What is net pay? Gross pay? Net income? When it comes to payroll taxes and other documents that request income information, these can be terms that confuse people. They are often terms that we don’t come across elsewhere. Net pay and net income may be examples of this unfamiliar vocabulary, although many of us see net pay information is included in a pay stub frequently.
When referring to a person’s income, you’ve probably seen the terms “net pay” and “gross pay” used. These two terms are not interchangeable.
What is net pay vs. gross pay
Gross pay, wage, or income can basically be defined as the total income a person makes. For a monthly gross wage, that’s the hourly wage multiplied by the number of hours the person worked that month, or it is the person’s set monthly salary. Per the IRS, if the person received tips during the month, they would be added in and included in the gross wage total.
Gross income is sometimes referred to as a person’s income before taxes. In other words, it also includes all of the employer’s payroll deductions. Money taken out of a paycheck for income tax, Medicare, and Social Security is still considered money the employee received as part of their salary, so it’s counted as part of their income.
The additional money that an employer contributes towards an employee’s retirement or pension is not considered a part of the gross income because the employee is not receiving that money at the time. Thus, you can follow this very general formula for how to calculate net pay from gross pay:
Gross Pay – Payroll Deductions = Net Pay
There are some other items that are excluded by the IRS, but they are very specific, and other organizations may consider these items a part of the gross pay.
Net pay or wages, however, are considered a person’s wages after withholding deductions, sometimes referred to as their take-home pay. This is the money an employee actually has to spend every month. It does not include income tax, Medicare, or Social Security payments.
When comparing two employees’ gross and net pay, remember that just because they have the same gross wage, they may not receive the same net pay! This is because one may be married, have additional income tax withheld, or receive a different tax credit.
Filling in forms?
Different forms ask for one or both types of income, depending upon the purpose of the form.
What if someone simply wants to know your amount of income? That usually means they want to know your gross rather than your net pay.
IRS Form W-4 includes a worksheet for computing amounts to be withheld. In many cases, the organization needs to know how much money you actually have to spend each month.
For example, when applying for a mortgage, the lender is more concerned with how much money the person or couple actually brings in every month. So they want to know your net pay (instead of the gross pay) when determining if the applicant can actually afford the desired loan amount.
Business vs. personal income
Up to now, we have been discussing personal income as either gross or net pay. Sometimes the terms net wages or net income are used as synonymous with net pay.
In the case of your small business, gross and net income are defined slightly differently.
For businesses, the gross income is all of the money you brought in that year. It’s your total revenue (not total profit).
Just as with individuals, many lenders and other organizations are much more interested in a business’s net income. However, a business’s net income is computed a little differently — the business owner must subtract out costs from the gross profit (instead of subtracting out deductions like taxes and Medicare payments).
Business costs may include the following:
- Actual costs of the products sold
- Employee gross salaries
- Administrative overhead costs (building rental, utilities)
- Any business-related purchases (new equipment, general everyday items, etc.)
- Depreciation on items (the loss of value on capital equipment)
- Amortization on properties
- Interest on any borrowed funds
Because it can be difficult to understand how to calculate some of these costs, many small business owners work with a CPA or other tax expert to determine their company’s net income.
A simple online payroll solution like Patriot Software’s PAY can help owners track payroll expenses while our accounting software can help you track other income and expenses with an affordable, easy-to-use, 24/7 recordkeeping system.