Gross Income Vs. Net Income: Differences and How to Calculate

The terms gross income and net income can sometimes be confusing. Gross income is the total money you earn, while net income is your profit after subtracting expenses and deductions. Since gross income is used to calculate net income, it’s important to understand how both work. 

If you run your own business, knowing the difference between gross income and net income is essential for managing your finances and tracking your business performance. These numbers also have a big impact on your tax obligations.  

By learning what gross income and net income mean, you can understand their key differences and why they matter for your business.

Gross Income vs. Net Income: What You Need to Know

What Is Gross Income?

Definition: Gross income, also known as gross salary or gross pay, is the total amount you earn in a year before any expenses are taken out. It’s the total revenue your business generates from providing services or selling products, before taxes, deductions, or other costs. 

How to Calculate Gross Income: Add up all the money you’ve earned from your clients or customers in the past year. For example, if your client payments total $90,000, that’s your annual gross income. 

Why Gross Income Is Important: Gross income is a crucial measure of your business’s revenue potential. It helps you analyze which clients or projects earn you the most and identify opportunities for growth. By tracking your gross income year over year, you can evaluate trends and set future goals for your business. 

What Is Net Income?

Definition: Net income, also known as net salary or net pay, is your profit after subtracting all business expenses and deductions from your gross income. 

How to Calculate Net Income: Start with your gross income and subtract expenses like marketing, office supplies, and taxes. Include deductions you’re eligible for, such as a home office, retirement contributions, or professional fees. 

For example, if your gross income is $90,000 and your expenses total $30,000, your net income is $60,000. 

What Are the Differences Between Gross Income and Net Income?

Understanding the difference between gross income and net income is critical for both personal finance and running a successful business. 

• Gross income shows the total revenue your business generates. It’s a useful tool for evaluating sales trends and tracking how your business is growing year over year. However, it doesn’t reflect how much profit you’re actually making.
• Net income shows your profit after expenses, giving you a clear picture of your business’s financial health. If your net income is lower than expected, you might need to cut expenses or focus on more profitable projects.

By understanding how to calculate gross and net income, you can make informed decisions about managing expenses, raising consulting rates, or pursuing high-value clients and projects. 

Gross Margin vs. Net Margin: What You Need to Know

Gross margin and net margin are two key profit margin ratios found on your income statement. These figures help you understand how effectively your business turns revenue into profit and are essential for measuring your company’s financial health.

What Is Gross Margin?

Gross margin shows how efficiently your business produces goods or services. Tracking this number over time helps you identify trends—steady margins suggest stability, while large swings may point to underlying issues.

It’s important to remember that gross margin benchmarks vary by industry and market conditions. Keeping an eye on your competitors and industry standards can help you determine where your business stands.

How to Calculate Gross Margin

Formula:
Gross Margin (%) = (Total Revenue – Cost of Goods Sold) ÷ Total Revenue × 100

• Total revenue is the income from regular business operations.
• Cost of goods sold (COGS) includes direct costs like materials and labor—not indirect costs like rent or marketing.

Example: If your revenue is $50,000 and your COGS is $40,000: ($50,000 – $40,000) ÷ $50,000 × 100 = 20% gross margin

What Is Net Margin?

Net margin accounts for all business expenses—not just COGS. This includes operating costs, taxes, rent, and more. Because of this, net margin is usually lower than gross margin. It reveals how much actual profit you’re making from your total revenue.

How to Calculate Net Margin

Formula:
Net Margin (%) = Net Income ÷ Total Revenue × 100

• Net income is your revenue minus all expenses.
• Total revenue is your total income over a set period.

Example: If your revenue is $50,000 and total expenses (COGS + operating costs) are $43,000, your net income is $7,000.
$7,000 ÷ $50,000 × 100 = 14% net margin

This means 14% of your revenue is actual profit.

What Does Net Income Mean for My Business?

Net income reveals your actual profit and shows the financial health of your business. If your gross income is much higher than your net income, it might be time to analyze your expenses and consider cost-saving measures. 

