What is Gross vs. Net Income?

Quickly, how would you would answer this question: "What's your income?"  Did you think about the amount of your payday deposit? Did you think about the amount on your income tax return for the year? One is your net income and the other is your gross income. Everyone should understand the difference between gross and net income and why both numbers are important in your financial life.Quickly, how would you would answer this question: “What’s your income?”

Did you think about the amount of your payday deposit? Did you think about the amount on your income tax return for the year?

One is your net income and the other is your gross income.

Everyone should understand the difference between gross and net income and why both numbers are important in your financial life.

Let’s review some of the common factors that go into calculating your gross and your net income – both monthly and annually.

Monthly Gross Income vs. Net Income

Your monthly gross income is what you earn at your job before any deductions. You can find your gross income on your pay stub. From this number, multiply by the number of pay periods per year and divide by 12 to get your average monthly gross income from that job.

Your monthly net income is your take-home pay – whether you receive a check or have direct deposit set up with your bank account. To calculate your monthly net income, multiply your take-home pay by the number of pay periods per year and divide by 12.

Your gross income can be reduced by items such as:

  • Federal income tax withholding
  • State income tax withholding
  • City income tax withholding
  • Social Security & Medicare withholding
  • Health insurance and savings plans
  • Union dues
  • 401(k) contributions

Why You Should Know the Difference on a Monthly Basis

For families and individuals, there are several reasons to know the difference between gross and net income:

Cash-Flow Planning

Household and personal expenses are going to be paid out of the net income  – while the money taken out for taxes, insurance and retirement savings is not available to pay the bills. Most household bills generally cycle each month and it’s easier to create a monthly budget using a monthly new income estimate.

Net Pay Per Hour

By dividing net income by the number of hours worked, you can calculate your net hourly wage. This is a good number to know for both hourly and salaried employees. When making a purchasing decision, you can figure out how many hours you need to work to buy a new TV or big vacation.

Example: Terry works a full-time job at $18 an hour. Payday is every other Friday. Terry earns a gross income of $1,440 over 2 weeks but has the following deductions:

  • Income taxes ($216)
  • Social Security and Medicare ($81.36)
  • Health insurance contribution ($75)
  • 401(k) contribution at 5% ($72)

Terry has a net income of $995.64 to use for cash-flow planning. When Terry works on a monthly budget, only about $2,157 ($995.64 x 26 pay periods / 12 months) is available to give, save and spend. Knowing the net income, Terry can budget out how much money is available for each category and for each item.

Terry brings home about $12.45 per hour in net pay ($995.64 / 80 hours).

Annual Gross Income vs. Net Income

Your annual gross income can include many types of income that are above and beyond your paycheck:

  • Interest on bank accounts
  • Dividends and capital gains on investments
  • Alimony
  • Child Support
  • Income from side businesses
  • Income from part-time or seasonal jobs
  • Income from rental property
  • Annual bonus from employer
  • Gains from sale of antiques or collectibles
Your annual net income can be estimated during the year based on your net paycheck and estimating the net amount from the above items. Keep in mind that payroll tax withholdings are estimates. Only after completing your income tax return with all sources of income will you know the exact tax obligation.

Why You Should Know the Difference on an Annual Basis

By adding up all the sources of income for your family, you can use this information to:

  • Develop an annual budget for your family that includes all miscellaneous income sources
  • Develop an action plan for the misc. income so that money doesn’t just fritter away in the bank account
  • Plan for annual expenses such as insurance, car registration, Christmas expenses, and vacations
  • Develop good tax strategies
Knowing the gross and net income from specific job can help you make a decision about changing jobs or locations. When comparing the compensation packages of two jobs, it’s important to understand the effects from:
  • Taxing authorities
  • Tax brackets due to changes in income
  • Healthcare deductions
  • Bonuses and other perks

Example: Terry is considering applying for a different job within the city limits. The new job will have an additional city income tax of 1% and will require about $30 more in gas for the additional miles to the office every pay period. The new job offers lower cost health insurance and Terry is willing to contribute more to the 401(k) plan for the higher match.

