Gross income is one of the most important metrics in financial accounting. It refers to, as its name implies, gross sales revenue before deductions for expenses and taxes are made. Not all businesses use gross income; however, many companies choose gross income because it makes sense given that costs incurred during doing business need to be subtracted from the sales revenue generated to determine the profit of a company. Gross income is also known as gross earnings, and it’s commonly abbreviated with the acronym “GI.”
How Gross Income Works
Income is a key measure of your financial well-being. However, while the concept of income is simple in theory but calculating your income can prove to be quite tricky.
Take, for example, I earn a monthly salary of $3,000. This amounts to a gross income level of $36,000 annually. In this case, then I’m taxed in accordance with my income level, 30% tax bracket for example. I will have to pay $9,600 as taxes or social security contributions after earning $36,000. This effectively means that a gross income of $36,000 is reduced to $26,400.
The gross income level is particularly crucial for taxation purposes and the use of gross income as a benchmark can improve tax collection by enabling policymakers to determine who should be taxed at more than one rate. It also helps in determining how much people would receive in social security benefits if they are made unemployed or ill.
It’s not only your income as an employee that is subject to taxation. There are also other sources of gross income that are subject to taxation.
Other Sources of Gross Income
1. Investment Income
Income that is received as a result of investment or ownership of securities such as stocks, bonds, and notes.
2. Business Income
Income received as a result of one’s ownership, management, or participation in an otherwise recognized business activity.
3. Farm and ranch Income
Income earned from performing work on a farm or ranch.
4. Rental Income
Income earned by letting out a property of one kind or another to others for their use in fair return for payment received.
5. Income from Estates or Trusts
Income that is paid to a beneficiary of an estate or trust, assuming that the beneficiary has qualified under applicable rules.
6. Unemployment Compensation
Compensation that is paid to workers by government agencies when the individual is unemployed and actively seeking new employment, assuming that he has qualified for the compensation.
7. Social Security Benefits
Benefits that are paid in partial or total replacement of work-related income and which are paid under any social security arrangement adopted in the US or under a similar plan adopted in another country.
8. Canceled Debts
Amounts that are forgiven as payment for loans or other indebtedness, provided that the indebtedness was incurred by the use of property or services as capital to generate income.
9. Capital Gains
Income earned from sales of a capital asset such as real estate or stocks and bonds. Capital gain income is taxed as ordinary income, but only when the asset sold was held for more than one year before its sale.
10. Interest and Dividends
Income received by a person as the result of holding investments in financial instruments such as stocks, bonds, certificates of deposit or other types of accounts that are considered to be financial capital.
11.Other income includes:
Child support alimony, gambling wins, mineral rights, pension, royalties, self-employment, and freelancing.
Tips
Some other gross income sources like inheritance, workers’ compensation, life insurance payouts, and municipal or state bonds are not subject to taxation.
Once you are paid, your employer withholds state and federal taxes, Medicare, and social security taxes before dishing out the salary to you. If you are self-employed or operate as a freelancer, you must report your gross income and pay your taxes.
Why Understanding Gross Income is Important
Understanding your gross income is very important because if you have an unfortunate incident of a divorce, it determines whether you can pay for child support or alimony.
The knowledge of your gross income is very important because it helps you to plan for your future and also your retirement.
Lenders also use your gross income to determine whether you are eligible for a loan or not. Ideally, lenders will use your debt-to-income ratio to determine whether you are fit to receive a loan. The best debt-to-income ratio (DTI) should be less than 36 though some banks will offer loans to you if you have a ratio of 50.
Gross Income vs Net Income
While gross income is the total income you receive before any deductions, net income is the amount after the deductions and taxes are paid.
The typical deductions could include business expenses, insurance premiums, wage garnishment, child support, health savings, retirement savings, among other deductibles.
These deductibles lower the taxable income, which is referred to as pretax deductions. Roth IRA taxes and certain voluntary benefits do not lower the taxable income and are referred to as post-tax deductions.
The other names used to refer to net income are disposable income or take-home income, meaning this is the amount you are left with to cater for your expenses. It is advised that you do your budgeting using the net income and not the gross income.
The reason why you should not do your budget using the gross income is that you still do not know how much your deductions will amount to. If you budget $2500 based on your gross income of $3200, the net income after deductions might be $2300 leaving you shy of $200.
