In simple terms, the difference between gross and net income is that gross income refers to the total income of a business, while net income is what remains after deducting expenses.
However, gross and net income are slightly different for tax purposes depending on whether you are an employer or an employee:
- Employers pay the tax grid income
- Employees pay taxes rough income
Because employers are required by law to withhold taxes from employees, business owners must consider both perspectives.
This article outlines the basics that employers need to know to pay taxes on their profits, as well as how to properly withhold employee wages.
Calculation of net and gross income for a business
gross income is all the money your business has brought in over a period of time, while net income What remains after deducting your business operating expenses from your gross income.
Proper documentation of business expenses is a crucial prerequisite for calculating net income. You need to have a clear picture of what you spend on your business, not to mention the IRS requires documentation for all business expenses claimed on tax returns.
In addition, certain industries, such as healthcare or businesses that receive government funding, also have legal documentation requirements.
Deduct expenses from gross income
To calculate gross income, you need to determine the expenses that your business incurs during the tax year.
While this is not an exhaustive list, here are some of the most common expenses that businesses use to calculate net income:
- Cost of Goods Sold (CoGS) – Cost of sales and production of your business
- wages and salaries – Not just pay, but benefits like 401(k) matches and FICA taxes
- Rent and utilities – Electricity, water, internet and the cost of the space occupied by your business
- Various supplies – such as paper, ink, laptops or office furniture
- Marketing and advertising – The cost of promoting your business
- insurance – including property, liability or workers’ compensation
- Depreciation and amortization – The cost of using and replacing equipment, machinery and other capital infrastructure
- interest – Cost of money loans
- Travel or entertainment – such as plane tickets, meals or hotels
- Uncollectible accounts – Services you provide, but for whatever reason, your customer is unlikely to pay
| Did you know that sole proprietorships are the most likely businesses to be audited? Financial experts suggest this may be because they are the most common source of misreported income. If you want to file your taxes with confidence, consider indinero’s business tax services. |
Tax treatment by type of business
Now that you’ve calculated your business’s net income, you can calculate your taxes. But the way taxes are calculated depends on which business entity you have chosen.
Sole proprietorships, partnerships, limited liability companies (LLCs) and S-corporations are pass-through entities; Owners report their income as personal income on their tax returns and pay regular income tax.
C-corporations, on the other hand, pay corporate taxes while their owners pay regular income taxes on dividends. It’s rare, but LLCs can also choose to be taxed as a C-corporation.
One last thing: If your business doesn’t make a profit in a given year, you’re not responsible for applicable corporate or income taxes. Additionally, you can carry forward net operating losses as a tax deduction for future years.
Calculating gross pay versus net pay for retaining employees
As an employer, you are legally required to withhold taxes from your employees’ wages.
The business should have a good understanding of the methodology for deducting these taxes from employees’ salaries; Otherwise, they or their business could be held liable for the money. In addition, there are some benefits that, although not legally required, are usually deductible.
If you are unsure about the process, Indino Accounting Services can help.
Deduction of taxes
| Note: In addition to deducting the following taxes, make sure you understand how to file Form 941 with the IRS. This is how you report the amount of federal tax owed. |
Federal income tax – The rate at which your employees’ income is taxed depends on which tax bracket they fall into. The main brackets are given below; Visit the IRS website for detailed information on tax deductions and specific threshold cases that can save your business money.
| Excise duty rate | One filler | married filers |
| 10% | up to $11,000 | up to $22,000 |
| 12% | 11000 – 44725 | 22000 – 89450 |
| 22% | 44,725 – 95,375 | 89,450 – 190,750 |
| 24% | 95,375 – 182,100 | 190750 – 364200 |
| 32% | 182,100 – 231,250 | 364,000 – 462,500 |
| 35% | 231 250 – 578 125 | 462 500 – 693 750 |
| 37% | More than 578,125 | More than 693,750 |
State income tax – Rates vary by state, and nine states do not impose an income tax. Visit your state government website to learn more about your state income tax rates.
Local income tax – Varies according to regions. Again, refer to your local authority website or visit your local council for further information and guidance.
Social Security and Medicare Tax – Also known as FICA taxes. Typically, the rate is split between the employer and the employees. You can learn more on the IRS site here, including current rates.
Other common deductions
Not all of these deductions apply to everyone; These deductions depend on your company and the specific benefits you provide to your employees.
- Pension plan contributions – such as a 401(k), 403(b) or elective IRA
- Life insurance premiums – Employers sometimes encourage this
- Union charges – Bonuses paid by employees to trade union members
- Health insurance premiums – Employers usually pay some or all of this premium, but not always
- salary garnishments – such as child support or back taxes
Calculation of net employee compensation
Now that we’ve covered the most common taxes and benefits, it’s time to figure out what to pay your employees. Use the following steps:
- Start with gross pay. This is either the hourly wage multiplied by the number of hours worked or the annual wage divided by the number of pay periods.
- Take pre-tax deductions. These elements reduce the tax burden by withholding taxes before they are calculated. Examples of pre-tax deductions include 403(b) or 401(k) retirement contributions, health savings accounts, and flexible spending accounts.
- withholding taxes – Federal income, FICA, state and local
- Trim the salary – Pursuant to any applicable court order
- net pay – is what remains
Deducting retirement plan contributions or health insurance premiums is relatively easy. They are either based on percentages based on gross income or monthly premiums.
However, knowing exactly how much tax to withhold can quickly become complicated. Talk to a tax professional to get peace of mind about your withholding practices.
conclusion: Gross vs. Net
Since employees pay tax on gross income and employers pay tax on net income, businesses need to understand the differences between these terms.
Owners who have a good understanding of gross and net income will save money at tax time. If you want help managing your employee withholding or business taxes, talk to an inDinero Business Tax Services professional.
