Gross income is the total amount earned before taxes, while net income is the amount received after taxes. Taxes can take up to 42.5% of a person’s salary, depending on their tax bracket. Net income is the most important number, as it is the amount of money a person actually sees in their paycheck. Freelancers pay taxes separately and can determine their net income by subtracting the amount of taxes paid.
Gross income refers to all the income a person earns before taxes are taken out of their paycheck. It is different from net income, which is the amount of money a person receives to take home. Gross income is used in several important calculations, such as determining a person’s maximum acceptable debt to income ratio when the individual is trying to qualify for a mortgage.
In the United States and many other countries, people must pay income tax on wages. In the United States, for example, a person must pay federal income tax, state income tax, and, in some cases, local income tax. You are also required to pay Social Security and Medicare taxes on up to a portion of your income; Starting in 2010, for example, people must pay 6 percent of income in Social Security taxes and another 1.5 percent in Medicare taxes on the first $106,000 United States dollars (USD) in income.
Depending on a person’s tax bracket, this can mean they end up paying up to 42.5 percent of their salary in taxes, assuming they are in the 35th percentile tax bracket. While many people are in a lower tax bracket than , the percentage can still be more than 25 percent of the total money earned. This means that when a person is told they are hired for a job that pays $40,000 per year, they are not actually bringing home $40,000 per year.
In that example, the figure of $40,000 USD per year is the individual’s gross income. That is the amount the employer is actually paying out of pocket to the worker. Since the IRS takes its cut, the worker does not receive that full amount. Taxes are deducted directly from every paycheck he receives, so the net amount he takes home, net income, is lower than it would have been if taxes were not deducted.
Because the United States tax system is a pay-as-you-go system, tax deductions are deducted from each paycheck before the employee sees it. Therefore, although most people quote their salaries in terms of gross income when asked, the most important number is net income, since that is the amount of money they actually see in their paychecks and the amount they really have to spend on other necessities. For freelancers, on the other hand, all the money is paid to the individual; then he writes a check for his taxes quarterly or annually and can subtract the amount of the check he wrote to determine his net income or profit.
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