How To Calculate Income Before Taxes
Updated June 24, 2022
Whether you're preparing your income tax returns or applying for a loan, it's important to know how to calculate your income before taxes. Understanding this calculation can help you make smarter financial decisions and help you budget your income accordingly. In this article, we explain what your income before taxes is, explain how to calculate income before taxes and provide you with the pros and cons of looking at your income before taxes.
What is your income before taxes?
Your income before taxes refers to your gross income. While net income is the amount of money you earn after you subtract taxes and other deductions, gross income refers to the amount of money you earn before factoring in these deductions. Essentially, gross income refers to your total compensation or your take-home pay before deductions. It includes your salary, overtime, bonuses, commissions and other income sources. To better understand gross income as it compares to net income, consider the following calculation to determine gross income:
Net income - deductions = gross income
How to calculate income before taxes
When you want to calculate your income before taxes, you're looking to find your gross income. The calculation you use to determine your income before taxes depends on whether you're calculating it for you as an individual or for your business. Here's a look at both of these calculations:
Individual income before taxes
Rather than being the revenue you receive from a product or service and the expenses associated with their production, your gross income refers to the money you make from working before taking into account various deductions. Since both your annual salary and gross income refer to the total amount of money you make before tax, you don't need to do this calculation if you know your annual salary. If you don't know your annual salary, use these steps to calculate your individual annual income before taxes:
1. Get your paycheck
To calculate your annual income before taxes, obtain a copy of your most recent paycheck. Then, determine how much you were paid during that pay cycle.
2. Divide your pay amount by the number of pay cycles
If you receive a monthly paycheck, multiply the amount you got paid via your last paycheck by 12. If you receive a weekly paycheck, multiply the amount you got paid by 52. If you get paid hourly, multiply the number of hours you worked during a given year by your hourly rate to determine your gross annual income. For example:
Monthly paycheck amount x 12 = gross annual income
Weekly paycheck amount x 52 = gross annual income
Hours worked during a year x hourly rate = gross annual income
If you have multiple sources of annual income, your calculation becomes much simpler. For example, let's say you earn an annual income from the following sources:
Full-time job: $50,000
Renting out real estate properties: $60,000
Dividends from shares at another company: $5,000
To calculate your gross annual income using this scenario, take the sum of all of these income sources as follows:
$50,000 + $60,000 + $5,000 = $115,000
This means you earned a total gross income of $115,000 during that year.
Business income before taxes
If you want to calculate your company's income before taxes, you need certain figures found on the balance sheet. Use the following steps to perform this calculation:
1. Find your sales revenue and cost of goods sold
Sales revenue refers to the total amount of money your business earns from selling its goods and services without any deductions. In comparison, the cost of goods sold refers to any costs related to the manufacturing and production of the goods and services the company sells.
2. Subtract the cost of goods sold from sales revenue
Now that you have these figures, subtract the cost of goods sold from your company's sales revenue as follows:
Sales revenue - cost of goods sold = gross income
For example, let's say your company generates $50,000 in sales revenue and has $20,000 in labor expenses, machinery costs, supply costs and other expenses. In this scenario, you'd perform the following calculation:
$50,000 - $20,000 = $30,000
This results in a gross income of $30,000 for your company.
Advantages of looking at income before taxes
Calculating income before taxes comes with several advantages for both businesses and individuals. Here's a look at some of the reasons why you should calculate your individual income before taxes:
Helps with budgeting**:** When you create a budget, you use your gross income to manage your finances. Knowing this figure can help you make smarter allotments and purchases.
Determines child support or alimony allotment: Your gross annual income is used to determine how much you'll pay or receive in child support or alimony.
Helps determine loan approvals: When you apply for a loan where you have to make monthly payments, your lender typically determines your approval based on your gross income exceeding a certain amount.
Makes filing taxes easier: To file taxes, you need your gross annual income. Knowing this figure can help you determine what you owe or how much you'll receive in return.
Helps evaluate your finances for rental applications: Landlords use an individual's gross income to evaluate their ability to pay rent on time.
Here's a look at how the calculation of income before taxes comes into play for business:
Helps determine valuable investment opportunities: Investors use a company's gross annual income to evaluate the investment opportunities it provides. Knowing this figure can help them make more strategic decisions regarding their particular investments.
Evaluates financial performance: Gross income provides companies and their investors with an indication of its financial performance. Essentially, a company's income before taxes analyzes the effectiveness of a business' operations.
Disadvantages of looking at income before taxes
While calculating your income before taxes comes with several benefits, it also has its drawbacks. The main disadvantage of looking at your income before taxes is its inaccurate perception of your earnings. When you look at your gross income, it looks like you're getting more money than you actually are.
Let's say you earn an annual salary of $50,000. Since this is your gross income, it means you're not taking home every dollar of that $50,000 during that year. In reality, you only get what's left over after taxes and other deductions.
In terms of business, looking at your company's gross income makes it seem as though you have more revenue coming in than you actually do because this figure hasn't accounted for any expenses you've incurred. While you can use your gross income to help you budget, looking at this figure can also complicate your calculations as an individual or business if you can't differentiate it from net income.
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