The term net of tax refers to the amount left after adjusting for the effects of taxes. Net of tax can be a consideration in any situation where taxation is involved. Individuals and businesses often analyze before- and after-tax values to make investment and purchasing decisions. Net of tax is also an important part of expense analysis when reviewing annual tax filings and the net income of businesses.
Net of tax analysis can be important to consider in all situations where taxes may be involved.
Some scenarios where the net of tax can be especially important include large asset purchases with sales tax, before and after-tax contributions, and income taxes for individuals or businesses.
Net of Tax
In the financial industry, gross and net are two key terms that refer to before and after the payment of certain expenses. In general, ‘net of’ refers to a value found after expenses have been accounted for. Therefore, the net of tax is simply the amount left after taxes have been subtracted.
There can be several scenarios where the net of tax is important. Three of the most common are large asset purchases with sales tax, before and after-tax contributions, and an entity’s total profit after tax.
Taxes can be a part of asset sales and purchases. Most large assets like cars, trucks, and motorcycles require a sales tax at the time of purchase. Sellers of these items may also be required to pay taxes on capital gains. Property has its own tax rules and is often not subject to sales tax. Many real estate owners can often qualify for tax breaks that help them reduce any capital gains taxes they might have to pay on real estate property sold.
In general, a buyer will need to calculate all of the expenses involved in buying property. If an individual buys a $10,000 car with a $2,000 sales tax then they owe 12,000 for the car, and the net of tax value is $10,000.
If a company sells one of its assets, it is usually not responsible for sales tax but may have to pay capital gains taxes. If a company sells a factory for $1 million but realizes that it must pay $400,000 in capital gains taxes, then its net of tax profit would be $600,000, all things considered.
Net of tax strategies can be important in the investment and financial planning world. Since investors must pay taxes on their capital gains, many strategies are deployed to reduce or avoid the impact of taxes. To do this, there are several investments and investment vehicles labeled as tax-advantaged. Municipal bonds are one of the most common tax-advantaged investments with the majority of the asset class offering no federal tax on gains. Investors can also choose to hold assets for more than one year to pay a reduced long-term capital gains tax versus the short term capital gains tax. Moreover, some investors may invest to avoid alternative minimum taxes (AMT) which can apply to any investor but usually are a factor for taxpayers who itemize or higher net worth individuals with incentive stock options.
Before and after-tax investing or contributions can also be important for many investors. Any before-tax contribution lowers the value of taxable income. Any after-tax contribution is considered to be net of tax with taxes already subtracted.
Investing in 401ks or individual retirement accounts (IRAs) is often done with before or after-tax contributions. 401ks and traditional IRAs are often paid into from pre-tax dollars which helps to lower an investor’s taxable payroll income. Effectively, these types of vehicles tax the investor at the time of withdrawal. Alternatively, Roth IRAs are invested with after-tax dollars. Thus, Roth IRAs are not taxed at the time of withdrawal.
Roth IRA accounts can also provide special opportunities to take advantage of investment opportunities without taxation. If an investor had an IRA account with $100,000 in stocks and $100,000 in bonds, they could potentially sell stocks and bonds within the account without ever paying taxes on gains.
Some companies may also offer tax-advantaged benefits like pre-tax deductions for the purchase of transportation cards as part of their employee benefit plans. Any pre-tax deductions for regular expenses can be helpful because they lower the taxable amount and increase net of tax values.
Analyzing gross versus net income for an annual tax year is also often an important scenario that involves the net of tax consideration. Overall, individuals and businesses can take expense deductions that reduce their taxable income. Entities may also take credits that reduce any tax they owe. Both individuals and businesses make regular tax payments throughout the year, which should also be monitored to ensure optimal net of tax earnings.
Individuals can plan on the following annual income tax rates for 2021:
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The annual tax rate generally assessed on corporations.
At the end of the year when entities file their tax returns, certain deductions or credits can help to reduce the taxes they owe. Arriving at the total net of tax figure requires subtracting all of the income taxes paid throughout the year from the gross revenue received. If an entity receives a refund at tax time, this can be a type of reimbursement for taxes already withheld. In general, individuals and businesses usually seek to take advantage of as many tax deductions and credits as possible to reduce the total taxes paid and increase their annual net of tax value.