Gross vs Net Income

Gross income is the total amount of income an individual or business earns before any deductions. For individuals, it might be in cash, retirement funds, bonuses, or other allowances. It includes all monetary and non-monetary benefits received by an employee from their employer, without any deductions.


 

For business: \({\text {Gross income = Revenue - Cost of Goods Sold}}\)
 

For individuals: \({\text {Gross income = Total Earnings Before Deductions}}\) 

Components of gross income: 

• Salary and wages: The payments employees receive for the work they perform in an organization include bonuses and overtime pay. 
   
• Interest from savings: Interest is the money we earn from money deposited in banks, fixed deposits, or other interest-bearing accounts. 
   
• Dividends from shares: Profits distributed by companies to their shareholders as a return on investment 
   
• Rental income: Rent is the money received from renting property such as a house, apartment, or commercial space. 
   
• Business profits: Earnings generated from operating a business or self-employment activities.
   
• Capital gains: Profit earned from selling assets such as property, stocks, or other investments at a higher price than their purchase cost.
   
• Pensions and annuities: Periodic payments received after retirement, either from a pension fund or annuity contract.

For example, if Riya earns a salary of $5000 per month, receives $2000 as interest from her savings account, and earns $3000 from renting her apartment. Then find her gross income. 
The gross income of an individual is the total earnings before deductions
So, Riya’s gross income \(= 5000 + 2000 + 3000 = 10000\)

Net income is the amount of money an individual or business actually keeps after all deductions. For individuals, net income is in-hand salary; for businesses, it is profit. Employees receive net income only after deductions such as taxes, health insurance, and pensions.

 

For individuals: 

\({\text {Net Income = Total Revenue - Total Expenses  }}\)

 

For Businesses:
\({\text {Net Income = Gross Income - Business Expenses + Other Income }}\)

Common sources of net income
 

• Salary: The pay received for working; it can be daily, weekly, or monthly. 
   
• Hourly wages: Payment employees receive based on the number of hours worked. 
   
• Net business profit: Earnings from self-employment or business operations after all business expenses have been deducted.
   
• Professional fees: Payments received for specialized services, including consulting, freelancing, or professional expertise.
   
• Commissions and bonuses: Additional earnings based on performance, sales targets, or company incentives beyond regular pay.

For example, imagine Tom is running a lemonade stand. In one day, he earns $50 from selling lemonade. This is his gross income, the total money earned. He also spent $10 on lemons and cups.
Net Income \(= 50 - 10 = 40\)

Understanding how each source of income influences the tax process. Different types of income affect the calculation of taxable income, the deductions that can be applied, and the credits that may be granted.
 

• Gross Income: Gross income includes all taxable earnings, such as salary, bonuses, business income, interest, and rent. It is used to calculate overall tax liability and determine adjusted gross income. 

• Earned Income: Earned income comes from active work, such as wages, salaries, tips, etc., and determines eligibility for deductions and credits, such as the Earned Income Tax Credit (EITC).

• Passive Income: Passive income includes rent, dividends, and other non-active income; taxable but does not count as earned income for credits or retirement contributions.

Learning the difference between gross and net income helps one make financial decisions wisely. Let’s take a look at a few:

 

Gross and net income play an important role in budgeting, tax calculations, business decisions, and everyday financial decisions. These simple tips and tricks help students quickly distinguish between gross income and net income.
 

• Understand what net income and gross income are. Gross income is the total amount earned, while net income is the take-home amount after deductions.
   
• Memorize the formulas to make the calculation easier. The formulas are
  \({\text {Gross Income = Revenue − Cost of Goods Sold (COGS)}}\)
  \({\text {Net Income = Gross Income − (Operating Expenses + Taxes)}}\)
   
• Teachers can use visual aids, such as charts and pie diagrams, to help students easily understand how gross income is reduced to net income.
   
• Understanding deductions such as taxes, insurance, pensions, and loan repayments helps prevent errors in salary calculations.
   
• Parents can discuss their payslip or business income, so that children can understand how income is used in real life.

There are many real-life applications for gross and net income. Understanding them enables individuals and companies to maintain financial stability. We will now learn how they apply:

• Personal Finance: Net income helps us understand how much we earn, our monthly expenses, and our savings.
   
• Employment and Salary Planning: Employees can make financial decisions like salary negotiations by understanding their gross and net income.
   
• Household Budgeting: Determining the net income helps individuals set aside money for tax, rent, and other expenses.
   
• Business and Entrepreneurship: Businesses can understand their profitability by calculating their net income.
   
• Investment and Wealth Management: Investors can use their knowledge of gross and net income to assess financial health before making investment decisions.