By: Tom Wheelwright
You should emulate Donald Trump! Don’t be triggered… By that I mean, I want you to understand the purpose of the tax code and invest your money accordingly.
The common fallacy that our culture and media spread is that the rich don’t pay taxes because they cheat. Sorry to burst your bubble BUT…aside from the rare criminals, the rich don’t cheat. They invest their money in government incentivized activities.
They understand this important principal:
The tax code is written so that governments provide incentives not only to boost the economy and other programs they support, but also to control the way their economy grows, including sector growth and the size of the company impacted.
Why would they do that?
The 5 Goals of Every Government:
- Keep the peace.
- Protect the people.
- Feed the people.
- Shelter the people.
- Educate the people.
Key Concept: The individual pays taxes on gross income while businesses pay taxes based on net income, which is income after certain expenses. This is how the benefit of many incentives are realized.
Tax incentives play a major role in each of the government goals. Tax laws:
- Incentivize business creation, which creates jobs.
- Stoke energy and technology production, both of which increase economic performance and protect the nation.
- Encourage agricultural investments, which feed people and provide a level of national security.
- Increase construction and management of housing, providing shelter for people.
- Encourage people to obtain higher levels of education.
The 7 Primary Investments Incentivized by Tax Laws:
- Technology | Research & Development
- Real Estate
Tax incentives are not merely gifts to the rich. Neither are they loopholes. A loophole is an unintended consequence of a rule or law.
Key Concept: The government wants to leverage its funds. Taking on investment internally would mean spending one dollar and at best receiving one dollar’s worth of housing, energy, crops, or technology in return. Through tax incentives, the government can spend one dollar on a tax credit and in return private builders will spend nine of their own. In this scenario, the government ends up with $10 worth of housing at a cost of $1. That is smart.
Investment 1: Business
Government Purposes: Job creation, innovation, production, and trade
Why Job Creation? It costs governments much less money to encourage job creation in the private sector. Private job creation not only creates taxes from the labor but also taxes on the business profits.
Tax Incentives for Business:
- General Business Credits
- Deductions: The requirements for an expense to be deductible is that it (1) Serve a business purpose, (2) Be in line with what is considered ordinary for the business type and size, (3) Be necessary, and (4) Be documented. The purpose of an expense is to create income and drive economic growth and development.
- Capital Expenditures (Accelerated Depreciation & Amortization): Buying equipment that will produce income for multiple years can be expensed in the year that it is purchased. By allowing an immediate deduction for equipment and other assets, the government encourages long-term investment and thus frees up cash that would otherwise go to taxes to help expand business operations.
|Corporate Tax Rates||Individual Tax Rates|
The point: The US is in line with the rest of the world for tax rates to businesses and individuals.
Investment 2: Technology | Research and Development
Government Purposes: Healthcare, innovation, and national security
Tax Incentives for Technology and R&D:
- Tax Credits (% in the US): 10% of qualified research expenditures. In Texas, it is up to 50% of the taxpayer’s liability.
- Tax Deductions (% In the US): 100% immediate deduction of research expenditures if no credit is taken.
There are 4 requirements that must be met for the deduction to qualify as a research expense:
- Business deduction
- New or Improved business component
- Process of experimentation
Investment 3: Real Estate
Government Purposes: housing, commercial development, energy, technology, manufacturing, and jobs.
Every country has tax incentives for real estate, and most of them only apply to investment in real estate. The US and a few others do provide incentives for home ownership though. This is offered through the interest deduction against taxable income.
Tax Incentives for Real Estate
- Deductions: same as business incentive.
- Depreciation: you depreciate the expense of the components of real estate over its useful life.
- Land: NA
- Building: 27.5 – 39 years
- Land Improvements: 15 years (outdoor lighting, fencing, covered parking, landscaping)
- Contents of the building: 5 – 7 years
- Recapture rates when sold prior to expiry of useful life top out at 25%.
- Tax Credits: Used to encourage construction and ownership of low-income housing, maintaining historical buildings, and providing access for the disabled.
- Low tax on cash sales: Capital gains rates (0-28% for the US) are typically applicable when the property is held for longer than 1 year.
- Nontaxable sales of real estate: 1031 like-kind exchange
- Nontaxable debt: Cash from putting debt on a property is not taxable.
- Eliminating tax: You die and pass on to your heirs at a step up in the basis based on the current valuation.
Why doesn’t the government just build housing themselves?
Historically, some governments have taken on direct responsibility for building residential housing. This was most prevalent in Russia and Poland during the Soviet years. In recent years, it is more common for governments to incentivize private development. The result is better housing at a lower cost to the government.
Investment 4: Energy
Government Purpose: Environment, productive competitiveness, national security.
Tax Incentives for Energy:
- Deductions: Cost of equipment, development, and operations
- Depletion Deduction: 15% of the sales price of oil, regardless of the number of reserves remaining in the ground. Effectively, only 85% of income from oil and gas is taxable.
- Renewables Credits: 26% of the cost of installing solar panels.
Investment 5: Agriculture
Government Purpose: Food, shelter, exports
Tax Incentives for Agricultural:
- Deductions: In addition to current expenses being deductible, many farm and ranch assets are deductible in the year purchased, including some farm and ranch buildings.
- Hobby Loss Rules Apply: Allows a presumption that the taxpayer is engaged in for profit if in 3 of 5 consecutive years (2 of 7) in the case of breeding, training, showing, or racing of horses), the activity is profitable. I.e. You can’t expense a veggie garden. It must be a legitimate business.
Investment 6: Insurance
Government Purpose: Peace, economy, retirement, security, welfare
Tax Incentives for Insurance:
- Deductions: expenses an employer incurs related to health insurance is 100% deductible.
- Nontaxable nature of life insurance proceeds: The life insurance premiums are not tax deductible. Life insurance proceeds are not taxable, however, they are subject to inheritance taxes. If heirs own the life insurance policy, the proceeds escape income and estate taxation.
- Nontaxable nature of investment earning
Investment 7: Retirement Savings
Government Purpose: Keep the peace, take care of the elderly
Tax Incentives for Retirement Savings:
- Programs: 401k, IRA, Pension and Profit-Sharing Plans
- Deductions: 401k ceiling of $20,500, IRA and Roth IRA ceiling is $6,000, Profit Sharing ceiling is $61,000
It doesn’t matter who the President is when it comes to taxes. Why? All politicians prefer to use taxes to manipulate and direct the economy. Because of that, there will always be tax incentives.
The question we should ask is, “Where should I invest my money to produce the least amount of taxes?”