What Is the Difference Between Gross Income and Net Income?

Your gross income and your net income are two different figures that are important to know, with the former being the total amount of income on your paycheck and the latter your actual take-home pay minus deductions and withholdings.

While you may use your net income for budgeting purposes, for instance, your gross income is what you would need if you're applying for credit or starting your tax return. Here's what you should know about gross versus net income and why it matters.

What Is Gross Income?

As an individual taxpayer, your gross income includes all of the income you receive from all sources. For many people, this might only be your salary or wages from your employer before any taxes and other deductions—such as for health insurance premiums and retirement contributions—are taken out. 

Depending on your situation, gross income may also include investment gains, rental income, interest, dividends, and compensation for services, including fees, commissions, fringe benefits, and similar items.

What Is Net Income?

If you're an employee, your net income from your employer is your take-home pay after taxes are withheld, and other deductions are made from your gross income. Calculating your net income from your job is fairly straightforward. 

If you have other sources of income, you'll also add those to your total gross income before you subtract taxes and other deductions to get your total net income.

Self-Employment Net Income

If you are self-employed, you usually must pay self-employment tax if you had net earnings of $400 or more.

Generally, the amount subject to self-employment tax is 92.35% of your net earnings from self-employment. You calculate net earnings by subtracting business expenses from the gross income you earned from your trade or business.

How Your Income Is Taxed

On your pay stub, you'll see a number of taxes withheld from your paycheck. Employers typically withhold:

• Federal and state income taxes
• Social Security, or FICA, tax
• Medicare tax

Your withheld income taxes will vary depending on your gross income and exemptions. You can adjust your withholdings with your payroll manager using a W-4 form. However, Social Security and Medicare taxes are fixed at 6.2% and 1.45%, respectively.

Adjusted Gross Income

Your adjusted gross income (AGI) is a number that the IRS uses to help calculate your taxable income as well as determine whether you qualify for certain tax deductions and credits.

You can calculate your AGI by subtracting any deductions that you may qualify for from your gross income.

Examples of tax deductions include:

• Student loan interest payments
• Educator expenses
• Certain retirement account contributions
• Some expenses for self-employed taxpayers.

How To Calculate Your Tax Bill

When you file your tax return, you'll start with your gross income and take out any deductions to arrive at your AGI. If you don't have any tax deductions, the IRS will allow you to take a standard deduction.

Standard Deduction

The standard deduction reduces your taxable income by a specific dollar amount, lowering your tax liability. Your standard deduction can change from year to year per the IRS and can vary depending on your tax filing status. Below are the standard deductions for the 2022 and 2023 tax years.

 The 2022 tax year (the return you'll file in 2023)

• For single taxpayers and for those who are married but filing separate returns: $12,950
• For heads of households: $19,400
• If you're married and filing jointly, or if you're a qualifying surviving spouse with a dependent: $25,900

 The 2023 tax year (the return you'll file in 2024)

• For single taxpayers and for those who are married but filing separate returns: $13,850
• For heads of households: $20,800
• If you're married and filing jointly, or if you're a qualifying surviving spouse with a dependent: $27,700

Tax Credits

Once you've subtracted your deductions, you'll arrive at your taxable income before tax credits. If you qualify for tax credits, you'll apply them directly to your tax liability, reducing it dollar for dollar to get your final tax bill for the year.

Examples of tax credits include:

• Earned Income Tax Credit (EITC), which helps low- to moderate-income workers and families receive a tax break
• Child Tax Credit, which helps qualified families with children get a tax break

Once you've subtracted your deductions and tax credits, you'll arrive at your taxable income, which the IRS uses to determine how much you owe for the year.

If it turns out that you paid more than you needed to, either through withholdings from your paycheck or estimated tax payments, you have two options. You can receive a refund for the difference or credit the amount to the following year's tax bill. Conversely, if the taxes owed exceeds your withholding, deductions, and tax credits, you'll owe the IRS at tax time.

Federal vs. State Income Taxes

The federal government has a graduated income tax rate, which means that taxpayers with higher incomes pay higher rates than those with lower incomes. With state income taxes, however, you may have to pay a graduated income tax, a flat income tax, or no income tax at all.

Taxable vs. Nontaxable Income

It's important to note that some income is not taxable.

Examples include:

• Child support payments
• Alimony payments if you were divorced after Dec. 31, 2018
• Certain employee benefits
• Life insurance payouts
• Inheritances
• Municipal bond interest
• Unrealized investment gains
• Financial gifts
• Roth IRA and health savings account (HSA) distributions

When To Use Gross and Net Income

In addition to knowing the difference between gross income and net income, it's also important to know when to use each figure. 

For example, if you're creating your monthly budget, you'll typically use your net income because that's the money you have to work with every month. But if you're applying for a loan or credit card, you'll typically use your gross income instead of your net income. 

Gross vs. Net Income for Self-Employed Taxpayers

If you earn self-employment income as a freelancer, independent contractor, or sole proprietor, the difference between gross and net income is a little more complicated.

Your gross income is all of the payments you receive from clients or customers for the year before expenses. If you're a freelancer or independent contractor, clients typically don't withhold taxes from payments made to your business.

Your net income, on the other hand, is what you have left after you subtract all of your eligible business expenses and estimated tax payments from your gross income. This is what the IRS will use to determine your tax liability for the year. 

The Bottom Line

Understanding net versus gross income is important for your budget, taxes, loan applications, and more. Taking the time to understand how to calculate them and the different ways they affect you can help you be better prepared at tax time—and lead to better decisions about your money management.

Frequently Asked Questions (FAQs)