Gross vs Net Income: What is the Difference?
It wasn’t until I received my first salary paycheck that I truly realized a difference between gross vs net income. The first thoughts that came to my head were “Where is my money?” and “Give me back my money!”
Before I graduated college, I accepted a position with a software company. In an uncertain job market at the time, I was just pleased to be hired. Honestly, when I saw the offer sheet’s salary, I thought I would be rich.
So, don’t feel embarrassed if the difference is not evident to you. When I realized what the actual take-home pay was and living in a major metropolitan city, I had to be more mindful of my spending and personal finance.
Understanding the difference between net income and gross income is essential to knowing your real buying power and savings rate. So, if you’re trying to save up for a house down payment or saving up for medical school, you’re in the right place!
But, net income isn’t a term for individuals. Any business, especially a small business, also needs to calculate net income. So, if you’re a small business owner, I’ll be sure to touch on that as well.
Gross Income vs Net Income: What’s the Difference?
Individuals and businesses both use the terms gross income and net income. However, the net income has different meanings depending on the deductions or expenses
Individual
Gross income is the total income before any deductions are applied, such as federal income tax, state income tax, local income tax, Social Security, and Medicare. Other deductions can be payroll deductions, such as pre-tax contributions to retirement accounts, healthcare programs, a Flexible Spending Account (FSA), a Health Savings Account (HSA), and a Dependent Flexible Spending Account.
Therefore, my annual gross income was the amount stated in my offer sheet mentioned in my introduction.
On the other, net income is the income after all the previously mentioned deductions are applied. In other words, net income is the take-home pay. For businesses, net income is the income after a company subtracts the costs of goods sold (COGS) and other expenses from their revenue.
It’s important to note that net income is not necessarily the same as taxable income or adjustable gross income (AGI). I’ll go into more detail about that topic a little later.
Business
A business gross income also is a company’s total revenue before accounting for any expenses, such as operating expenses, depreciation, costs of goods sold, etc. Therefore, to calculate gross income, corporate finance would add up all the total amount earned for all your revenue streams.
However, net income is gross income minus the mentioned business expenses. A business owner can find at the bottom line of a company’s income statement the net profit, net earnings, and, most especially, the line item net income.
Net income also can be used in other financial statements. Businesses can also use net income in the balance sheet and the cash flow statement.
In contrast, net operating income is the operating profit minus operating related expenses. Furthermore, a person can also calculate the net operating income by adding the net income, interest expense, and taxes.
Individual List of Deductions
Below is a list of standard deductions that the federal and state government and an employer take from a person’s gross annual income:
Federal income tax
The Internal Revenue Service (IRS) imposes a tax on all income sources. The government uses these taxes to make changes and improvements to various parts of the country, such as military, infrastructure, education, and aid where needed. The IRS bases the tax amount owed on the tax bracket one’s taxable income falls within.
State income tax
State income tax is similar to federal income tax. The main difference is that the state government uses the taxes to fund projects at a state level. The tax amount due also depends on one’s taxable income and their state’s tax bracket.
Social Security
The government uses social security to supplement older citizen’s retirement income. Social security is not a retirement plan but a way to cover a percentage of their income. Employees pay 6.2% of their wages while the self-employed pay 12.4 of their gross pay toward social security.
Medicare
Medicare is a health insurance program intended for elderly citizens where the government uses the funds to pay for medical-related expenses. The tax is 1.45% of an employee’s wages.
Payroll Deductions
There are a couple of payroll deductions that can lower a person’s net income. Some examples of these payroll deductions are participating in a high deductible health plan, tax-advantaged retirement accounts, and other health savings accounts, such as an HSA, FSA, and a Dependant FSA.
What is Taxable Income?
Taxable income is the income the IRS uses to determine how much tax an individual owes. The IRS bases the tax owed on which tax brackets the taxable income fits within. The IRS publishes these tax brackets annually (you may also see below for 2021 Federal tax brackets).
It’s important to note that the taxable income is not the same as gross income or net income. Instead, taxable income is the result of subtracting qualified tax deductions from the gross income. Thus, IRS also refers to taxable income as adjusted gross income (AGI).
2021 Federal Tax Brackets and 2021 Standard Deductions
Below are the federal tax brackets and the standard deductions for the tax year 2021 per the Internal Revenue Service.
Some terms to also be familiar with are marginal tax rate and effective tax rate. The marginal tax rate means the highest tax bracket. On the other hand, the effective tax rate is the tax amount ratio due to the gross income (not necessarily the average tax rate).
