When your income passes a certain threshold, your income is subject to taxes. Therefore, an individual or corporation does not receive their full wages because they must subtract the cost of taxes. The state or federal government levies taxes to fund various services, such as transportation, or for social benefits, like Social Security, Medicare, Medicaid, and more. The amount of your wages that are left over after the taxes are applied is known as “net of tax.” In the United States, your net of tax is affected by how much you earn because different tax rates apply to different income brackets. This is known as a progressive income tax—rates increase when income hits a certain threshold. Here’s a hypothetical example of a progressive tax system:
10% tax on income up to $10,00012% tax on income from $10,001 to $30,00022% tax on income from $30,001 to $80,00024% tax on income from $80,001 to $160,000
Individuals and business entities can increase their net of tax in part by reducing the taxes they owe through deductions and credits. Tax deductions and credits are also available to individuals, allowing you to keep more of what you earn. For example, individuals can deduct several types of costs, including medical expenses and interest on student loans. Individuals can also improve their net of tax through various tax credits, such as:
Earned Income Tax Credit: This tax credit provides a tax break to workers and families with low- to moderate-incomes.Child and dependent care credit: Available to parents and guardians, this tax credit is useful for mitigating the costs of babysitting and daycare. The credit can also extend to caring for an individual who is physically or mentally unable to care for themselves.Lifetime learning credit: If you’re seeking post-secondary education, this tax credit can help offset some of the costs of obtaining a degree.
Several types of business expenses are tax-deductible like rent, interest on commercial loans, employee salaries, business insurance, employee benefits, and more.
Example of Net of Tax
Consider this simplified, hypothetical example of net of tax. You earned $50,000 this year. However, you paid $7,500 in income taxes. To calculate your, you would subtract $7,500 from $50,000. $50,000 - $7,500 = $42,500 So, in this scenario, you would have an income net of tax of $42,500.
Net of Tax and Retirement
Your income can still be subject to taxation when you retire. Like other forms of income, your retirement savings is also subject to taxation. For traditional 401(k) plans, income taxes are deferred until you withdraw from your account. Any pensions you receive from your employer are taxed, as well. You will owe federal income tax on each pension annuity and periodic pension payments. If you opt for a lump-sum payout, you are required to pay the taxes on the entire amount when filing your tax returns.
