Gross income is known by a few names – pre-tax income, gross profit, before-tax income, and gross pay to name a few – but this should not confuse you. Regardless of which name you know it by, this metric is the most important number to know when it comes to determining personal or business tax obligations.
So, what exactly is gross income and how is it calculated?
What is Gross Income?
Essentially, gross income is the total amount earned by a business or individual over a certain period of time. For individuals, it’s generally calculated on a yearly basis, but companies usually report their gross earnings on a quarterly basis.
Determining what income should be included when calculating gross income can be difficult. The numbers that businesses use are different from those used by an individual. Understanding such differences will help you better understand what this figure tells you about a business, and what needs to be included as income for tax purposes.
Calculating Gross Income
As we mentioned, exactly how to calculate this number is different for individuals than it is for businesses. To understand each, we’ve broken down the information into two parts below.
Gross income represents the total income earned by an individual on a paycheck before deductions and taxes. It’s comprised of all income received by an individual from sources including wages, interest income, rental income, and dividends.
Individuals who are employed full-time have their annual wages or salary before tax to use as their gross income. However, as we discussed above, full-time employees may also have other income that comes from other sources. In this case, it always has to be calculated into their income as well.
The gross profit is a line item on a business’ income statement. This figure is the company’s yearly profit before any taxes or expenses are deducted. Basically, it represents all revenue earned by a company from selling goods or services after all direct costs that were incurred from producing the goods are subtracted.
Direct costs include items such as equipment used in the manufacturing process, labor costs, supply costs, costs of shipping, and costs of raw materials. It’s important to note that taxes are not deducted because they are not directly linked to the production or sale of a product.
To calculate gross profit, a company will use the following formula:
Gross Income = Gross Revenue - Cost of Goods Sold
How to Read It on Tax Forms
Understanding the meaning of each box on your yearly W-2 can make filing your taxes less stressful. On this form gross income, the total amount of salaries and wages are found in Box 1 of the W-2.
If you’ve calculated your own income, and the number is different from what your employer included on the W-2, there’s no need for alarm. Companies will generally take out pretax deductions when reporting this number. Such deductions can include contributions made to employer-sponsored retirement accounts, spending accounts, parking, medical premiums, and so forth.
You can check your last pay stub for the year if you’d like to know your total gross pay before any such deductions were made.
Gross vs. Net Income
Some people get net income and gross income confused. Here are the differences between these two types of income.
As you already know, gross income is the total of all income received from working a job or providing goods or services to clients, before taxes, expenses, or other deductions are made.
Alternatively, net income is the profit that an individual or business earned after expenses are subtracted. In terms of a company, net income is calculated by deducting all business expenses such as advertising costs, taxes due, interest expenses, and any other eligible deductions such as legal or professional fees.
When net income is calculated, a positive value means the company turned a profit, while a negative value means the company incurred losses.
If there is a significantly high difference between a company’s net income and gross profit, it should review all expenses and eliminate all unnecessary expenses and work to reduce those expenses that are necessary.
For individuals, net income is the amount of money earned after deducting federal and state taxes, health insurance, social security taxes, and so on.
What is Adjusted Gross Income (AGI)?
AGI provides a more accurate figure of what your income looks like after specific itemized deductions are made.
While gross income is an important number to know, your AGI will affect how much income taxes you will owe. This number will be calculated while completing a tax return. However, to ensure there are no mistakes, it’s best to use tax software or even seek help from a professional tax expert.
Examples of deductions you can include are IRA contributions, alimony payments, moving expenses, student load interest deductions, educator expenses, and some health insurance deductions, among many others.
The AGI is a critical number to understand as it will also affect the amount of a refund check you receive, if you are eligible for one.
In the end, gross income is very important and everyone should understand how to calculate it. The good news is that you generally don’t have to do many calculations, unless you earn a great deal of side income from rental properties, dividends, etc.