2021 Federal Tax Brackets
| Tax Rate | Married, jointly | Single |
|---|---|---|
| 10% | Less than $19,900 | Less than $9,950 |
| 12% | $19,900 - $81,050 | $9,950 - $40,525 |
| 22% | $81,050 - $172,750 | $40,525 - $86,375 |
| 24% | $172,750 - $329,850 | $86,375 - $164,925 |
| 32% | $329,850 - $418,850 | $164,925 - $209,425 |
| 35% | $418,850 - $623,300 | $209,425 - $523,600 |
| 37% | Over $623,300 | Over $523,600 |
2021 Standard Deductions
| Filing Status | Deduction Amount |
|---|---|
| Married, filing jointly | $25,100 |
| Single | $12,550 |
| Heads of household | $18,800 |
How to Calculate Net Income?
For an individual, the net income formula is the gross income minus taxes. This formula doesn’t include any payroll deductions, such as contributing to a tax-advantaged retirement account. However, you should take payroll deductions to estimate your annual take-home pay accurately.
Individual Net Income = Gross Income – Federal Income Tax – State Income Tax – Social Security – Medicare
For a business, the net income formula is the revenue subtracting costs of goods sold and expenses.
Business Net Income = Sales Revenue – Costs of Goods Sold – Expenses
Here are some additional formulas for reference that show the gross profit and net profit in the form of a percentage.
Net Profit Margin = Net income / Sales Revenue
Gross Profit Margin = (Sales Revenue – Costs of Goods Sold) / Sales Revenue
Calculating Individual Net Income Example
In this example, we have a single individual living in Atlanta, GA, with a taxable income of $76,000.
Federal Income Tax
The following are taxes due per the 2021 federal tax brackets:
- 10% of $9,950 = $995
- 12% of $30,575 ($40,525 – $9,950) = $3,669
- 22% of $35,475 ($76,000 – $40,525) = $7,805
Therefore, the federal income tax due is $12,469 ($995 + $3,669 + $7,805). Furthermore, this individual’s marginal tax is 22%, and the effective tax rate is 16.4%.
State Income Tax
According to Tax-Brackets.org, below are the taxes due per Georgia’s tax brackets:
- 1% of $750 = $7.50
- 2% of $1,500 ($2,250 – $750) = $30
- 3% of $1,500 ($3,750 – $2,250) = $45
- 4% of $1,500 ($5,250 – $3,750) = $60
- 5% of $1,500 ($7,000 – $5,250) = $75
- 5.75% of $69,000 ($76,000 – $7,000) = $3,968
Therefore, the state income tax due is $4,178 ($7.50 + $30 + $45 + $60 + $75 + $3,968).
Social Security & Medicare
Social security is 6.2% of $76,000, which is $4,712, and Medicare is 1.45% of $76,000, which is $1,102.
Final Calculation
According to the net income formula, the net income for $76,000 gross income is $53,539 annually, about $4,462 a month or $2,231 bi-weekly.
Net Income = $76,000 = $12,469 – $4,178 – $4,712 – $1,101 = $53,539
Remember, this final calculation does not include any payroll deductions, such as contributions to a company 401k, medical and dental programs, health savings account, etc.
How Much is $76,000 in Different Cities?
Can you make a year living off $76,000? From a federal level, the federal income tax, social security taxes, and Medicare tax are the same across all states, which is about $18,283.
The state’s income tax brackets are where the net incomes vary. You don’t need to pull out a total tax calculator or a salary calculator here. I did all the math to calculate the tax payments. You’re welcome!
| City | State Income Taxes | Annual Net Income |
|---|---|---|
| Los Angeles, CA | $4,908 | $52,809 |
| Denver, CO | $3,519 | $54,198 |
| Washington, DC | $4,860 | $52,857 |
| Orlando, FL | $0 | $57,717 |
| Chicago, IL | $3,762 | $53,955 |
| Boston, MA | $3,800 | $53,917 |
| Omaha, NE | $4,304 | $53,413 |
| Las Vegas, NV | $0 | $57,717 |
| New York City, NY | $5,023 | $52,694 |
| Nashville, TN | $760 | $56,957 |
| Dallas, TX | $0 | $57,717 |
| Salt Lake City, UT | $3,762 | $53,955 |
| Seattle, WA | $0 | $57,717 |
Conclusion
When determining what kind of lifestyle you want to live, it’s essential first to understand how much you can afford. You won’t legally pocket 100% of the salary presented to you on your offer sheet. There are several deductions applied to your paycheck that will ultimately determine your net income but also can lower your taxable income.
Thus, when looking for new job opportunities, especially ones requiring relocating, you need to consider all the taxes, payroll deductions, and, most importantly, the cost of living.
For instance, in San Franciso, it requires more money to afford an apartment than a North Carolina city. You may need to find immediate additional income sources to live in an area with a higher living cost, especially if you have other major expenses like student loan debt.
As a fun fact, it shows that a person with a lower annual salary than another person’s yearly salary can easily have a higher net pay than the other person. Moreover, a person who works fewer hours can also have a higher hourly rate.
Mathematically, it’s all relative!
