Gross Annual Income: Why This Number Matters

By Markets Fool.com


Photo:Got Credit.

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Median pay for the 200 most highly paid CEOs in America topped $17 million in 2014, up 21% over year-ago levels. That might seem like gross annual income, but it's not the most common explanation of the term "gross annual income."

When the term gross annual income is bandied about, it's usually done without judgment, simply summarizing someone's income over a year -- before anything is subtracted from it or before it is adjusted in any way. It includes almost all income, from a wide variety of sources, such as salary, bonuses, tips, dividends, interest, rental property income, severance pay, alimony payments, gambling winnings, and so on. Even a canceled debt you once owed is usually considered income to you.

There are some exceptions, though. For example, some of the kinds of income that generally don't count in gross income are child support payments, life insurance proceeds, money you borrowed (such as via a car loan or mortgage), qualified scholarships, and gifts and inheritances. (Inherited retirement accounts sometimes do count.)

Tax talk
Your gross annual income matters for a variety of reasons. For starters, it's what you begin with when preparing your tax return. In a nutshell, here's how your tax is determined:

Gross income
- Adjustments
= Adjusted Gross Income (AGI)

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Adjusted Gross Income (AGI)
- Exemptions
- Deductions
= Taxable Income

The taxes you ultimately pay each year are based on your taxable income, not your gross income.

In the summary above, adjustments are amounts such as contributions made to traditional IRAs or 401(k)s, alimony payments you made, student-loan interest you paid, health insurance payments you made if you're self-employed, and qualified moving expenses.

Your adjusted gross income begins with your gross annual income. Photo:LendingMemo.com.

The resulting AGI is used to determine your eligibility for certain credits, such as dependent care credits, the earned income credit, educational credits, and the child tax credit, and for certain deductions, such as total itemized deductions, miscellaneous itemized deductions, charitable contributions, and the medical deduction allowance. The AGI is further modified, becoming the Modified Adjusted Gross Income, in order to determine whether your retirement-plan contributions are deductible, among other things.

Gross annual income, loans, and investing
That's not all, though. Gross annual income is important in other ways, too. For example, if you want to take out a mortgage, your lender will likely be interested in your gross income, as it more accurately reflects the cash that you collected during the year than the AGI does. The lender is interested in how much you make, not how much you make after you've subtracted various expenses, or after you paid your taxes.

Gross annual income is also an important concept if you're an investor assessing a company. Its gross income is how much money it has taken in once you subtract the cost of producing the goods or services sold. So if Scruffy's Chicken Shack (ticker: BUKBUK) takes in $150 million and spent $100 million on chickens, spices, and labor, its gross income will be $50 million. From that, its gross profit margin can be calculated: $50 million divided by $150 million is 0.33, or 33%.

Once you have gross annual income under your belt, your taxes and your investing may be better off.

The article Gross Annual Income: Why This Number Matters originally appeared on Fool.com.

Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter,has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.