Planning for State-Specific Costs

Where you operate your business can significantly impact your net income. States with no income tax, like Texas or Florida, allow you to keep more of your earnings, while high-tax states may require more careful budgeting. Researching tax rates and business-related costs in different states can help you decide where to establish or expand your operations. 

It’s also crucial to factor state taxes into your pricing strategy. If you work in a state with high taxes, you may need to charge more for your services to maintain profitability. Planning for these costs upfront can prevent financial surprises and help you stay competitive. 

Understanding how gross income translates to net income can vary significantly depending on the type of work, state-specific tax regulations, and eligible deductions. Let’s break this down with examples from three distinct professions: 

Example 1: Independent IT Consultant in New York

Gross income: $120,000 per year 

New York has some of the highest state income taxes in the U.S., which can greatly impact net income. Here’s how gross income transforms after taxes and expenses: 

• Gross income: $120,000
• Common expenses: $20,000 (office space rental, software subscriptions, and hardware upgrades)
• State income tax: Approx. 6.85% on taxable income
• Federal income tax: Based on tax bracket (~22% for this income range)
• Net income: After subtracting taxes and expenses, the consultant might take home approximately $75,000 annually.

This example highlights how taxes and necessary expenses can significantly reduce net income in high-tax states like New York. 

Example 2: Freelance Graphic Designer in Florida

Gross income: $60,000 per year 

Florida is a low-tax state with no state income tax, which can help maximize net income. Tax deductions like home office expenses play a major role in reducing taxable income: 

• Gross income: $60,000
• Common expenses: $10,000 (design software, marketing, and home office setup)
• Federal income tax: Based on tax bracket (~12-22% for this range)
• State income tax: $0
• Net income: After deductions and federal taxes, the designer might retain around $45,000 to $50,000.

Compared to high-tax states, freelancers in Florida or Nevada benefit from the absence of state income tax, giving them a higher percentage of take-home pay. 

Example 3: Contract Business Consultant Across States

Gross income: $80,000 per year 

For contract workers, industry-specific expenses like tools, equipment, and travel costs significantly impact net income. Here’s an example breakdown: 

• Gross income: $80,000
• Expenses: $25,000 (equipment purchases, vehicle maintenance, and licensing fees)
• State income tax: Varies (e.g., 5% in Georgia or 0% in Texas)
• Federal income tax: Based on tax bracket (~22% for this range)
• Net income: In Texas, where there’s no state income tax, net income might reach $45,000. In Georgia, after state taxes, net income could drop to around $42,000.

This example illustrates how location and industry-specific expenses can make a notable difference in take-home pay, especially for roles that require frequent travel or costly equipment. 

Check Out: Bill Rate Vs. Pay Rate: What Is the Difference?

Where Can I Find Tax Tips for Small Business Owners and Entrepreneurs?

Reducing your tax burden requires proactive financial planning. Contributing to retirement accounts, like a SEP IRA or Solo 401(k), can lower your taxable income while helping you save for the future. Additionally, keeping detailed records of deductible expenses, such as home office costs, travel, or professional memberships, ensures you can claim every eligible deduction. 

Working with a tax professional can also make a big difference. They can help you identify lesser-known deductions, ensure compliance with tax laws, and optimize your filing strategy. These efforts not only reduce the amount you owe but also provide a clearer picture of your business’s financial health. 

Explore More Resources for Independent Professionals From MBO Partners

Knowing the difference between gross and net income is key to managing your finances effectively. Gross income reflects your earning potential, but net income shows the money you actually take home after expenses and taxes. This understanding helps you make smarter decisions about pricing, budgeting, and long-term planning. 

By tracking both gross and net income, you can identify areas for improvement and ensure your business remains sustainable and profitable. Consider checking out tools like tax calculators to estimate your take-home pay or consult a financial advisor for tailored advice. They can guide you in optimizing your earnings and preparing for tax season. 

For more tips and insights, check out related articles or resources designed to help small business owners and independent contractors succeed. The more you learn, the better equipped you’ll be to navigate your financial journey. 

And to learn how to calculate net income based on expenses and deductions, or to better track your financial performance, try using our consulting fee and bill rate calculator.