If you are not a numbers person, it can be tricky to understand your accounts, especially when you take into account all the different jargon that comes with it.
From assets to gross and net income, there are lots of new words that you need to learn, and this is part of what makes your accounts so confusing.
Two terms that often confuse people are gross income and net income. A lot of people often get these two mixed up, and find it tricky to know which means what.
In particular, a lot of people struggle to remember if your net income is your income before or after taxes.
In this guide, we’ll be taking a look at whether your net income is your income before, or after, taxes, and lots more.
So, if you want to find out more about this terminology, keep on reading!
Is Net Before Or After Taxes?
First things first, let’s take a look at whether your net income is before or after taxes. Your net income is actually your income after taxes have been deducted.
But net income isn’t a term just used for personal finances, it is used for company finances too.
For a company, their net income will be their total income after expenses have been deducted.
So, as well as taxes being deducted at this stage, other things, such as overheads and payroll deductions, will be deducted.
Essentially, the net income is what is left at the end of the process, essentially making it the company’s profit.
In personal finance, your net income will be your overall income after deductions are made.
These deductions will primarily be made up of tax, but they will also include things such as pension contributions too.
Your net income is the money that you actually receive into your own personal account when you get paid.
So, net income is your income after taxes. But what is the term for your income before taxes? Let’s take a look.
What’s The Difference Between Net And Gross?
Earlier on we mentioned “gross income”. As we have said, net income is your income after tax, meaning that gross income is the term used to refer to your income before you pay any taxes.
So, the primary difference between net and gross income is where these terms are used in the tax process. Gross income comes before tax, net income comes after.
For a company, their gross income will be the overall income that they make at the end of a financial year.
This will be their income before any deductions, so it is likely to be much higher than what their net income will be.
Companies tend to have a lot of overheads, so there is usually a significant drop once deductions are made.
For an individual, your gross income will be your total income before things such as taxes, benefits, and other payroll deductions are made.
So, it will be the figure before you contribute to things such as your pension or HSA.
As an employee, your gross income should be the income listed as your salary. In contrast, your net income will be your “take home” pay.
What Affects Net Pay?
One of the main things that alters the figure between your gross and net income is your taxes, but this isn’t the only deduction that will be made before you receive your money.
So, let’s take a look at what else affects net pay, and what taxes you are actually paying.
One of the biggest deductions from your gross income will be your taxes. This is primarily because you will often find yourself paying multiple different taxes, these might include:
- Federal Income Tax
- State Income Tax
- Social Security and Medicare Tax
Health Insurance Premiums
A lot of employers, especially those with a good reputation, will cover the majority of your health insurance premiums.
However, there will still usually be a small amount which employees have to pay directly out of their own salary. These deductions will usually be made every time you get paid.
When you work, you are not only working to fund your current lifestyle, but your future lifestyle too.
This is because you will need to contribute to your retirement plan every time you get paid.
Some retirement plan payments will be deducted from your gross pay, such as 401k contributions.
If you are in debt, and owe a lot of money, then it is possible for the Courts to put a wage garnishment on your salary.
This essentially means that money will be deducted from your gross income and given to repay this debt, before you receive the money.
It takes the repayment option out of your hands, and forces you to pay back the money that you owe.
How To Calculate Net Pay
So, your net pay will usually be impacted by taxes along with the other deductions that we have spoken about above.
Now to wrap this up, let’s take a look at how employers calculate your net pay.
First, your gross pay is calculated. This is done by multiplying the number of hours that you have worked with the hourly rate, if you are paid by the hour.
If you are paid a salary, then your salary will simply be divided by the number of months that your contract covers to work out your gross income.
From your gross income, health insurance premiums, 401k contributions, and pre-tax contributions will be deducted initially.
Once these have been deducted, all tax payments will be withheld from your paycheck as they are usually contributed by your employer from your own money.
Finally, if there are any wage garnishments required from you, these will be deducted. The number that remains after these deductions will be your net pay.
In short, your net income is your income after tax. In contrast, your gross income is your income before tax, health insurance premiums, and other deductions.
Thank you for reading!