For most Americans, the tax law appears to be a complex series of rules intended to keep them from their money. Several politicians are calling for a simplification of the tax law with some presidential candidates even calling for a 3-page tax law and abolishment of the Internal Revenue Service. People are more and more frustrated with filing their taxes and cringe when their paycheck gets smaller and smaller from taxes withheld.
For businesses and their owners, though, the tax law can have the extreme opposite effect. Rather than being difficult and expensive, with the right education it can be easy and profitable. The reality is that the tax law in the U.S. and every other developed country is nothing more or less than a series of tax incentives for business owners and investors. The key is for businesses and their owners to understand just how easy it is to take advantage of thousands of opportunities for reducing their taxes simply by getting a clearer picture of how the tax law works.
Every government has a litany of policies it wants to promote. These policies range from social, to economic, to environmental, energy and even international. Governments have long understood that the best way to promote a policy is to give an incentive to those who can have the greatest effect on the policy. For example, parents tend to have the biggest effect on the education of children, so the government gives incentives to the parents for providing for the education of their children. The same is true for economic policy. Economic policy is impacted most by business owners and their investors. So business owners and investors are the ones given incentives to follow government policies. Such incentives include incentives for hiring, incentives for expansion, and incentives for researching and developing new products and processes.
The incentives for business owners expanded considerably in the tax bill passed in December 2015. Entitled, “Protecting Americans from Tax Hikes (PATH),” the new bill extended and in many cases made permanent many tax benefits available to manufacturers, technology companies, and other businesses. Here are a few of the most important incentives and how businesses can take advantage of amazing tax savings.
- Research & Development Tax Credit
The research and development (R&D) tax credit is the oldest of the “extenders.” Until now, it has always been a temporary incentive in the law, never extended for more than a few years. PATH makes this incentive permanent. The result is that businesses now can plan their R&D expenditures well into the future and count on the tax incentive that goes along with these expenses. This credit can be as high as 10 percent, though the net effect after giving up the R &D deduction in favor of the credit is 6 percent of R&D expenditures.
Many businesses do not realize that they may qualify for this credit. The R&D credit does not only apply to inventions, it also applies to developing new, more efficient, or more effective business processes. Many of these business process improvements qualify for the R&D credit. And in most states, there are state credits even bigger than the federal credit. Arizona has a 20 percent credit, so combined with the federal credit, more than 25 percent of an Arizona business’ R&D expenses can be paid for by the government.
- Section 179 Expense and Bonus Depreciation
Another tax incentive that has been extended from year to year since it was first expanded in 2002 is the small-business deduction for equipment. Two little-known aspects of this incentive are that businesses can take the deduction for used (not just new) equipment and that, combined with the permanent change to leasehold improvement depreciation (now 15 years), they can take the deduction for most of their costs of improving their leased space.
The deduction was raised from $25,000 to $500,000 and will be indexed for inflation. Along with the extension of the 50 percent bonus depreciation deduction (which only applies to new equipment), small businesses can take a tax deduction for a large part of any expansion of their business or the building that houses their business.
- Work Opportunity Tax Credit and New Markets Tax Credit
Two incentives that impact both economic and social policy extended by PATH are the Work Opportunity Tax Credit and the New Markets Tax Credit. The Work Opportunity Credit is a tax credit for hiring certain types of workers, including veterans, working poor (e.g., those on food stamps SNAP) and ex-felons. The New Markets Credit is a credit for investing in struggling communities. Most of these communities have their own tax incentives in addition to the federal tax credit. The combination of these two credits provides an opportunity for expanding businesses to find workers while receiving tax benefits for hiring.
- Exemption for Gain on Sale of Small Business Stock
Another small business tax benefit made permanent by PATH is the exemption from tax of 100 percent of the gain on the sale of small business stock. Any company just starting up with a plan to sell the company in 5-10 years could benefit from this incentive. The shareholders must be the original shareholders and must hold the stock for at least 5 years. And the company must be taxed as a C corporation (a taxable corporation). While the usual recommendation is to form small businesses as S corporations (where the income and loss flow through to the shareholders), the exemption of 100 percent of the gain from tax is significant and should not be overlooked.
- 5-Year Transition from C Corporation to S Corporation Status
Converting a company from taxable (“C”) to flow through (“S”) can generate terrific tax benefits for a company. PATH made this easier by reducing the transition time from C to S corporation from the original 10 years to only 5 years.
These are just a few of literally thousands of tax benefits available to business owners and investors. Only a small portion of the tax law actually raises taxes. The rest is a guide to reducing your taxes, especially for entrepreneurs.
Tom Wheelwright is a leading tax and wealth expert, Best-selling Author (Tax-Free Wealth), CPA and CEO of ProVision Wealth. Tom is best known for making taxes ³fun, easy and understandable², and specializes in helping entrepreneurs and investors build wealth through practical and strategic ways that permanently reduce taxes. As a Rich Dad Advisor to Robert Kiyosaki (“Rich Dad Poor Dad”), Tom frequently speaks at Rich Dad conferences worldwide. His work has been featured in Forbes, Accounting Today, ABC News Radio, the Real Estate Guys Radio Show, and Money Radio 1510 Business for Breakfast. taxfreewealthadvisor.com