What Is Gross Income?
Understanding the definition of gross income can be important because gross income is the starting point for calculating many other types of income.
By Debra Donston-Miller | American Express Credit Intel Freelance Contributor
4 Min Read | March 5, 2021 in Money
Your gross income is used as the starting point for determining your taxable income, as well as your ability to pay rent and pay back loans.
It’s calculated by adding together all of your income sources.
Gross income is used to calculate net income, adjusted gross income, and modified adjusted gross income.
Remember when you received your first-ever paycheck? You may have been disappointed to find that your take-home pay was less – maybe even a lot less – than the amount you expected. That’s probably when you first came across the idea of gross income and wondered what it meant in the context of net income and, eventually, various other forms of “income.”
For individuals, gross income is all the money you earn before taxes and other deductions are subtracted. Your earned income can come in many forms: salary, bonuses, tips, hourly wages, rental income, dividends from stocks and bonds, and savings account interest. In the less traditional but growing “gig” economy, people can earn income from multiple part-time, temporary, or freelance positions. All the monies earned from these jobs would count toward your gross income.
To avoid confusion, it’s worth knowing that there’s a different gross income definition for businesses. For a business, gross income, also known as gross profit, is the revenue earned from goods minus the cost of those goods. Gross profit is a line item in a profit and loss statement.
It’s important to know what your gross income is because it’s used for many purposes that may matter to you, including:
- Loan qualification: When applying for an installment loan, lenders usually make sure your gross income meets a certain minimum requirement before deciding whether to approve the loan.
- Rental housing: Landlords usually check the gross income of potential renters to help determine whether they’ll be able to pay their rent on time.
- Credit limit: Credit card issuers usually consider your gross income when determining your credit limit.
- Taxes: Gross income is part of the equation – the starting point, really – that federal and state tax agencies use to determine how much you owe in taxes.
- Salary negotiations: Knowing your current gross income can help you negotiate for a higher gross income in the future.
Calculating your gross income is fairly straightforward. You simply add up all of your income sources before any tax deductions or taxes. For example, if last year you earned $100,000 in salary, $1,000 in interest income, and $12,000 in rental income, your gross income for the year would be $100,000 + $1,000 + $12,000 = $113,000.
Then, that $113,000 gross income is used to calculate other forms of income.
Your net income is calculated by subtracting taxes and other deductions, such as retirement account payments, health insurance payments, and loan payments, from gross income. Those deductions are the reason for that surprise when you looked at your first paycheck – it was for your net, not gross, income. Net income is similar for businesses, which calculate net income by subtracting taxes, operating expenses, depreciation, and other costs from sales revenue.
Adjusted gross income, or AGI, is defined as gross income minus qualified tax adjustments. Your AGI appears on your tax return and is important because it’s used for three key tax reasons:
- Calculating the portion of your income that will be taxed.
- Determining your eligibility for certain tax credits and deductions.
- Enabling you to e-file your taxes, since e-filing uses last year’s AGI as a form of verification.
Modified adjusted gross income (MAGI) is – no joke – an adjustment of your adjusted gross income. Like AGI, your MAGI is mainly used to determine certain tax benefits. Unlike AGI, there are several ways to calculate MAGI, but one factor remains constant: Each MAGI starts with adjusted gross income. Beyond that, each MAGI calculation is slightly different depending on the specific tax benefits you’re trying to qualify for.
Your gross income is determined by adding together all sources of income before taxes and other deductions are taken out. Gross income is important because it’s used, among other things, to assess your ability to make payments and the amount of credit that lenders believe they can safely make available to you. Gross income is used as the starting point to calculate other forms of income, including net income, adjusted gross income, and modified adjusted gross income.