Gross and Net Income
By Gautam Bhatia
That feeling of excitement seeps the room, you’re breathing heavy, excitement and elation await. It’s the moment for your first-ever paycheck! You’ve thought a million times what you’re going to do with it. Maybe it’s that elusive new iPhone you always wanted to have! Maybe it’s that gift for Mom to show her that her hard work and tears for you have finally paid off!
Whatever it may be, you stroll into the HR’s office to collect that shiny cheque of 5000 USD. As you receive your envelope, you carefully lift the lid making sure you don’t tear anything. You can’t wait to see the cheque with your own eyes!
And then, disappointment hits.
Is this a joke! You expected three beautiful zeros on your cheque, what’s with this arbitrary looking number, and more importantly, why is it less than the salary you were expecting. Too embarrassed to ask your HR, you silently walk back to your desk, dejected that your first experience of receiving a cheque that you earned has now turned sour.
Why did this happen?
In this short article, we explore the reasons why so many of us have the above experience. We look at two terms that are familiar to experienced workers in the job market but may not be those in school or college or those working for the first time.
These two terms are GROSS INCOME and NET INCOME.
Gross Income is your total income earned before taxes or deductions.
This includes but is not limited to your salary, your wages, bonuses, and tips, commission, interest earned from investments, lottery winnings, insurance income, self-employment income, liquidation of existing assets, and investments.
Think of gross income as the sum of money earned from work and investments.
Net Income is the money leftover of your gross income after you take care of necessary “non – negotiable” expenses.
“Non-negotiable” expenses take the form of expenses commonly knows as taxes (mandated by law) and deductibles.
Think of net income as the sum of money you own to take economic decisions.
Let’s use an example to understand this further,
Imagine a world where every month the God of Gummy bears has promised to deposit fifty gummy bears to you – your gross income – in exchange for running his empire. In exchange for this, you agree to follow his “Constitution for Gummy Bear Deposits”.
In the constitution, you are required every month to give ten gummy bears to your family members. These ten gummy bears are like your taxes paid to the government.
You now have forty gummy bears left.
You decide to put away five gummy bears every month so that when the God of Gummy bears decides to stop giving them to you, you still have some left-over stock.
Think of this as money put away every month in a fixed deposit or a retirement fund.
You further decide to give away five additional gummy bears to Cousin Jimmy every month to look after him as he does not get paid by God of Gummy bears and is dependent on you.
Think of this as the money you set aside to care for a dependent.
You now have thirty gummy bears every month which you can use as you please – this is your net income.
Retirement funds, Dependent funds, healthcare, and dental funds are important deductibles that are taken out from your gross income every month to get to your net income.
In general, the main difference between a deductible and an expense (electricity bills, phone bills, rent, etc.) is that a deductible is usually tax-exempt while an expense generally requires you to pay a sales tax and is therefore still part of your net income.
We’ll talk about the different types of taxes and their effect on your income in the next article.