For many practical purposes, we effectively have a consumption tax. The only income that is taxed is income that is consumed or income that is saved. Let’s walk through how the income tax really works.
If you're an employee, all of your income is taxed—some now and some later when you take it out of your savings plan called a 401(k). That’s not how it works for a business owner or professional investor.
A business owner who makes money in their business and then spends it in their business is not taxed on that money. Spending money on or in a business is deductible. If that business owner buys an asset, such as equipment, the equipment is deductible under Section 179. If they buy real estate for their business, they can do a cost segregation study and deduct most of their investment through bonus depreciation.
While bonus depreciation is scheduled to sunset in 2026, there is bipartisan support for extending it and making it permanent at 100%. As long as a business owner continually reinvests in their business, they pay no tax. They only pay tax on the money they take out of their business for personal use or consumption.
A professional investor receives the same tax treatment as a business owner. For example, a professional real estate investor who collects rent and puts that money back into the property receives a deduction for either repairs or any other current expense of the property. If they improve the property, they can get bonus deductions on any equipment or land improvements.
A professional investor who puts their money into energy or agriculture receives similar, and sometimes better, tax treatment than a real estate investor. Fossil fuel development investments receive preferential tax treatment through intangible drilling cost deductions and depletion. Investors in renewable energy receive both bonus depreciation or Section 179 deductions, plus they receive tax credits that come right off the top of any remaining income tax obligation.
Farmers and ranchers have even greater tax benefits, as they get to deduct practically everything they put back into their farming or ranching operations.
The tax system is already largely a tax on consumption. This trend has been going on for decades, beginning with JFK and continuing with the Reagan, George W. Bush, Trump, and Biden administrations.
Remember that as long as you meet the four tests for deductions, you get to deduct all of your business and investment expenses, and you will only pay tax on what you spend or save.
Want to learn more about how you can make way more money and pay way less in tax? Book a call with the team at TFW Advisors® today!