What is After-Tax Income
After-tax income is the net income after the deduction of all federal, state, and withholding taxes. After-tax income also called income after taxes, represents the amount of disposable income that a consumer or firm has available to spend.
When analyzing or forecasting personal or corporate cash flows, it is essential to use an estimated after-tax net cash projection. This estimate is a more appropriate measure than pretax income or gross income because after-tax cash flows are what the entity has available for consumption.
BREAKING DOWN After-Tax Income
Most individual tax filers use some version of the IRS Form 1040 to calculate their taxable income, income tax due, and after-tax income. To calculate after-tax income the subtraction of deductions from gross income is done. The difference is the taxable income, on which income taxes are due. After-tax income is the difference between gross income and the income tax due.
Consider the following example, Abi Sample earns $30,000 and claims $10,000 in deductions, resulting in a taxable income of $20,000. Their federal income tax rate is 15%, making the income tax due $3,000. The after-tax income is $27,000, or the difference between gross earnings and income tax ($30,000-$3,000=$27,000).
Individuals can also account for state and local taxes when calculating after-tax income. When doing this, sales tax and property taxes are also excluded from gross income. Continuing with the above example, Abi Sample pays $1,000 in state income tax and $500 in municipal income tax resulting in an after-tax income of $25,500 ($27,000-$1500=$25,500).
Calculating After-Tax Income for Businesses
Computing after-tax income for businesses is relatively the same as for individuals. However, instead of determining gross income, enterprises begin by defining total revenues. Business expenses, as recorded on the income statement, 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 the total revenues and the business expenses and deductions is the taxable income, on which taxes will be due. The difference between the business' income and the income tax due is the after-tax income.
After-Tax and Pretax Retirement Contributions
The terms after-tax and pretax income are used when talking about retirement contributions or other benefits. For example, if someone makes pretax contributions to a retirement account, those contributions are subtracted from their gross pay. After deductions are made to the gross salary amount, the employer will calculate payroll taxes.
Medicare contributions and Social Security payments are calculated on the difference after these deductions have been taken from the gross salary amount. However, if the employee makes after-tax contributions to a retirement account, the employer applies taxes to the employee's gross pay and then subtracts the retirement contributions from that amount.