Gross Income Vs Net Income

The difference between gross and net income is important for consumers as well as corporates. Developing an understanding of gross income vs 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.

Understanding Gross Income Vs Net Income

Gross Income for Consumers: Gross income for consumers 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 and 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: Gross income for corporates 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*Cost per Unit of Sales - Cost of Goods Sold

Net Income for Consumers: Net Income for consumers is 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 percent 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 other qualified retirement plans and deductions for MSA ( Archer Medical Savings Accounts). AGI is used to determine the 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. Interested readers may refer to the article on table of SIMPLE IRA contribution limits.

Net Income for Corporates: The computation of net income for companies has been discussed in great detail in the article titled, 'profit and loss statement sample'. One may refer to the same for additional details.

Net Income before Tax = Sales - Cost of Goods Sold - Operating Expenses - Non-cash Operating Expenses + Non-Operating Income - Non-Operating Expenses
Net Income after Tax = Net Income before Tax - Taxes

What is Important? Gross or Net Income?

The distinction between gross vs 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 percent 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 percent but in no case should they exceed 11 percent 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. Thus, knowledge of both gross and net income is desirable.

It's evident from the above discussion 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 online gross income and AGI calculators are available on the internet.