The new job pays $21 per hour with deductions for:

  • Income taxes, increased by 1% city ($268.80)
  • Social Security & Medicare ($94.92)
  • Health insurance ($50)
  • 401(k) contribution of 6% to get full match ($100.80)

Terry’s gross income will increase each paycheck by $240 ($1680-1440) because the hourly rate is higher ($18 v. $21). However, net income will only increase by $170 ($1165.48-995.64) per paycheck.

Even with the additional $30 gas and higher retirement contribution, Terry will have more money to give, save and spend with the job change.

A Contractor’s Calculations

By definition, a contractor is not an employee and does not have estimated taxes, Social Security, or Medicare withheld from their compensation.

If you work part-time or full-time as a contractor, you should understand what percentage to set aside for taxes based on your household tax brackets. Self-employed individuals are required to pay “both sides” of Social Security & Medicare – so double the percentage of what is deducted from an employee’s paycheck.

Many contractors find it helpful to transfer a calculated percentage of income into a special savings account for taxes to save towards quarterly deposits and avoid a bite during tax season. A tax professional can help estimate tax payments based on income and likely business deductions.

Keep in mind that the calculations in this article are based on a specific set of circumstances, and your results will differ! So make sure to do the math yourself to come to the right figures for you in the current year.

Have you ever thought about the difference between your gross income and your net income in terms of either actual dollars or percentages? What did you do with this information?

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  1. Ron

    We have an “on-going” discussion in our home about tithing on gross or net income?
    Does anyone else have these types of discussions and are you able to find a biblical answer?

    • NCN

      Strictly speaking, “tithing” is an old testament thing, based in the law. As believers under grace (free from the law), we are free to give “with a cheerful heart”. So, give freely, based on the needs of the church and based on your blessings. #freeinHim (Just my 2 cents…)

    • GM

      Tithing was practiced approximately 400-plus years before the law was given in the old testament with Abraham giving a tenth of his spoils to Melchizedek (Genesis 14:18) whom many scholars describe– and I believe–was a Christ-like figure (Hebrews 7:6. There are many laws that were given we as believers still practice (and should practice) under grace, killing, adultery, honoring our parents, covetousness, etc., etc. As with all things, each of us are free to choose what we will or will not do, even when it comes to following the instruction of tithing. (Genesis 14, Hebrews 7)

  2. Christy

    When I think about how much money I make annually, I think of my net income. I believe the several thousand dollar difference makes a, uh, difference in what you can afford and how you think about your lot in life (I know, I know, you should always be saving and budgeting your money wisely no matter how much you’re making). However, I’m curious: what are most people quoting when asked this question? What are most people referring to when they’re asking this question?

    • Like Christy, I rarely think of my gross income since the net-income is the actual take-home pay. However, if one should enter a new tax bracket or moves into a job with higher health-care contributions, union dues, then one will encounter greater reductions in their paycheck. Thus, the gross income should be put into greater focus in such occasions. This article is very timely, as many more individuals will need to know their gross income, particularly the difference between last year’s gross income and their gross income for 2013. The expiration of the payroll tax cut will cause tax increases across all income levels. Good piece!

  3. Into Independence

    One observation I noticed early on was …. If I contribute 11% of gross income to a 401K, it does not reduce my net (take home) income by 11%. The net pay reduction works out to be less than the 11%. This is a really good and speaks to the tax advantages of a 401K.

  4. Yolanda

    To Ron: tithing on net or gross. I believe that we should tithe on our first fruits. This being said like in the article we can only budget to give from our Net pay. I tithe off of my net pay before 401k contributions. Uncle Sam takes almost a third so I view my actual pay as the portion I get to keep. When I look at my gross pay I feel like I am doing well. Then I look at my net and its just over half my gross. I am happy to be employed but deductions can be a challenge to overcome. I agree with this article budget on your take home salary. The net pay.

  5. Caesar F

    This was good to read as I always confuse between the two. Although I must say after doing the math, my annual net income doesn’t look too great, which makes me more alert about my money usage but none too happy about.