Net of Taxes Meaning
Net of taxes refers to the final amount left after the deduction of taxes. Since the payment of taxes is the legal & statutory obligation for any business which cannot be avoided, the analysis of before and after-tax values requires serious consideration in strategizing the major investment and operating decisions of the company.
Net of Taxes Formula
The amount net of tax can be calculated by subtracting the amount of taxes from the gross value.
Example of Net of Taxes
For Example, the total Income of ABC Inc. for the year ending 2019 was $ 1,000.00. However, ABC Inc. is liable to pay the U.S. federal corporate income tax at the applicable rate for the year 2019, which is 21%. The Net Income after taxes of the company is calculated as below:
Calculation of Net Income after Taxes
Now, it is vital to understand the significance of gross income and net income. Gross Income of U.S. $ 1,000.00 represents the total earning of ABC Inc. after considering all the manufacturing, general, and selling expensesSelling ExpensesThe amount of money spent by the sales department on selling a product is referred to as selling expenses. This includes expenses incurred on advertising, distribution and marketing. Because it is indirectly related to the production and delivery of goods and services, it is classified as an indirect cost.. However, the company can neither keep the entire gross incomeGross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity. as its retaining earnings nor declare any dividend payoutsDividend PayoutsThe dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) to the company's net income. Formula = Dividends/Net Income on gross income. The company, by law, is under obligation to honor its taxes. Hence, the company can only declare dividendDeclare DividendDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities. on its net disposable income Disposable Income Disposable income is an important mechanism to measure household incomes, and includes all sorts of income such as wages and salaries, retirement income, investment gains. In other words, it is the amount of money left after paying off all the direct taxes.after taxes of U.S. $ 790.00
Significance of Net of Taxes Values in Various Business Events
The importance of considering Gross and Net values can affect various business decision can be observed in the following business scenarios.
#1 – Sales of Goods / Services
Generally, all the goods and services offered by the businesses involve the levy of sales tax on it as mandated by the tax laws. Sales taxSales TaxThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company's welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%). is an indirect tax on the income of the end-user, i.e., the burden of sales tax is generally passed to the customers by the companies by adding the tax amount in the selling price of their goods and/or services.
Let us suppose, ABC Inc. sells artistic pen sets at the selling price (inclusive of sales tax @ 20%) of U.S. $ 120.00 per unit. John bought 10 pen sets and paid the U.S. $ 1,200.00 to the company.
Since the selling price was inclusive of sales tax, the selling price of a pen set is the U.S. $ 100, and the U.S. $ 20/set is added as the amount of sales tax. Due to which ABC Inc. is liable to pay the amount of sales tax collected by the company to the Government. The company is required to separately show the sales tax amount in its financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. as:
Calculation of Net SalesNet SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales.
- =$1200 – $200
#2 – Sales of Assets and Investments
Whenever a company makes the sale of its assets such as furniture, machinery, etc., or any investment like bonds, shares, or sale of any of its business, any profit earned from such sale is known as capital gains. Since the capital gain is an income for the seller, it attracts levy of income tax on such gain amount.
For instance, ABC Inc. holds 25000 common stocks of Z Inc. The company acquired the stocks 5 years ago at a price of U.S. $ 20 per share. At present, the shares of Z Inc. is trading at the U.S. $ 80 per share. The company decides to sell half of its investment at the current price of U.S. $ 80 per share. The value of capital gains can be derived as:
Calculation of Capital Gains
- =$1000000 – $250000
Assuming the capital gains are taxable at a flat rate of 10%. The Net earnings on the sale of investment will be the number of capital gains minus tax on the capital gain.
However, to save the amount of capital gains, the company can reinvest it in for a certain lock-in period as defined in tax laws. Such reinvestmentReinvestmentReinvestment is the process of investing the returns received from investment in dividends, interests, or cash rewards to purchase additional shares and reinvesting the gains. Investors do not opt for cash benefits as they are reinvesting their profits in their portfolio. can allow the exemption of tax on the amount of capital gains reinvested by the company.
#3 – Taxes on Income
If a company earns a profit, it cannot be considered as final disposable income. Before appropriating the total income into retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. and dividend payouts, the company has to pay income tax on the total profit made during the year by the company. The net income after deducting the amount of tax can only be considered as disposable income.
Thus, to maintain growth in the profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. trends, the company is required to forecast its before and after-tax earnings with due diligence and care.
Even in the case of individuals, the amount of salary they receive at the end of every month is the net take-home payTake-home PayTake-home pay is the net amount paid to the employees after deducting contributions like retirement account contributions, a premium on insurance, social security and Medicare contributions, benefits and taxes from the gross pay. after deducting taxes and other contributions. The amount of tax can be reduced by making regular contributions to 401K payments. Thus, it is important for individuals as well to keep a check on their before and after-tax payouts in order to properly plan for payment of taxes.
Net of tax amount is the amount left after making adjustments for tax. Since the key objective of any business is to maximize the wealth, the understanding of gross and net values can help the business entities to strategies their pricing policies, investment decisions, dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity. decisions, through financial tax planning.
This has been a guide to the Net of Taxes and its meaning. Here we discuss an example to calculate the net of taxes using the formula and its significance values in various business events. You can learn more about accounting from following articles –