What Is After-Tax Income?
After-tax income is the net income remaining after all federal, state, and withholding taxes have been deducted. It is also known as income after taxes and net of tax amount. This figure represents the amount of disposable income available for personal or business expenditure.
Key Takeaways
- After-tax income is calculated by subtracting federal, state, and withholding taxes from gross income.
- It indicates the disposable income that can be used by a consumer or a firm.
- Calculating after-tax income for businesses involves determining total revenues and subtracting business expenses to yield taxable income.
Understanding After-Tax Income
Most individuals utilize the IRS Form 1040 to determine their taxable income, tax due, and resultant after-tax income. To calculate after-tax income, you subtract deductions from your gross income. The remaining amount is the taxable income, and the difference between gross income and the tax due is defined as after-tax income.
Consider this example:
Abi Sample earns an annual gross salary of $30,000 and claims $10,000 in deductions, resulting in a taxable income of $20,000. With a federal income tax rate of 15%, the tax due amounts to $3,000. Consequently, Abi’s after-tax income stands at $27,000 ($30,000 - $3,000).
State and local taxes are additional deductions that can be accounted for in calculating after-tax income. For instance:
Abi also pays $1,000 in state income tax and $500 in municipal income tax, resulting in an adjusted after-tax income of $25,500 ($27,000 - $1,500).
When analyzing or forecasting personal or corporate cash flows, estimating after-tax net cash provides a more accurate measure than either pretax income or gross income, reflecting the entity’s true disposable income.
Calculating After-Tax Income for Businesses
Much like individuals, businesses compute after-tax income, though the process begins with defining total revenues instead of gross income. Business expenses listed on the income statement are deducted from total revenues to derive firm income, followed by any applicable deductions to ascertain taxable income.
The disparity between total revenues minus expenses and deductions is the taxable income, on which taxes are calculated. Subsequently, the after-tax income is determined by subtracting tax due from the business’s income.
Balancing After-Tax and Pretax Retirement Contributions
In the context of retirement contributions, terms after-tax and pretax refer largely to how these contributions are treated relative to income.
If pretax contributions are directed into a retirement account, they are subtracted from gross pay before tax calculations. Medicare and Social Security contributions are then based on this reduced amount. Conversely, if contributions are made after-tax, the employer calculates and applies tax on the gross salary prior to deduction.
Related Terms: gross income, taxable income, net cash, tax deductions, disposable income.
References
- Internal Revenue Service. “Form 1040.”
- Internal Revenue Service. “Retirement Topics - Contributions.”
