Gross income is a fundamental concept in the US tax system. It’s simple to understand at a high level, but has some finer points that can confuse the unwary tax filer. Read on to learn what gross income means, how to calculate gross income, and a few ways to reduce your tax liability.
What does gross “income” mean?
Gross income, simply put, is all the money you make in a year before taxes and deductions. It’s contrasted with net income, which is your “take-home pay”, the money you keep after taxes (and other deductions, like an HSA or a 401k).
Your gross income is an important number because it is the starting point for your taxes— you are taxed on your gross income minus any deductions you qualify for.
For most employees, their employer deducts their estimated taxes from each paycheck. These employees’ gross income never even hits their bank account, because their employer is withholding their taxes and sending it to the IRS throughout the year. This is different for the self-employed, or 1099 contractors. These people are simply paid what they are paid (their gross income) and should be setting aside their taxes so they aren’t hit with a massive bill during filing season.
There are some finer points on calculating gross income when it comes to tax filing individuals versus businesses with their corporate applications. We’ll discuss that next, but here’s a summary so far.
- Gross income vs net income
- Gross income is (pretty much) all the money you make in a year
- Net income is your “take-home pay”
- You are taxed on your gross income minus any deductions you qualify for
- Most employees already have taxes removed from their paychecks
- Self-employed individuals should set aside their estimated taxes from their gross income
Gross Income for Individuals: What is my gross income?
Finding your personal gross salary is easy. For most individuals, you can simply take your W2 form at the end of the year (or any salary paystub throughout the year) and the amount will be listed on the form. The W2 will list it as “wages, tips, and compensation”. Most company pay stubs will call it “YTD Gross Income”, as pay stubs only list your gross income “year-to-date”, or up to that pay stub. It’s that simple!
What does gross income mean for my taxes?
Generally speaking as individuals, your gross income is the starting point for your taxes. Typically, if you have a higher gross annual income, you will need to pay more in taxes. However, (And this is where it gets tricky) there are certain deductions you can use to reduce your taxable income to maximize the money you get to keep. While there are others, 401ks and HSAs are the two most common deductions you can use to reduce your tax liability.
A traditional 401(k) is an individual retirement savings account that has untaxed contributions. This means that if you contribute to a traditional 401(k), your taxable gross salary is considered “less” by the government. You contribute, taco-free, to the 401(k), which can then accrue interest with your untaxed money until retirement. You should note that while this tax deduction only applies while contributing to it, not when withdrawing. Withdrawals from a 401(k) in retirement are taxed as income. The benefit is that your account was able to grow interest on untaxed dollars.
Important note on 401(k)s: unlike a traditional 401(k), a Roth 401(k) is still taxed in the year you contribute to the account. This type of account will not reduce your taxable income regardless of your gross salary. The advantage of a Roth is that withdrawals in retirement are tax free. You should do your research and consult with an advisor before deciding which retirement account is best.
HSAs (Health Savings Accounts) can also reduce your taxable gross salary. Depending on your plan, your HSA contributions may count as deductions against your gross annual income, allowing your to reduce your liability when doing taxes.
Gross Income For Businesses: What’s different?
Asking “what does gross income mean” gets an entirely different answer when you’re asking as a business owner. This is essentially because of two reasons: It is calculated differently, and it is taxed differently.
Business gross income is defined as their annual revenue minus the cost of goods they sold. It’s not a very frequently used term, because it essentially equates to net profit (total revenue minus expenses). In a business financial statement, gross income is typically only used if there is something further that will be done with the income, extraneous to the business goods and services. This is why it isn’t the same as an individual’s gross annual income. Other terms, like net profit or other financial terms are better used by businesses to describe company costs and revenue. These other metrics, like net profit margins, are more specific at telling the business whether their total costs and expenses are exceeding their sources of revenue, allowing them to account more specifically for where they need to alter amounts of money, expenses, or goods and services provided.
Understanding what gross income means is simple enough, with just a few snags that you should be aware of. Find it on your W2 or your paystub (if your company doesn’t provide paystubs you can generate one here), and decide how you should use credits and deductions to minimize your tax liability and leave this tax season smiling.