FAQ
What is considered gross income?
Basically, all items of value you get can be considered gross income. Salaries, gratuities, pension, alimony (up until 2019), unemployment benefits, and even the price of prizes or awards.
What is adjusted gross income (AGI)?
Your gross income, less certain deductions towards taxes: student loan interest, educator expenses, or contributions to a traditional IRA, is AGI. It is a significant figure since tax credits and exemptions are based on your AGI in a number of ways.
Gross income: prior or after taxes?
Always preceding taxes is gross income. What is left after deducting federal, state, and FICA taxes is your net income.
What is the difference between gross income and gross profit?
Gross profit is also used interchangeably, but it is applied to a business specifically, and gross profit is the total sales that are received by the business minus the cost of producing the goods (COGS). Gross income refers to a business as well as gross profit to a business, and total earnings in the case of an individual, before making any adjustments.
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