What Is Net Income?
Net income for an individual is your total income minus taxes and any other deductions, like health insurance and retirement contributions. For employees, net income is typically the final amount you see on your paycheck.
If you receive other sources of income outside of a traditional paycheck — such as interest, rental or investment income — what’s left over after paying taxes and other qualified deductions adds to your net income. Your net income is an important starting point when creating a personal budget because it is the amount of money you have to pay expenses.
Net income is a term also applied to businesses, but business net income differs from individual net income. Business net income, also called net profit, is what’s left over from the total revenue the business brings in after subtracting taxes and operating expenses.
Net Income and Tax Withholding
Your net income will be affected by how you fill out IRS Form W-4 with your employer. It’s important to understand how each section of the form impacts your take-home pay and influences whether you’ll receive a refund or owe money when you file your taxes.
- Multiple Jobs or Spouse Works
- If you have multiple jobs, you’ll usually have to file a W-4 with each employer. You’ll also have to account for your spouse’s job if you are married and file a joint income tax return.
- Claim Dependents
- You can claim dependents — including your children — if your income is less than $200,000 (or $400,000 if you are married and filing jointly) to receive credits toward your tax liability. You multiply the number of dependents you have by the credit amount listed on the form to determine your total credited amount.
- Other Adjustments
- This section is where you decide whether to have more or less money withheld from your paycheck. For example, you may choose to have more withheld to prevent a surprise tax bill at the end of the year or to cover taxes you’ll owe if you have a self-employed side job. Withholding less money will give you more take-home pay from each paycheck, but you may have a larger tax bill at the end of the year.
Filling Out a Form W-4: Three Sections that Affect Net Income
You can use the IRS Tax Withholding Estimator to make sure you have the right amount of taxes withheld from your paycheck. The IRS recommends using the estimator at the start of each new year to make sure your withholding amount is up-to-date with any changes to the tax code.
It is good practice to update your W-4 with your employer each time your personal or financial situation changes.
Read More: Federal Tax Brackets
Net Income vs. Gross Income for Individuals
While net income is your take-home pay, gross income is the total amount of income you receive before taxes and deductions.
Because lenders use it to determine your credit worthiness, gross income can be important for getting credit and when applying for a mortgage or a car loan.
Common Deductions That Lower Gross Income to Net Income
- Income tax withholding (federal, state and local where applicable)
- Social Security and FICA tax withholding
- Medicare tax withholding
- Health care and dental insurance premiums
- Retirement plan contributions — 401(k), 403(b), individual retirement account (IRA), etc.
Source: Indeed
Typically, you’ll see both gross and net income listed on your pay stub or paycheck. The gross income is the larger number, and the smaller number is your net income. Your net income is also listed on your W-2 form used to file income tax returns each year.
How to Calculate Your Net Income
Your net income is typically shown on your paycheck or pay stub as your take-home pay. If you have other sources of income, use the net income formula below to calculate your total net income.
Simply add all your sources of income, then subtract your total tax and other deductions. The result will be your net income.
If you are paid weekly, multiply your total weekly net income by 52 to get your annual net income.
Why Is Net Income Important for Individuals?
Net income is important for any individual’s personal finance goals. It is the amount of money you have to cover your expenses — food, clothing, lodging, transportation and other costs. Knowing your net income also allows you to estimate wise discretionary spending, or your ability to pay for the things you want as well as need.
If you create a budget, you will use your net income figure to determine how much money you have to pay for your expenses.
You should also reexamine your net income from time to time, especially if your personal or financial situation changes. Fluctuations in your net income can affect how much you can put away in retirement plans or into other financial plans and needs.
