What is gross income?
September 1, 2022 5 min read
Depending on where you look, gross income might be described in a few different ways.
The IRS defines it broadly, saying it includes “wages, dividends, capital gains, business income, retirement distributions as well as other income.”
When it comes to a person’s paycheck, it might be related to the income earned before payroll taxes and other deductions, such as insurance and retirement benefits, are taken out.
Income can be earned as someone else’s employee, through self-employment or through side work or gigs. But no matter where income is coming from, it’s important for a number of reasons related to budgeting, borrowing and taxes.
- Gross income is the money a person makes before withholdings and deductions.
- Deductions include things such as taxes, retirement contributions and insurance costs.
- Gross income is used to calculate a person’s debt-to-income ratio, a factor in lending decisions.
- Net income and adjusted gross income are calculated based on gross income.
Why understanding gross income is important
It doesn’t take much explanation to understand why the amount of money someone has coming in is important. But beyond basic pay and wages, there are other places it can be important, too. Gross income plays a part in determining tax withholdings from each paycheck and in filing state and federal taxes correctly each year. It’s also used in some lending decisions to calculate a person’s debt-to-income ratio.
How gross income works
Gross income is often a reference to what’s in a person’s paycheck before things like taxes are taken out. So-called pretax deductions might also be taken out.
Here are a few common deductions:
- Social Security taxes.
- Medicare taxes.
- Health insurance costs.
- Funding for flexible spending accounts.
- Retirement contributions, such as 401(k) plans.
- Life insurance costs.
- Job-related expenses.
- Union dues.
Based on those deductions, two people who have the same gross income could end up having different amounts of take-home pay—more on that below. But whether a person is salaried or hourly, a banker or a builder, the concept behind gross income is the same.
So gross income is the amount someone is paid before deductions. Net income is what’s left after those deductions. That’s why it’s referred to as take-home pay.
For example, let’s say John earns $50,000 per year. After his deductions and taxes are taken out, he may only take home $40,000. That $40,000 is his net income.
Although gross income is important for borrowing money, net income may be more helpful when it comes to budgeting. That’s because it’s a more accurate reflection of how much a person has available to spend.
Often called DTI, this ratio is one measure of a person’s financial health. And lenders may use it to judge loan or credit applications. Gross income is necessary to calculate debt-to-income ratio.
Adjusted gross income
Gross income can refer to more than just paychecks. When it comes time to file taxes, it’s related to other forms of income too. Recall that the IRS says it includes dividends, capital gains retirement distributions and business income—more on how it might relate to business below.
Adjusted gross income (AGI) is the amount the IRS uses when calculating taxable income. It’s gross income minus qualifying adjustments, such as:
- HSA contributions.
- Some student loan interest.
- Some college-related expenses.
- IRA contributions (in specific instances).
- Military moving expenses.
- Charitable donations.
- Teacher expenses.
- Business expenses.
AGI can be used to determine whether a person qualifies for tax deductions and credits.
Gross income and business
When it comes to business, gross income is also known as gross profit. When it’s expressed as a percentage, it may be called gross profit margin. To understand gross income for businesses, it helps to know a few more terms:
- Gross receipts: Generally, this includes all revenue received during a tax year. Sources might include money from sales and services.
- Cost of goods sold: Sometimes called COGS, this generally includes the expense of producing goods.
- Returns and allowances: This includes refunds, rebates and credits given to customers.
Accounting methods vary. But generally, gross income can be found by subtracting the cost of goods sold and returns and allowances from gross receipts. Net income goes a step further to factor in additional expenses, such as taxes and other operating costs.
Gross income in a nutshell
Gross income often helps determine how much money someone takes home from each paycheck. It may be used to determine the outcome of loan or credit applications. And it’s the starting point to figure out net income, which can help when developing a budget or setting financial goals.