Post-tax deductions impact everyone in an organization, from the payroll department to individual employees. Hence, a clear understanding of the concept and its role in payroll is essential. Here are some frequently asked questions that should help you grab the concept of post-tax deductions.
1. What are post-tax deductions?
Post-tax deductions, often called after-tax subtractions, are amounts deducted from an individual’s earnings after necessary tax withholdings. Common examples include Roth 401(k) contributions, life insurance premiums, union contributions, and disability insurance premiums.
2. What types of deductions are considered post-tax deductions?
Common types of post-tax deductions include Roth 401(k) contributions, Roth IRA contributions, charitable donations, union dues, certain insurance premiums (those for supplemental life insurance or certain disability insurance policies), court-ordered deductions (child support or alimony payments), and after-tax investments.
3. How are post-tax deductions different from pre-tax deductions?
The key difference between pre-tax and post-tax deductions is when they are applied in relation to income tax calculations. Pre-tax deductions reduce taxable income and provide immediate tax benefits, while post-tax deductions are applied after taxes are withheld and do not reduce taxable income.
4. Are post-tax deductions subject to income tax?
No, post-tax deductions are not subject to income tax because they have already been subjected to income tax. When post-tax deductions are taken from an employee’s paycheck, they are subtracted from the employee’s net income, which is the income remaining after income taxes have been calculated and withheld.
In other words, the money used for post-tax deductions has already been taxed as part of the employee’s gross income
The concept of "gross income" can differ slightly in its composition and definition across countries, primarily because of differences in taxation structures, income reporting standards, and cultural variations in what is considered taxable income.
In essence, while the general idea of gross income—as the total income earned before any deductions or taxes—are somewhat universal, the specifics can vary based on a myriad of factors rooted in a country's legal, economic, and cultural landscape.
For individuals, gross income signifies their earnings before any taxes or other deductions. This can include wages, interest, dividends, pensions, and rent.
For businesses, gross income, also termed as gross profit or margin, is the revenue minus the cost of goods sold (COGS).
Breaking down gross income
Individuals. Apart from wages, gross income encompasses pensions, interest, dividends, and rent. It's the foundation for tax returns. After accounting for deductions and exemptions, the result is the adjusted gross income (AGI), which then helps calculate taxable income.
Businesses. Gross income is obtained by deducting COGS from total revenue. It gives a snapshot of a product's performance and the company's overall profitability. Typically, this figure appears on a company's income statement.
Gross income vs net income
Gross income and net income are two fundamental financial terms that are often used in the context of individual earnings and business finances. While we explained what gross income is for individuals and businesses, here is a couple of words about net income.
Net income for individuals is the amount of money an individual takes home after all deductions have been accounted for. It's often called "take-home pay" or "net pay." This is the money an individual has available to spend, save, or invest.
Net income for businesses is the total profit remaining after all expenses have been deducted from the gross income. This includes operating expenses, interest, taxes, and other relevant costs. Net income gives a comprehensive view of a company's profitability over a specified period.
In essence, while gross income provides an initial understanding of earning potential, net income offers a clearer picture of actual earnings (for individuals) or profitability (for businesses) after all expenses and deductions are considered.
Calculating gross income for individuals
For individuals, gross income encompasses all of their earnings before any deductions or expenses are subtracted.
Wages and salaries. Begin with the total amount earned from work. This includes hourly wages, salaries, overtime, bonuses, and commissions. For those who receive regular paychecks, the gross income will often be listed as the total amount before taxes and other deductions.
Self-employment and freelance income. For those who are self-employed or freelance, gross income is determined by taking the total revenue from goods sold or services provided and then subtracting any direct business expenses, like the cost of goods sold. It does not account for other business expenses like marketing, utilities, or rent.
Rental income. If you earn money from renting out a property, add the total amount you receive from tenants. Don't deduct expenses like mortgage interest or maintenance costs at this point.
Dividends and interest. Include any dividends from stocks or interest from savings accounts, CDs, or other financial investments.
Retirement distributions. Include any money taken out from retirement accounts, unless it's a return of contributions from a Roth IRA, which is not taxable.
Alimony and child support. If you receive alimony or child support, this may also be included, though the rules can vary depending on jurisdiction.
Other income. Include any other sources of income, such as lottery winnings, gains from the sale of assets, or cash prizes.
Sum up all of the above components to arrive at your total gross income. After summing these, subtract tax deductions to get AGI. In the US, this total is typically reported on the W-2 or 1099 form.
Note that some incomes, like inheritance or social security benefits, aren't taxable. What’s more, the specific components of gross income and whether certain types of income are taxable can vary based on the country's tax laws and regulations where the individual resides.
Calculating gross income for businesses
Calculating gross income for a business is distinct from calculating it for individuals. For a business, gross income represents the total sales revenue minus the cost of goods sold (COGS). Here's how you can determine it:
Begin with the total revenue from all sales. This is the total amount of money brought in from selling products or services before any expenses are deducted.
