There are times when you may be asked what your total annual income is. It could be during income tax season or when you apply for a mortgage or car loan. But what does total annual income mean? What is (and isn’t) included in the calculation? In this article, I’ll show you how to calculate your annual income and explain the difference between gross and net income. I’ll also share some practical uses for this information outside of filing your taxes.
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Types of Total Annual Income
There are two main types of total annual income for individuals: total annual Gross income and total annual net income. Let’s take a closer look at the similarities and differences between the two.
Total Annual Gross Income Vs. Total Annual Net Income
Total annual gross income is the total amount of money you receive in a given year. When referring to your personal income, you would use calendar year dates to determine this number.
You will use your business’s fiscal year if referring to your business income. Total annual gross income can include money you receive from many different sources. Gross income is calculated before deducting money for any taxes, pre-tax insurance premiums, retirement contributions, or other pre-tax deductions.
Conversely, total annual net income includes any money you receive during a given year after subtracting deductions for expenses, insurance premiums, or other deductions. In other words, your total annual net income is the amount of money you earn that goes into your pocket or bank account throughout the year.
Here’s an example of the difference between the two:
- Total gross paycheck for one month: $4,000
- Deduction for federal taxes: -$438
- Deduction for state/local taxes: -$257
- Retirement contribution: -$200
- Healthcare premium: -$286
Total net income: $2819
In this case, Your total gross income for the month (assuming you have no other income sources) would be $4,000, and your total net income for the month would be $2,819.
Next, let’s discuss what sources of income should be included as you work to determine your total annual income.
What Does Total Annual Income Include?
Your total annual income includes two types of income: earned and unearned. Here are some examples of the types of income you might include in each category.
Earned Income
Earned income is income that you worked on your own to earn. It includes sources such as:
- W-2 job earnings, including wages, tips, bonuses, etc.
- Side hustle income
- Self-employment business income is paid directly to you as a sole proprietor or from a corporation.
Unearned Income
Unearned income is income you did little or nothing to earn. It includes passive income sources such as:
- Investment income
- Social Security or SSI disability payments
- Alimony payments
- Welfare benefits
- Unemployment benefits
- Gifts
- Lottery winnings
- Retirement income such as pensions and 401k/IRA distributions
In short, it is counted as earned income if you worked to get it. But it only counts as earned income if you worked within the previous calendar year to get it if that makes sense.
For example, you worked hard to contribute the money to your 401k account. But when you retire and start taking that income to live on, it will be considered unearned income because you didn’t actively earn it in the calendar year in which you claimed it on your taxes.
Instead, you earned it passively through investing, making it unearned income. Next, let’s talk about how to calculate total annual income numbers.
How to Calculate Total Annual Income
Calculating your gross annual income is easy. You can do so by following the steps below.
- Gather your gross income numbers from your previous year’s W-2 forms.
- Gather gross income numbers from any side hustles or second jobs before expenses are deducted
- Include any income from unearned sources such as investments, bank interest, pensions, government income such as Social Security, etc.
Add up the amount of these income sources to get your total annual gross income.
Consider calculating your annual net income by subtracting deductions from W-2 paychecks and expenses from a side hustle or small business income.
It’s important to know your gross income and net income because there are different uses for each income number. Now let’s discuss how to use the different total annual income numbers.
How to Use Total Annual Income
There are two primary uses for annual gross income and your annual net income amounts: income reporting and personal budgeting.
Total Gross Income for Reporting
You’ll mainly use your gross income for reporting purposes. This includes reporting to the IRS, reporting to banks if you need to get a loan, or reporting to the government for other purposes, such as determining how much child support you’re required to pay or eligible to receive.
Total Net Income for Budgeting
Total net income comes in handy for budgeting and financial planning purposes.
When you use a budgeting software tool, you can input either gross or net income numbers. However, using gross income numbers adds an extra step to your budgeting time as you need to list the deductions on your budgeting worksheet that gets you to your net income anyway.
I find it simpler to skip this step and budget using your net income. Knowing your annual net income can help you plan monthly and yearly financial goals and can help you create a spending plan that works for you.
Helpful Budgeting Tools
Here are some articles you might like regarding budgeting and financial goals. First, check out these ten free budgeting worksheets. They’re ideal for anyone who prefers using spreadsheets over budgeting apps.
If you prefer apps, check out our YNAB Review. YNAB, short for You Need A Budget, can help you break the paycheck-to-paycheck cycle. This article teaches you how to win at money, not by chasing more of it but by learning how to truly accomplish your financial goals. Do you want to save more money? The 100-Envelope Challenge might be of interest.
Final Thoughts
Being able to calculate your annual income can help you when you need to share your income numbers with government and financial entities. It can also help you to create a budget that works for you. One of the best ways to become familiar with the calculations is by filing your own income taxes. Whichever way you decide to learn, make calculating your annual income each year a habit.
The post What Is Total Annual Income and Why Is It Important? appeared first on Best Wallet Hacks.
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