The terms "net" and "gross" frequently appear on pay stubs and tax returns. Both types of pay represent money you have earned, but you'll often notice that your net pay is less than your gross. For some purposes, such as loan applications and income statements, you'll want to use your gross pay. For practical day-to-day budgeting, the net pay is the number you need to use.
Gross vs. Net
Gross pay is the total amount you earn. For example, if you earn $15 per hour and work eight hours a day, your gross pay for that day is 8 x $15, or $120. Net pay is the amount you actually receive after any preliminary taxes are removed, such as Social Security, federal taxes and money toward workers' compensation. If your total tax rate equals approximately 18 percent of your gross pay, subtract 18 percent, or $21.60 from that $120. This total, $98.40, is your net pay.
It's often hard to remember which term applies to which pay calculation. Think of net pay as tossing a fishing net over your income. A few items slip out through holes in the net, leaving you with the majority of what you earned, but not all of it. Gross, on the other hand, can mean large, not just disgusting, although it can be amusing to think of your gross pay as being disgustingly large. Even if your gross income seems small, thinking of it that way can help you remember that gross pay is the larger number, while what you catch in your "net" is a smaller amount.
If you are self-employed, your gross pay may seem like it's all yours, but when tax time comes, you'll owe more than you would if someone else paid you. This is because employers are responsible for half of certain taxes. If you're self-employed, you're responsible for the full amount. Until you figure out the amount you owe for your business, set aside 30 percent of your gross pay for taxes, and consider the other 70 percent your net. This keeps you from being hit too hard at tax time, and you can adjust it after your first tax cycle to allow you a more accurate gross vs. net.
Always base your household budget on your net income rather than your gross. This keeps you from spending money that is taken out of your paycheck before you ever see it. On your taxes, use your gross income. The tax forms help you adjust the gross to not only remove the taxes you've already paid but also to deduct other expenses. This becomes your "adjusted gross income," which is the basis for any taxes you owe or that the government owes you at the end of the year.