What is gross income? How it works and why it’s important
What is gross income
Gross income refers to the total earnings you receive from wages, tips, investments and interest, before taxes are deducted. The amount of money remaining after taxes are deducted is called net income. On a pay stub, for example, your gross income or gross pay is your total compensation before taxes and withholdings are deducted, while your net income or take-home pay is what’s shown after taxes and deductions are taken out. Net income is always lower than gross income unless you’re exempt from paying taxes and have no deductions.
Understanding what your gross income is and how it’s calculated is important because it’s a key factor in determining the rate you’ll pay for federal and state income taxes.
How gross income works
For many people, gross income is primarily the earnings you receive via a paycheck, which can be a combination of hourly wages, salary, commission and bonuses. In addition to wages, other sources of gross income may include:
- Alternative compensation for services rendered
- Business income
- Capital gains
- Dividends
- Gambling winnings
- Gas, oil, or mineral rights
- Income from discharged debt
- Income from a decedent or as an interest of an estate or trust (generally, assets inherited by a beneficiary aren’t considered income, but in some cases a beneficiary may owe inheritance tax)
- Interest from bank accounts, certificates of deposit (CDs), etc.
- Pensions and other retirement income
- Rental income
- Royalties
- Self-employment income
- Selling goods online or in-person
- Tips
The above sources of income are subject to taxation, though some examples of income that are generally non-taxable include alimony, inheritances, municipal or state bond income, workers’ compensation payments and life insurance proceeds.
Employers withhold state and federal income taxes and Medicare and Social Security taxes from your paycheck before you receive it. Meanwhile, it’s the responsibility of business owners and people who are self-employed, independent contractors or freelancers to pay their share of taxes from their gross income.
The gross income for a business is calculated by totaling its gross revenue minus the cost of goods sold (COGS).
Examples of gross income
Here’s an example of what gross income looks like for an individual on a weekly basis:
- 45 hours worked at $15 per hour = $675
- Commission = $150
- Bonus = $500
Total weekly gross income = $1,325
Here’s an example of what a taxpayer’s gross income might look like on an annual basis:
- Annual salary: $55,000
- Annual bonus: $5,000
- Rental income: $10,000
- Interest: $675
- Stock dividends: $500
- Side business income: $10,000
- Selling goods online: $1,300
Total annual gross income: $82,475
Here’s an example of a business’s annual gross income:
- Gross revenue: $275,000
- Cost of goods sold: $200,000
Total annual gross income: $75,000
Why understanding gross income is important
Gross income is an important concept to understand because it’s a starting point to calculate your tax liability. Gross income, minus certain adjustments, is known as adjusted gross income — and this amount is used to determine which tax bracket you fall into based on your filing status.
In 2024 and 2025, the federal income tax rates for each of the seven brackets are: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent. What’s more, if your gross income is below a certain threshold, you might not be required to file taxes.
Gross income is also used by lenders to determine how much they will allow someone to borrow for a loan, like an auto loan or mortgage. The lender will determine how much to lend based on the individual’s debt-to-income ratio, or DTI. The DTI is determined by dividing monthly debt payments by monthly gross income.
The higher someone’s DTI, the less likely a lender will want to loan money and the higher the interest rate on the loan will be. Ideally, DTI should be no higher than 35 percent; however, some lenders will lend as high as 50 percent DTI.
Gross income vs. net income
The total amount of pay received is gross income, while net income is the remaining amount after taxes and deductions are taken out.
Deductions could include:
- Health insurance premiums
- Life insurance premiums
- Voluntary benefits (accident, sickness, critical injury, disability, etc.)
- Flexible spending account contributions
- Health savings account contributions
- Job-related expenses (uniforms, union dues, meals, travel, etc.)
- Retirement contributions
- Wage garnishments
- Child support payments
Most deductions reduce taxable income, and they’re known as pretax deductions. Other deductions, such as contributions to a Roth IRA and certain voluntary benefits, do not lower taxable income and are referred to as post-tax deductions.
Net income is often called take-home pay, and should serve as the basis for creating a budget. Living expenses, bills, debt payments and other obligations should be budgeted based on your net income rather than gross income to account for the impact of taxes and other deductions. Budgeting based on your gross income likely will cause you to be short on your goals each month.
Here’s an example of why a budget should not be based on gross income without accounting for deductions and taxes. Sally has a monthly gross income of $4,000 and a net income of $3,000. She creates a budget with her gross income amount with total expenses equalling $3,500. Because Sally only brings home $3,000, she is short $500 on the monthly budget. Sally will either have to adjust her budget to account for the $500 or find a way to increase her net income by $500 to cover the remaining expenses.
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