What Is After-Tax Income?
After-tax income is the amount of money that can be spent after taxes are taken out. The amount of additional money the consumer or business will spend after taxes are deducted from all income.
After-tax income is sometimes called “net income” or “disposable income.” The word “disposable” refers to this part of the money that still exists after taxes are deducted from all income.
Understanding After-Tax Income
Individuals who are subject to taxation use the Internal Revenue Service’s Form 1040 to determine after-tax income. The gross income is the total income minus all deductions. The difference can compute the taxable income applied to federal, state, and local taxes. The difference between gross income and the taxes due is called after-tax income.
For example, If your annual property tax bill for this year is $6,000 and you have a mortgage interest deduction of $3,000, then property taxes are $1,500 ($6,000 – $3,000). If your deductions and other tax credits (for example, credit for child care and other work expenses) each amount to $8,000 ($8,000 x 15%), then your other tax credits reduce your property taxes by 25%, leaving $4,500 ($1,500 + $8,000 x 15%).
The two figures you need to subtract from gross income are property taxes ($1,500) and other deductions ($4,500). You can figure out the difference between these figures and the sum of all tax deductions ($15,500), which is $7,000 ($4,500 – $15,500). This is what you mean by “after-tax income.”
Calculating After-Tax Income for Businesses
Computing after-tax income for businesses is a complex process that gets even more complex when you add in some of the tax breaks available to certain industries, such as companies in the technology sector.
Like individuals, businesses begin by defining total revenues. As recorded on the income statement, business expenses are subtracted from total revenues producing the firm’s income. Finally, any other relevant deductions are subtracted to arrive at taxable income.
The difference between a business’s gross profits and the different operating expenses is a company’s net income. The amount of taxes that companies will have to pay is the tax liability. This tax liability is then deducted from a company’s net income to determine its after-tax income.
After-Tax and Pretax Retirement Contributions
The terms “after-tax” and “pretax” refer to retirement contributions and other benefits such as work-related life insurance or flexible spending accounts. “After-tax” contributions are made before taxes, while “pretax” contributions are made from gross pay that the federal and state governments have already taxed.
The Medicare and FICA (Federal Insurance Contributions Act) deductions, and your employer’s contributions to the Social Security Retirement Program, are taken from your gross paycheck before subtracting these amounts from your pay. However, suppose you make additional after-tax retirement contributions to a retirement account.
In that case, the amount of your employer’s contribution to Social Security is calculated on your gross salary minus such pretax deductions as the Medicare deduction and the deduction for contributions to a company retirement plan.
What Is the Significance of Corporate After-Tax Income?
Businesses can analyze whether a project is appropriate for the organization by judging whether the project has an adequate return. Projects that yield a higher after-tax income appear more profitable and attractive to businesses and investors.
Whenever a government imposes an investment tax, capital is diverted to more beneficial uses. When the tax is levied on the pretax return of an investment, it can be thought of as a tax on capital formation. Thus, when a corporate income tax is imposed, it reduces the rate of after-tax return required to give in an acceptable rate of return on investment capital.
What is the Significance of State Individual After-Tax Income?
State individual income taxes reduce a state’s after-tax income and the after-tax return of investments made by businesses. State tax rates can vary from as low as zero percent to as high as 13.3 percent, although several states have no state income tax.
Individuals and businesses who move to states with lower income taxes maximize their after-tax income by reducing their state income taxes and allowing them to invest more in other ventures.