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What is net income?
Net income, also called "take-home income," is the money that actually goes into your bank account after taxes.
Once you know what you bring in each month — and can predict this at least somewhat reliably — you’ll be able to create a budget.
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Net income vs. gross income
Think of it as a before and after situation. Gross income is all the money you make before taxes and deductions. Net income is what's left over.
Most people receive their income from either an hourly wage or a salary. We'll assume for now you're getting paid as a regular employee, not as an independent contractor, whose income will look a bit different.
Gross income is pretty easy to figure out. If you’re an hourly wage earner, your weekly gross income is the number of hours you work in a week multiplied by your hourly rate. If you’re working at the federal minimum wage of $7.25 and you work 40 hours in a week, your weekly gross income is $290. Your monthly gross income would be roughly $1,160.
If you’re a salaried employee, your monthly gross income is your yearly salary divided by 12. If your annual salary is $36,000, your monthly gross income would be $3,000.
Depending on how often you’re paid and where your payday lands in the month, these numbers might change slightly from paycheck to paycheck. You’ll want to make sure your gross income lines up with the wages or salary you were promised. All the numbers we’re discussing in this article should be listed on your paycheck stub.
Now, the really important question is, where did some of your money go between your gross income and your actual take-home pay?
The answer: taxes, mostly.
What are these payroll taxes?
An estimate of what you’ll owe in taxes annually is taken out of your paycheck throughout the year. This is called withholding and the money is paid to the government so you don’t find yourself with a surprisingly large bill come tax season.
When you do your annual tax return, the government compares the taxes already withheld from you with the taxes you actually owe. If it turns out you owe less than what's been withheld, you get a tax refund. If you owe more than what's been withheld, you’ll need to pay the IRS.
When you get a new job, your employer should have you fill out a W-4 form. You’ll want to fill out this form accurately so that your tax withholding estimate is as close to your actual tax liability as possible.
» MORE: How to fill out a W-4 form
Beyond federal income tax, you might see money withheld for your state or municipal income tax as well, depending on where you live.
Beyond federal income tax, you might see money withheld for your state or municipal income tax as well, depending on where you live.
You’ll also have deductions removed from your paycheck for Social Security and Medicare taxes, any employer-sponsored insurance contributions and any contributions into an employer-sponsored retirement plan, such as a 401(k) account.
You might also find information on your pay stub about other types of pay, like overtime, holiday and sick pay.
Net income for independent contractors
An independent contractor won't fill out a W-4 form when they start a new job and instead should receive a 1099 form come tax season.
If you make your livelihood as an independent contractor, you're self-employed and are responsible for paying income taxes and deductions on your own.
Unlike W-2 employers, your clients won’t withhold taxes for you throughout the year. The checks you receive for work are your gross income, which means that you’ll have to calculate and pay estimated quarterly taxes to the IRS and later get squared away when you file your annual tax return.
Another tax implication to be mindful of is the self-employment tax, a combination of Medicare and Social Security taxes. W-2 employees split this bill with their employers, but freelancers are on the hook for the entire thing. The good news is that you can generally deduct half of it later on, when you file your annual return.
Calculating your net income as a freelancer can be trickier since your withholdings aren’t deducted in a neat package on your paycheck, but the general principle is the same: it’s what is left over after taxes.
From income to budgeting
So now you know why the net pay printed on your check differs from your gross income. This after-tax take-home income is the number you’ll need to start budgeting, but you’ll want to add back in any retirement or insurance contributions that were automatically deducted.
These automatic contributions are part of your budget, and you’ll want the ability to break them out of your total take-home income into different budgeting categories.
There are many other types of income beyond just wages and salaries, but these are the basics to get you started.
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