What is Gross Income?
Gross income refers to all of the income a person earns before taxes are taken out of his paycheck. It is distinct from net income, which is the amount of money a person gets to bring home. Gross income is used in several important calculations, such as determining a person's acceptable maximum debt-to-income ratio when the individual attempts to qualify for a mortgage.
In the United States and many other countries, people are required to pay income tax on wages. In the US, for example, an individual must pay federal income tax, state income tax, and in some cases local income tax. He is also required to pay Social Security and Medicare taxes up to a portion of his income; as of 2010, for example, individuals are required to pay 6 percent of income in Social Security tax and another 1.5 percent in Medicare taxes on the first $106,000 US Dollars (USD) in income.
Depending on a person's tax bracket, this can mean he ends up paying up to 42.5 percent of his wages in taxes, assuming he is in the 35th percentile tax bracket. While many individuals are in a lower tax bracket, the percentage can still be upwards of 25 percent of total money earned. This means that when a person is told he is hired for a job that pays $40,000 USD per year, he does not actually bring home $40,000 USD per year.
In that example, the $40,000 USD per year figure is the individual's gross income. That is the amount that the employer is actually paying out of its pocket to the worker. Since the IRS takes its cut, the worker doesn't receive that full amount. The taxes are taken directly out of each paycheck he receives, so the net amount he brings home — the net income — is lower than it would have been if the taxes were not deducted.
Because the United States tax system is a pay-as-you-go system, the deductions for taxes are taken out of each paycheck before the employee ever sees it. Thus, although most people quote their salaries in terms of gross income when asked, the most important number is net income, since that is the amount of money they actually see in their checks and the amount that they actually have to spend on other necessities. For self-employed individuals, on the other hand, all money is paid out to the individual; he then writes a check for his taxes quarterly or annually and can subtract the amount of the check he wrote in order to determine his net profit or income.
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