Determine the Cost of Goods Sold. COGS represents the direct costs associated with the production of the goods sold by a company. This includes raw materials, direct labor, and other direct costs but does not include indirect expenses such as sales, marketing, and distribution.
For retailers or wholesalers, COGS includes the cost of inventory that was sold during the period. For manufacturers, it includes raw material costs, labor costs, and manufacturing overhead.
COGS can be determined using the formula “COGS=Beginning Inventory+Purchases−Ending Inventory”
Once you have both figures, subtract the COGS from the total sales revenue:
Gross Income=Total Sales Revenue−COGS
The result is the gross income or gross profit. This number gives an idea of how efficiently a business is producing its goods. It doesn't account for other operating expenses, taxes, or interest.
For example: If a company has total sales of $500,000 and COGS of $300,000, its gross income is $200,000.
Calculating monthly gross income
If you’re an individual, check your pay stub for pre-tax monthly earnings. For hourly workers, multiply the hourly rate by monthly hours. You can also divide the annual salary by 12. This method is relevant for employees, freelancers, and contractors. Remember to consider other earnings, like from investments or side jobs.
If you’re a business, use gross income = Gross revenue - COGS, focusing on monthly data. . Therefore, post-tax deductions are made with after-tax dollars, and no additional income tax is applied to them.
5. Can I change my post-tax deductions?
The ability to change post-tax deductions is influenced by employer policies, the type of deductions involved, and any qualifying life events that may allow for adjustments outside of regular enrollment periods. It’s advisable to familiarize yourself with your employer’s specific policies and consult with HR or payroll representatives for guidance on making changes to your deductions.
6. Is there a limit to how much I can contribute to post-tax retirement accounts?
The annual contribution limits for post-tax retirement accounts, such as Roth IRAs or Roth 401(k)s, are set by the government and may change each year. Here are some contribution limits as of 2023.
Roth IRA (Individual Retirement Account)
For the tax year 2023, the annual contribution limit for a Roth IRA is $6,500 for individuals under the age of 50 and $7,500 for individuals aged 50 and older (including catch-up contributions).
These limits are subject to income restrictions, and contributions may be reduced or phased out for individuals with higher incomes.
Roth 401(k) or Roth 403(b) Plans
Roth 401(k) and Roth 403(b) plans offered by employers have higher contribution limits than Roth IRAs.
For the tax year 2023, the annual contribution limit for these plans is $22,500 for individuals under the age of 50, with an additional catch-up contribution limit of $7,500 for those aged 50 and older.
Roth 457(b) Plans (for government employees)
Contribution limits for Roth 457(b) plans can vary by employer and may be influenced by the age of the account holder.
For 2023, individuals under age 50 could contribute up to $22,500.
7. Can I claim a tax deduction for post-tax charitable donations?
Depending on your tax situation and the specific tax laws in your country, you may be eligible to claim deductions for charitable donations on your income tax return. In the US, you can claim a tax deduction for post-tax charitable donations, but there are specific rules and requirements that must be followed. Consider the following key points to stay on the safe side.
Itemizing deductions. To claim a tax deduction for charitable donations, itemize your deductions on your federal income tax return using IRS Schedule A (Form 1040).
Qualified charities. The charitable organization to which you make contributions must be a qualified tax-exempt organization under Internal Revenue Code. Most established charities, religious organizations, and nonprofit groups fall into this category.
Documentation. Keep records of your charitable contributions, including receipts or written acknowledgments from the charity.
Limits on deductions. You can generally deduct up to 60% of your AGI for cash contributions to qualified charities.
Non-cash donations. If you donate non-cash items, such as clothing or household goods, you may also be eligible for a deduction.
Special deduction for 2021. Due to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security (CARES) Act allowed for an above-the-line deduction of up to $300 for cash charitable contributions made by eligible individuals who did not itemize deductions for the 2020 tax year. This provision was extended for the 2021 tax year, allowing for an above-the-line deduction of up to $300 ($600 for married couples filing jointly) for cash donations to qualified charities, even if you take the standard deduction.
8. Do W-2s show after-tax deductions?
No, W-2 forms do not typically show after-tax deductions. W-2 forms provide a summary of an employee’s taxable income and the various taxes and pre-tax deductions that have been withheld during the tax year. After-tax deductions, which are subtracted from an employee’s net (after-tax) pay, are not included on the W-2 form because they do not affect the calculation of taxable income or tax withholding.
Yet, voluntary after-tax contributions to certain non-Roth pension plans might appear in Box 14.
9. What are statutory deductions?
Statutory deductions, also known as mandatory deductions, are deductions from an individual’s income that are required by law. These deductions are typically enforced and regulated by government authorities, and employers are obligated to withhold and remit the specified amounts to the appropriate government agencies.
Statutory deductions are an essential part of an individual’s compensation and include income tax, social security tax (FICA), medicare, unemployment insurance, workers’ compensation insurance, and child support and alimony.
