Tap to Read ➤

Gross Income vs. Net Income: A Comparison

Aparna Iyer
The distinction between gross income vs. net income is important for consumers as well as corporates. We attempt to help you understand the concepts with utmost lucidity.
Comprehensive knowledge of gross income and net income is helpful to consumers, who would like to figure out the exact amount of money that should be allocated to essential expenses, like monthly mortgage payments, car loan repayments, etc.
Publicly traded companies are required by law to file the 10-Qs and the 10-Ks with the Securities and Exchange Commission (SEC). The income statement, or the profit and loss statement forms an important part of the report, clearly illustrating the difference between the gross and the net proceeds for the company under consideration.
When an organization discusses 'netting' money, it actually, is talking about the net income. The net income is the real-deal income; the sum you are left with, in hand after the deductions have been met.
There are times, when the organization may net absolutely nothing, i.e., when the expenses are catered, but there is no money left. In this case no gross profit is earned by the company.

Understanding the Concepts

Gross Income for Consumers

This refers to the total personal income before taxes, allowances, and tax deductions are taken into account.
Gross income includes the following items:
  • Wages
  • Salary
  • Tips
  • Taxable interest
  • Ordinary dividends
  • Capital gains (losses)
  • Taxable amount of IRA distributions
  • Taxable amount of pensions and annuities
  • Business income
  • Alimony received
  • Unemployment compensation received
  • Rental income from real estate
  • Income from royalties
  • Trusts
  • Taxable refunds
  • Taxable amount of Social Security benefits

It's important to note that gross income does not include the tax-free amount of Social Security benefits, gifts and inheritance, and interest from tax-free bonds.

Gross Income for Corporates

It is referred to as gross profit. It is computed by subtracting the cost of goods sold from the revenue that is generated. In other words --
Gross Profit = Sales x Cost per Unit of Sales - Cost of Goods Sold

Net Income for Consumers

Popularly known as Adjusted Gross Income (AGI). It is computed by deducting the following items from Gross Income:
  • IRA contributions
  • Interest paid on student loans
  • 50% of Self-employment tax
  • Moving expenses
  • Contributions for health insurance made by the self-employed
  • Alimony payments
  • Penalties for early withdrawal of savings
  • Contributions to Simplified Employee Pension plan and SIMPLE IRA
  • Contributions to qualified retirement plans
  • Deductions for Archer Medical Savings Accounts

AGI is used to determine individual's tax bracket, qualifying credits, and allowable contribution limits for tax-deferred retirement accounts.
Federal income tax liability for individuals is arrived at by subtracting itemized deductions from adjusted gross income (net income). These deductions include expenses, such as mortgage interest, medical expenses, charitable contributions, local and state taxes, gifts, real estate taxes, etc.
Net Income before Tax = Sales - Cost of Goods Sold - Operating Expenses - Non-cash Operating Expenses + Non-Operating Income - Non-Operating Expense

Net Income after Tax = Net Income before Tax - Taxes

Degree of Importance

The distinction between gross and net income becomes important for consumers, who are interested in availing home mortgage for buying a house. It's not advisable for consumers to spend more than 33% of their monthly gross income on mortgage payments.
If they find themselves in the situation of paying more than the recommended figure, they should consider alternative arrangements, like renting. Again, car loans repayments should ideally be 8%, but in no case should they exceed 11% of gross monthly income.
Companies pay a portion of the net income after taxes as dividends to consumers, while retaining the rest. Retained earnings are generally greater for companies that have growth prospects.
Companies in the mature growth phase prefer paying out most of their net income after taxes as dividends to shareholders. Information about past earnings and dividends is useful for investors, who are interested in receiving dividend income as well as those interested in capital appreciation.
While calculating gross and net income, you are subsequently acquainted with the expenses incurred accompanied by various dimensions of the business, so that the lucrative and potentially profitable aspects of the business are stimulated to facilitate growth.
Make sure that both figures -- gross and net income -- must feature on the federal tax return. Where inviting investors is the considered proposition, ready your income statement, as they would like to scour the same, ere investing.
However, if you have filed a loan application to fulfill ad hoc commitments, the institution that considers granting the sum to you, verifies the documents with regard to your gross income and net income statement. It is only, when the entire verification process is deemed satisfactory that the loan is sanctioned.
It is evident that computation of gross income vs. net income is important for consumers as well as companies. Although, the computation seems complex, consumers will be delighted to know that gross income and AGI calculators are available on the Internet.