How much money do you really have to spend? What about your employees? To figure out your available spending money, you need to find your disposable personal income. What is disposable personal income?
What is disposable personal income?
A worker’s disposable personal income (DPI) is how much money they have to spend after subtracting taxes, including income tax, Social Security tax, and Medicare tax. Individuals can either spend or save disposable personal income.
If you are self-employed, your DPI is your available money after subtracting self-employment tax and income tax. Self-employment tax goes towards Social Security and Medicare taxes. Generally, you will make estimated tax payments throughout the year to cover your tax liabilities.
If your small business is incorporated, you are likely not considered self-employed. Taxes are typically already withheld from your salary, so you don’t need to pay taxes on your own.
As an employer, you are responsible for withholding income and FICA (Social Security and Medicare) taxes from an employee’s wages. The employee’s paycheck is known as their net pay, which is their take-home pay. Disposable personal income is similar to net pay. However, DPI does not factor in other deductions— such as health insurance premiums and retirement plan contributions.
If you have independent contractors, you do not withhold taxes. Independent contractors are responsible for paying their own taxes and calculating disposable income.
The U.S. Bureau of Economic Analysis compiles disposable personal income information to indicate how the economy is doing. If disposable personal income is high, individuals have more money to put back into the economy.
You can use your disposable personal income to determine your retirement plan contributions, budgets, and spending plan.
Disposable vs. discretionary income
Disposable income is the amount of money an individual has after taxes. On the other hand, discretionary income is how much an individual has after paying for taxes and necessities, such as rent, utilities, health insurance, and food. An individual can use discretionary income for non-essential items, such as a new television or vacation.
You can use disposable income to calculate discretionary income. Subtract essential spending from disposable income to find your discretionary income.
How to calculate disposable personal income
Calculating disposable income is fairly simple. Subtract your tax liability from your income (e.g., wages, commissions, etc.) to find your DPI.
To get started, use the disposable income formula:
Disposable Personal Income = Personal Income – Personal Tax Liability
If your DPI is less than what you need for essential items, such as rent and food, you may need to make lifestyle changes or take a bigger cut of your business’s profits.
Let’s say your biweekly owner’s draw is $2,000. You are self-employed and single. You must calculate your self-employment tax liability, which is 15.3% of your earnings. And, you need to determine your federal income tax liability.
Your self-employment tax payment is $306 ($2,000 X 0.153).
Using the income tax withholding tables in IRS Publication 15-T, your federal income tax liability is $175.
Now that you know your tax liability, you can calculate your DPI using the disposable personal income formula:
DPI = $2,000 – $306 – $175
DPI = $1,519
Your biweekly DPI is $1,519. You can use this money to pay for essential bills and goods as well as non-essential items.
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This article has been updated from its original publication date of July 31, 2015.
This is not intended as legal advice; for more information, please click here.