Gross income and net income have multiple definitions depending on their usage. Typically, gross income is a larger amount than net income. On the income statement, gross income is found closer to the top. Net income is also referred to as "the bottom line" because it is found at the bottom of your business' income statement. Here's how gross vs. net income amounts relate to your small business, its financial statements, and its taxes.
What is gross income?
Here are a couple of different situations where you may use the term "gross income" in your business.
Financial statements
On your income statement, gross income—also referred to as gross profit—is simply sales revenue minus the cost of goods sold (COGS). Gross income measures what is left from your sales revenue after accounting for the direct costs of production. Items in COGS include:
- Raw materials costs
- Direct labor costs
- Shipping and handling costs
- Overhead costs that are directly linked to production
Income tax return
On your tax return, gross income generally refers to the sum of all your income from all sources. It does not include certain non-taxable items, like income you have contributed to a tax-deferred retirement account.
As a small business owner, you may pay taxes in a variety of ways depending on your business organization. Owners of pass-through entities—such as sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations—pay taxes on their Form 1040, U.S. Individual Income Tax Return. Significantly less common for small businesses, the C corporation pays taxes directly as a business entity on Form 1120, U.S. Corporation Income Tax Return.
If you are an owner in a pass-through business, you will include your share of the business' income on your Form 1040. For sole proprietors and single-member LLCs, your business' gross income is listed on Line 7 of Schedule C, Profit and Loss From Business, which accompanies your Form 1040.
In addition, if you have a standard job where you work as an employee for another employer, that income is also included on your Form 1040. Other sources of income include independent contractor income, rental income, dividend income, and interest income. If you file jointly with a spouse, his or her income will also be included on your joint tax return. All of these sources of income are added together on your tax return, and your personal "gross income" appears on Line 9 of Form 1040.
What is net income?
Here are a couple of different situations where you may use the term "net income" in your business.
Financial statements
Net income is the "bottom line" on the income statement—the financial statement that displays your business' revenue and expenses for a certain period of time. It is the amount of profit you have left once all expenses have been deducted from revenue. If net income is negative, it is referred to as "net loss."
You subtract selling, general, and administrative (SG&A) expenses, depreciation, amortization, interest expense, and income taxes from your gross income to arrive at net income on the income statement.
Income tax return
For sole proprietors, net income from your pass-through business appears on Line 31 of the Schedule C that accompanies Form 1040. Personal net income is not explicitly identified on Form 1040, but you can calculate it by subtracting Line 24, Total Tax, from Line 15, Taxable Income.
Other pass-through business owners report net income from the business on Part II of Schedule E, Supplemental Income and Loss.
Other important income types on your tax return
As a small business owner, adjusted gross income (AGI) and taxable income are two other important types of income that appear on your tax return.
Adjusted gross income
Your AGI, located on Line 11 of Form 1040, will either be the same or lower than your gross income. AGI subtracts "adjustments to income" from your gross income. Page 2 of Schedule 1, Additional Income and Adjustments to Income, lists all possible adjustments to income. Some of the common adjustments to income include:
- Educator expenses
- HSA deductions
- Moving expenses for members of the Armed Forces
- Self-employed retirement and health insurance
- Alimony paid
- Student loan interest deduction
The Internal Revenue Service (IRS) uses AGI to determine your eligibility for common tax credits and deductions.
Taxable income
Your taxable income appears on Line 15 of Form 1040. It is your AGI minus the standard deduction or the total of your itemized deductions and the qualified business income deduction (QBID), a significant deduction for owners of pass-throughs. Your taxable income is the amount that the IRS uses to figure your total tax.
Each of these terms means something specific to the IRS. Having a good understanding of the items that make up each type of income can help you to tax plan more effectively for your small business.
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