After-Tax Income: Explanation and How to Calculate It

After-Tax Income: Explanation and How to Calculate It

After-tax income is the net income amount available to invest, save, or consume after applying federal, state, and withholding taxes. It is a person’s disposable income. Companies, and individuals, make economic decisions in light of how they can best maximize their after-tax income.

Understanding After-Tax Income

Simply put, after-tax income is essentially total paycheck minus total taxes. It represents the disposable earnings that a person can spend. For corporations, after-tax income provides a more accurate forecast of cash flows because it provides a true measure of the cash available for spending.

Salary before taxes is the total paycheck before taxes. It is also known as gross income.

After-tax salary is the money you take home after all taxes and contributions have been deducted, known as net income.

While calculating your after-tax income seems relatively straightforward, many types of taxes can be deducted. Commonly deductible taxes include federal, provincial, and state taxes. When calculating gain after-tax, withholding taxes, that is, taxes withheld from an individual’s salary and paid directly to the government can also be deducted.

The calculation may also deduct local taxes such as sales and property taxes. Provincial or territorial taxes may also include health insurance premiums in some jurisdictions. Some jurisdictions provide tax credits, which encourage investments in small businesses. If credits are available, deductible taxes and increased after-tax income will reduce.

Calculation of income after tax for enterprises

The calculation of income for businesses is relatively similar to individuals. Companies start by determining total income, not gross income. Selling expenses recorded in the revenue statement are deducted from the firm’s total revenue. Finally, any relevant deductions are deductible.

The difference between total revenue and business expenses and deductions is taxable earnings on which taxes will be paid. The difference between the revenue of the enterprise and the income tax payable is income after taxes.

After-Tax Income: Explanation and How to Calculate It

How is income after taxes calculated?

The after-tax income formula is quite simple, as shown below:

  • Income after tax = gross income – taxes

To calculate your after-tax income you don’t need professional tools, subtract your total taxes from your gross income. For example, suppose a person receives an annual salary of $50,000 and is taxed at 12%. This will result in taxation of $6,000 per year. Therefore, this person’s paycheck after taxes would be $44,000.

The after-tax income calculation follows the same formula for corporations, except that net income replaces gross income. Net income is equal to total revenue minus expenses and losses. Corporations will disclose their net income in the revenue statement when calculating year-end financials.

After calculating the net income, the corporation subtracts all applicable taxes to find the after-tax profit. Generally, corporations want to show higher after-tax earnings, which is a sign of profitability.

Real-life example

Suppose a person in San Francisco receives an annual salary of $75,000. Employees must pay 8.65% in federal insurance premiums (FICA), which contribute to services such as Social Security, Medicare, and unemployment insurance. In California, individuals must pay a federal income tax of 14.13% and a state income tax of 5.43%.

To calculate an individual’s after-tax income, we must first calculate their total taxes by summing their tax rates:

  • General taxes = 14.13% + 5.43% + 8.65% = 28.21%
  • $75,000 x 0.2821 = $21,157.50

So total annual taxes for an individual is $21,157.50.

Net income after taxes (NIAT)

Net income after taxes (NIAT) is similar to income after taxes, except it applies to corporations rather than individuals. Also referred to as profit or net income, net income after taxes refers to the remaining profit after deducting all expenses (including taxes).

In addition to taxes, net income after taxes also deducts operating expenses, interest, dividends, and depreciation. In the context of corporate finance, net income after taxes is a significant number because it represents the remaining profit for owners and shareholders. A higher NIAT usually results in a higher share price for publicly traded companies.

How does the expense factor affect income after tax?

The relationship between the tax code to expenses also matters for after-tax income and business investment decisions.

Business earnings are the difference between revenue and expenses. When businesses can fully account for the cost of investing in machinery, equipment, and buildings in the first year, the company can maximize its post-tax return on investment. This reduces after-tax returns on investments. The failure to allow full and immediate write-offs of business investment costs effectively shifts the tax burden forward in time, as businesses today face a higher tax burden because they cannot fully deduct their expenses.

When things like equipment, machinery, and buildings costs can only be deducted after a few years rather than immediately, the business cannot recover the total value of its investment. The value directly removed under a full cost recovery policy is worth more to the company than the value deducted for depreciation later in the year. The result is a higher capital cost, which reduces capital accumulation, productivity, and wages.

The Tax Cuts and Jobs Act’s full spending provision, allowing the total business investment cost for certain investments to be written off immediately, will remain until 2022 before it begins to be phased out.

After-Tax and Before-Tax Retirement Contributions

The terms “income after-tax” and “income before tax” often refer to pension contributions or other benefits. For example, if someone makes pre-tax contributions to a retirement account, those contributions are deducted from their gross salary. After deducting the gross salary, the employer can calculate taxes.

Medical care contributions and Social Security payments are calculated based on the difference after deducting these contributions from your gross salary. However, if the employee makes post-tax pension contributions, the employer applies taxes to the employee’s gross salary and then deducts the pension contributions from that amount.