Gross vs Net Income: Definition and How to Calculate

A gross income is an employee’s total income before taxes and deductions are subtracted. A net income is an employee’s gross income minus taxes and other paycheck deductions.

While both gross and net income means the money an you earn as an employee, there is one difference:

Gross income is the money an employee earns from hourly salary, hourly wage, bonuses, and commissions.
Net income is the money an employee is left with after subtracting taxes and any deductions for health insurance, retirement plans, or other benefits.

For example:

Gross income: You’re paid $20 bucks an hour to work at Twitter. You worked 40 hours per week. You’re paid on a weekly basis. That means your gross income (total earned) is $20 per hour X 40 hours = $800.
Net income: Once you have your gross income, subtract the taxes (Social Security Tax, FICA, Medicare Tax, etc.). What you have left after taxes is your net income which is the amount you take home for that week.

State law requires that every paycheck must have a paystub stating your gross income, taxes, deductions, and net income. If you need to know what a pay stub is, I wrote a blog on what is a pay stub. If an employer does not provide a pay stub, an employee can sue for money damages.

Paystub Showing Gross vs Net Income

Why is it Important to Know the Difference Between Gross Income and Net Income?

Understanding gross income vs net income is important for understanding your taxes, and can help you budget for your monthly living expenses. Also, understanding the difference between gross income and net income is important to know how much money you earned and you will receive on pay day.

When individuals have a clearer understanding of the key differences between gross income and net income, they better understand how much their employers will pay them. Being familiar with these two concepts also helps individuals budget more effectively and understand how their state and the country tax them.

While understanding these issues is important for individual employees, it is also vital for employers and small business owners to understand how much they pay their workers and if they are paying them the correct amounts. For example, business owners who understand how gross income and net income compare can more effectively negotiate salaries, hire workers, budget for their companies, and oversee payroll.

What is Gross Income?

Gross income is the amount workers earn before employers and agencies withhold taxes and other payroll deductions, such as benefits, from their paychecks. Therefore, many consider gross income the “total” amount of the paycheck, although workers do not see the entire amount.

Net income is the amount workers are left with after withholdings have been subtracted. We also call net income “take-home pay” since it is the amount employees can deposit or spend. We will elaborate on net income later in the article.

Many sum up the concept of gross income as the wages employees earn before deductions. Many small business owners use “gross income” when reviewing compensation figures with new employees. Often, if an employer tells a prospective employer they will earn $75,000 during their first year, they mean gross income. But, realistically, the worker would earn less than $75,000 because of the necessary deductions.

Another place we see the gross income concept utilized is on state and federal tax forms. Many workers find it useful to view their gross income for the quarter or the year and then make sure that they complete all deductions properly and that they don’t lose any money.

What is the Formula for Calculating Gross Income?

The formula for calculating gross income depends on how the company pays the worker. For example, the calculation for salaried employees differs from the calculation for hourly workers. Let’s look at each scenario.

For workers on salary, divide their yearly salary by the number of pay periods in the year. Therefore, if someone makes $60,000 and their employer pays them monthly, their gross income is $5,000.

On the other hand, hourly workers can multiply their hourly rate by the number of hours in their pay period. Therefore, if a part-time worker works 30 hours at $10 per hour, their gross income will be $300.

If they apply, employers must also add overtime rates into these equations.

What is the Formula for Gross Income?

To figure out gross income, workers can multiply their gross income amount by the number of payment periods. For example, if a worker makes $1,000 per week and works every week during a year, they make $52,000. However, we must remember that this sum precedes any deductions and is the gross income, not the worker’s net income.

What is Net Income?

Net income means take-home pay or the amount employees earn after all payroll deductions are subtracted from their gross income. When employers pay employees, they receive a paystub with two amounts. One is their gross income, the full amount we just covered. The other amount is the net income the individual will receive. Net income numbers depend on the number of payroll deductions. Some deductions are voluntary; for example, some workers elect to pay X towards retirement. However, some deductions, such as taxes, are mandatory.

The compensation employees get to take home depends on various payroll deductions, some of which may be voluntary, whereas others are mandatory.

What Factors Determine One’s Net Income?

W-4s, Employee’s Withholding Certificates
When employees start a new job, they fill out Form W-4, which provides information about their filing status, dependents, and other sources of income. These details directly impact how much federal income tax the IRS deducts during each pay period.

Federal Income Taxes
The IRS calculates federal income taxes using a system that increases these tax withholdings based on income. When their gross income is larger, individuals pay more taxes.

State Income Taxes
Different states have vastly different tax policies. Some states tax incomes in the same progressive manner as the federal government, while others do not have any taxes. Some cities in the US also enforce their taxes.

Social Security and Medicare
These two taxes are also called payroll taxes, and employers must match them, as stated by the Federal Insurance Contribution Act (FICA).

Earnings Assignments

If an employee incurs debt, a court of law can dictate that their company withhold a percentage of their pay to make up for some of that debt. These earnings assignments include payments on student loans, alimony, credit cards, unpaid taxes, medical expenses, and other unpaid debts.

Health Insurance Costs
Many companies cover the cost of health insurance premiums, but workers also make contributions during each pay period.

Retirement Plans
Gross income is subject to retirement plan contributions, for example, 401K contributions.

What is the Formula for Calculating Net Income?

Calculating net income is much different from calculating gross income. However, using a basic formula, employees and employers should be able to determine their net payment amount.

Here are the fundamental steps to calculating net income:

First, figure out the gross payment amount. Use this equation: hourly rate times the total of hours worked. Or, divide the worker’s salary by the pay period number.

Then, subtract the figures for pre-tax contributions such as 401(k)s, health insurance, and more, depending on the individual.

Next, withhold taxes: FICA taxes, state taxes, federal taxes, and local taxes.

Finally, subtract wages if the worker currently pays any court-ordered sums, such as a debt on a credit card or student loans.

The remaining figure should be the employee’s net payment amount. We recommend reviewing it once more and checking the math to ensure the number is correct.

Contact Nakase Wade

We hope this article has helped you distinguish between gross pay and net pay, as well as figure out how to calculate each amount. In addition, knowing how employers arrive at these numbers helps workers identify paycheck problems or wrongful payments.

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