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For individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.”
What Is the Importance of Gross Income?
Gross income is the starting point in calculating an individual’s or business’ tax liability. Individuals calculate gross income by adding wages or salary, tips, dividends, interest, capital gains, income from rental properties, alimony, and pensions. Not all income is included in gross income for tax purposes, such as Social Security benefits or life insurance payouts.
Subtracting certain “above-the-line” deductions from gross income determines a taxpayer’s adjusted gross income (AGI), which is important for determining state and federal income taxes.
Business gross income is gross revenue minus the cost of goods sold, or the costs related to producing goods or providing services. This can be calculated for the entire firm or per product and is the starting point for measuring a firm’s profitability.
Gross Income vs. Net Income
Net income is gross income minus the cost of total expenses, taxes, and deductions for individuals and businesses. Firms use net income or “net profit” to convey how a business is performing and overall profitability. Net income can be a positive or negative value depending on whether gross income exceeds total expenses or not.
Taxable income is a portion of net income and refers to the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income.
Gross Income vs. Adjusted Gross Income (AGI)
To determine tax liability, taxpayers start with their gross income, then subtract certain expenses, such as up to $250 of educator expenses, certain business expenses, health savings account and flexible savings account contributions, moving expenses for Armed Forces members, the deductible portion of self-employment tax, tax-deferred retirement contributions, self-employed health insurance premium payments, the penalty for early withdrawal of savings, alimony payments for divorces that occurred prior to Dec. 31, 2018, up to $2,500 of student loan interest, and up to $4,000 of tuition and fees.
Once these “above-the-line” deductions are accounted for, taxpayers have calculated their adjusted gross income (AGI). Functionally, AGI reduces the amount of income that faces the individual income tax.
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