How To Calculate Your Net Income: 4 Steps

It’s important to know exactly how much money you take home. Not knowing this number can lead to creating a budget that doesn’t work, which could lead to overspending, incurring unnecessary bank fees or failure to reach your financial goals. To avoid this, you should learn how to calculate your net income.

What Is Net Income?

Net income is the amount of money you keep after taking out expenses from your paycheck, such as deductions and taxes. It’s the amount you take home versus your total income. Some common alternative names for net income are net pay and take-home pay.

In addition, business owners look at their net income to see whether their business profitable. However, unlike individuals, their expenses may include the cost of goods sold, depreciating expenses and operating fees. This information, along with revenue data, is usually found in a company’s income statement. The bottom line of this statement reveals whether the business has suffered a net loss or has earned money.

Net Income Vs. Gross Income

By contrast, gross income is the total income an individual or company earns before deductions. Your gross income is always larger than your net income. When calculating your net income, knowing your gross income is necessary because it’s the number you subtract all your deductions from to calculate it.

Net Income Formula

To find your net income, use the following formula:

Net Income = Gross Income - Deductions - (Retirement contributions + Medical and Dental expenses) - Taxes

Finding the answer to the equation involves four easy steps: locating your gross number, subtracting deductions, deducting retirement contributions, along with medical and dental expenses (if allowed) and subtracting taxes.

Calculate Gross Income

Your gross income can be found by adding up the total amount of income you’ll receive from your job annually. If you earn a salary, this is easy, since it’s simply your salary for the entire year.

For hourly workers, you can refer to your pay stubs to see your exact gross income.

To illustrate how this works, let’s pretend a guy named Bob earns $38,126.40 per year working for the city of Baton Rouge and gets paid bi-weekly. This figure would represent his gross income.

If Bob worked multiple side hustles, he’d have to add his earnings to his total income. But to keep things simple, let’s say Bob only has one job.

Subtract Deductions

Once you’ve calculated your gross income, the next step is to subtract deductions. Some common deductions are:

• HSA
• Health care expenses
• Short and long-term disability insurance

Any deduction you authorize your employer to withhold from your paycheck can qualify to be subtracted from your gross income.

Our fictional character Bob checks his pay stub and sees the following deductions withheld from his check:

• HSA – $85
• Dental insurance – $6.76
• Short and long-term disability insurance – $13.92
• Health insurance – $32.99

Since he knows that the above deductions will be taken from his check 24 times a year, he adds them up and multiplies by 24. The answer he gets is $3,328.08. He subtracts this from his gross income and gets the total $34,798.32.

For pretax deductions like the HSA and typical health care expenses, you’d lower your adjusted gross income. This could lower your tax bill.

Deduct Retirement Contributions, Plus Medical And Dental Expenses

After you subtract your deductions, the next step is to deduct your retirement contributions, along with any medical and dental expenses. If you’re eligible to contribute to a traditional IRA (individual retirement account), you could deduct the amount you contributed. However, if you choose to contribute to a Roth IRA, you won’t get a deduction since it’s not a tax-deductible account.

To deduct medical and dental expenses, you have to itemize your deductions. Once you’ve done that, the IRS will allow you to deduct the amount of the expenses that exceed 7.5% of your adjusted gross income. For more information, visit the IRS’s website.

In Bob’s case, he contributes $3,516.24 to his retirement fund annually. After subtracting this amount from his total in step 2 above ($34,798.32 - $3,516.24), he gets $31,282.08.

Subtract Taxes From Annual Pay

For the last step, you subtract all the taxes from your annual pay. These taxes may include federal taxes, FICA tax (6.2% Social Security tax and 1.45% Medicare tax), state taxes or self-employment tax.

For Bob, after totaling up his annual taxes, he got $4,016.88. Once he subtracted it from the total in the previous step, he got the answer for his net income: $27,265.20. Now, I hope you see that if he were to base his budget on his gross income, he’d be in trouble.

If you’d like to use a more simplified version of the formula to calculate your net income, use this one:

Net Income = Gross Income - Expenses

What Is Operating Net Income?

Like net income, net operating income is used to assess profitability, but it has to do with the profitability of a real estate investment. To calculate net operating income, you’d use the following formula:

Net Operating Income = Real Estate Income - Operating Expenses

You’d use this formula if you were trying to decide whether a rental property you own or one for sale would be a good investment.

For example, let’s say you owned an Airbnb rental property that brought in $60,000 a year in income. And you had to pay for the following expenses:

• $10,000 to repair costs
• $10,000 in cleaning services
• $2,000 in property taxes

To calculate your net operating income, you’d subtract $22,000 from $60,000, giving you a operating net income total of $38,000.

Unlike the net income formula, the net operating income formula doesn’t include taxes. Also, the formula doesn’t include the debt you might owe on the mortgage.

The Bottom Line

If you want to create a budget that’ll work, use the net income formula to calculate your take-home pay. Once you have this information, it’ll empower you to create a budget that fits your lifestyle. To stay on track, review your personal budget at least once a month. Try using one of the budgeting apps we recommend. By doing so, you’ll have a better chance of transforming your financial dreams into reality.