5 Legal Deductions for Entrepreneurs With the New Tax Law's 'Consumption' Approach
Here's how to maximize your business deductions for inventory, automobiles, equipment, real estate and energy.
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Entrepreneurs should take full advantage of the new incentives in the Tax Cuts and Jobs Act of 2017, and make plans now to invest more money in their businesses in 2019. To provide context, I've provided the big picture.
Below are five legal deductions that can save small business owners millions of dollars using the new U.S. consumption tax approach.
Here's what you need to know.
As background, income tax has traditionally been thought of as a tax on all of the net income of a business owner. That has included the net income of the business of being an employee.
The new tax law radically changes this assumption. Rather than a tax on income, the U.S. income tax has become a tax on consumption. So, employees are now taxed on their gross income tax, with no deductions for the cost of employment.
Now, any money reinvested into a business is tax-free. It doesn't matter whether the business belongs to the retail, service, manufacturing, real estate, energy or agricultural sector. Business owners now have greater incentives than they previously had, to increase investments in many areas, including inventory, automobiles, equipment, real estate and energy.
In contrast, only money taken out of the business for personal reasons is taxed.
The new law encourages production and punishes consumption by rewarding business investments that fuel the economy. The new law provides more ways for business owners to reinvest in their businesses and expand production with before-tax dollars, increase deductions and save millions of dollars over a lifetime.
Want to increase your tax savings? Here are five examples of legal tax deductions:
1. Inventory investment deductions
Entrepreneurs can now benefit from the new inventory rules. Instead of deducting inventory after it is sold, small retailers (with less than $25 million in sales) can now write off much of their inventory when it is purchased.
This change in the law can mean the difference between a business surviving and thriving versus failing. Previously, the requirement was to use after-tax dollars for building inventory, so this change may well have significant, positive impacts on retailers. As a result, inventory is becoming a tax-beneficial purchase instead of a tax liability.
2. Automobile bonus depreciation deductions
With the new tax law, business owners may now take major deductions for the year that their new vehicle was acquired versus spreading that expenditure over many years.
This tax change encourages more business owners to purchase vehicles instead of leasing them. Under the new law, the depreciation deduction for business automobiles, other than for SUVs and trucks over 6,000 lbs., increases to $10,000 for the first year, $16,000 for the second year, $9,600 for the third year and $5,760 for every year afterward.
In addition, there remains the traditional bonus depreciation of $8,000, except that it now applies to both new and used vehicles. This bonus depreciation also allows business owners (including professional real estate investors) to take a full deduction for SUVs and trucks that weigh over 6,000 lbs. for the year in which they were purchased, to the extent that they are used for business.
3. 100 percent deduction for oil and gas wells
Oil and gas has long been a tax-favored investment, where up to 80 percent of the investment was deductible in year one. With bonus depreciation, that deduction increases to 100 percent of the initial investment in the year the equipment is placed in service.
4. Real estate deductions for equipment
Along with equipment (computers, machinery), the Section 179 depreciation deductions for equipment has expanded to include, roofs, HVAC units, fire alarms and security devices for commercial properties.These purchases are all deductible when purchased, versus depreciated over many years.
Instead of deducting them through normal depreciation, taxpayers will be able to deduct 100 percent of the cost for the year they were added to the property.
5. Real estate bonus depreciation for used property
Under the new law, the real estate bonus depreciation applies to both new and used property. This change encourages more real estate investments, as well as investments in used equipment. And it means that much of the property can now be written off completely in the year the property was acquired, even if the property is used. Also, remember that, unlike what happens with Section 179 deductions, there is no income limitation on bonus depreciation.
What many often get confused about is whether they can take a deduction by investing in the stock market. They cannot. Reason: Buying stocks is not the same as purchasing goods and services that add money to the economy. As a result, stock market investments are not deductible, unless purchased through a qualified plan, such as an IRA or 401(k).
Bottom line, only the money that you consume for personal reasons will be taxed with the new tax law because everything else is a potential deduction. Entrepreneurs should take advantage of these incentives and make plans now to invest in their businesses. Business owners can build tax-deferred assets, and in some cases tax-free assets, simply by doing what the government wants them to do.