Gross Income: What Is It And Why Is It Important?
To the untrained ear, gross income may sound off-putting. No, it isn’t some shady side hustle, it’s a financial term that describes your total income before deductions. Gross income can play an essential role when budgeting for life expenses.
Understanding what your annual gross income is and how it relates to your net income will also make your financial life easier to navigate. Let’s get started.
What Is Gross Income?
Also called “gross pay,” gross income is the total amount of earnings a person, or business, makes before subtracting taxes and other expenses. For businesses, gross income may be called “gross margin” or “gross profit.”
Gross income is the starting point when filing your tax returns and it determines your federal income tax bracket. Annual gross income accounts for these earnings in a year.
Why Is Annual Gross Income Important?
Gross income plays an important role in your financial success. If you’re applying for a mortgage, gross income is key to knowing how much you can afford. Mortgage lenders and property owners also look at gross income as an indicator of your financial reliability. Lenders will also want to know how much of your income will go toward monthly payments.
Your gross income is unique to you but is an important starting point for understanding your finances.
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Gross Income Sources
When calculating your gross income, you need to include all sources. Most people receive income from at least one of the following:
- Wages and salary from a W-2 job
- Secondary or freelance jobs
- Tips from your place of employment
- Items sold online, or at a fair or venue, even as a hobby
- Rental income
- Unemployment earnings
- Capital gains from investments
- Alimony payments
- Pension payments
It’s important to note that all these forms of income are also taxable, meaning you’re legally required to report them on your Form 1040.
How To Calculate Gross Income
Calculating your gross income is simple: total up all your income sources before taxes or other payroll deductions.
Imagine you have an annual salary of $80,000. If you made $2,000 freelancing and $500 from selling items online, calculating your annual gross salary would look like this:
$80,000 + $2,000 + $500 = $82,500
Adjusted Gross Income Definition
Adjusted gross income (AGI) is a calculation taken from your gross income to determine the amount that is taxable. Your AGI is your gross income minus adjustments that the IRS follows. If you’ve ever heard of “tax deductions,” this is in reference to your AGI.
Here are some common deductions:
- Moving expenses due to job, business or military relocation
- Student loan interest or tuition fees
- Alimony payments
- Self-employed expenses
- Charitable donations
Itemizing your deductions will lower your AGI, which lowers your taxable income. Accurately reporting your AGI on the IRS Form 1040 determines your eligibility for claims on your tax return. The more claims you’re eligible for, the more money you’ll receive on your return.
Figuring out which deductions you qualify for can be tricky, so it’s best to consult with a local tax expert or CPA.
Modified Adjusted Gross Income
Modified Adjusted Gross Income (MAGI) is another part of your finances that’s important to know. Your MAGI determines the following:
- Whether you can contribute to a Roth IRA
- Whether you can deduct your regular IRA contributions from your taxes
- Your eligibility for the premium tax credit
To calculate your MAGI, take your AGI and add back the following deductions:
- Specific tax exemptions (homestead, disability, senior or veteran)
- Retirement fund and Social Security contributions
- Student loan interest or tuition
- Excluded foreign income
- Rental and other passive income or losses
It’s normal for your AGI and MAGI to be close in amount. While you can always contribute to a traditional IRA, if your MAGI exceeds the IRS’ limits, you won’t be able to deduct these contributions on your taxes.
To qualify for the premium tax credit, your MAGI must fall between 100% – 400% of the federal poverty line. Just like with your Adjusted Gross Income, figuring out your MAGI could mean more money back on your tax return.
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Gross Income FAQs
What’s the difference between gross vs. net income?
Gross income is the total of all your income while net income is what you’re left with after all the deductions are taken out. These deductions include:
- Income and Social Security tax
- Health insurance and health savings account (has) contributions
- IRA, 401(k) or retirement fund contributions
- Any necessary legal payments, like alimony.
A simple mnemonic device can help: net income is what’s in your “net.” It’s what you take home with you, which is also why it’s sometimes called “take home pay.”
Where does gross income come from?
Gross income can come from many different sources, not just employment. Gross income includes what you make from interest, dividends from stocks or bonds, pensions, rental income, gambling winnings, inheritances and more.
What’s included in gross income?
Gross income is everything you earn before payroll deductions. Your gross income should never exceed your adjusted gross income, which subtracts out the tax deductions, or “tax breaks,” you qualify for.
The Bottom Line
Don’t let financial terminology confuse or intimidate you. Knowing your finances and how they’re defined is important. Your gross income is every piece of your income, where your net income is what you take home with you. Lenders and property owners use gross income to determine what you can afford. Understanding your gross income and how to calculate your adjusted gross income and modified adjusted gross income can lead to savings on your taxes.
You should bring any questions or uncertainties about your finances or taxes to a financial advisor or tax professional. It’s important to stay informed about your finances, but also know when you need help with them. A financial advisor or tax professional can help you make the most of your income.
Check out our Quicken Loans® Learning Center for more information and tips on achieving financial wellness.
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