What is Net of Tax?
Net of tax is the amount after adjusting for the effects of income tax. Net of tax is most commonly calculated by taking gross figures, like the cash collected from the sale of an asset, and subtracting the taxes paid. Net of tax could also be used to show the final amount after accounting for the tax savings, for example, on a loss that allows a tax deduction.
Net of tax is basically the amount left over after taxes have been deducted. it is also known as after-tax. The net of tax figure is important because it allows you to factor in just how much of an impact taxes can have on a person or other entity. For investors, the net of tax figure can provide a good window into how companies and businesses are operating after taxes are deducted, and can answer key questions like what Company A's actual cash flow looks like or how big Company B's bottom line is.
Net of Tax
A Simple Net of Tax Example
If a company sells one of its factories for $1 million, but $400,000 of that is eaten up by taxes, the company may present the net of tax figure of $600,000 because that is the amount being added to the bottom line. The tax figure doesn't disappear, however, as it is accounted for in the gross figure given for income tax expense, and may be referenced specifically if it was a significant contributor to an unusually high tax bill.
Net of Tax Strategies in the Investment World
It is an important concept in the investment and financial planning world. Since investors must pay taxes on their capital gains, many strategies are employed to reduce the impact of taxes to ensure that an investor's net of tax portfolio is as large as possible. One major strategy to reduce the impact of taxes on a portfolio is known as asset location, which refers to what types of assets investors place into the different types of accounts available to them. Another strategy is to invest in tax-efficient securities, such as municipal bonds, which aren't subject to certain types of taxes, depending on a few factors.
Net of Tax Examples in Investment Portfolios
As a simple example of how using the right strategy can increase an investor's after-tax portfolio, consider the following.
An investor has an individual investment account with $100,000 invested in stocks and another $100,000 in bonds. The investor also has an individual retirement account (IRA) with $100,000 in stocks and $100,000 in bonds. He decides that he wants to reduce his overall stock exposure by $100,000 and place that money into bonds. For simplicity, assume that each of the four positions have long-term capital gains of $50,000.
Were he to sell $50,000 of stocks from the individual account, the situation would be:
Stocks = $0 with a tax liability of $50,000 x 15%, or $7,500. (Thus, only the net $92,500 could be invested in bonds.)
Bonds = $192,500
Compared to a trade in the IRA Account:
Stocks = $100,000
Bonds = $100,000
Given this trade, the investor's total net of tax portfolio would be equal to $392,500. However, if the trade was made in the tax-free IRA account, the net of tax portfolio amount would still equal $400,000, since no taxes are due on trades made in IRAs.