For Extra Profit Potential…Pick a Tax-Favored Business
Most tax information is essentially defensive. It deals with how to save taxes, avoid penalties, or defend deductions. Rarely discussed in tax literature is how to profit from taxes. Which businesses offer extra profits because of the tax laws? Which businesses are tax favored? Here is a list (with a brief non-technical explanation) of nine tax-favored businesses.
Real Estate. The tax laws treat nearly every kind of real estate business or investment with great tenderness. Whether you buy, fix, and trade you're not limited to independent in multimillion-dollar developments, the tax laws will help you to prosper.
Oil and Gas Production. How would you like to have a business where you can claim a tax deduction equal to 22 percent of your gross sales up to a maximum of half your net profits? In essence, this is what the law permits for qualified producers of oil and gas, until 1980. After 1980 the rate gradually drops to 15 percent. This depletion deduction is not limited to independent producers and royalty owners.
Mining Operations. Varying rates of percentage depletion ranging from 5 percent to 22 percent of sales are permitted for a broad group of mining or extractive types of businesses. As with oil and gas, the depletion is limited to half of your taxable profits, which is still very nice. Numerous minerals ranging from aluminum to zinc qualify for the 22 percent rate. The 15 percent rate applies to gold, silver, copper, and iron ore, while the 5 percent (minimum) rate applies to such things as gravel, sand, clay, and plain old stone. And don't scoff at a 5 percent depletion deduction. It could still cut your taxes in half if your taxable profit is only 10 percent of your sales.
Timber Growing and Cutting. Almost unscathed by the 1976 Tax Reform Act, timber growing offers a confusing array of tax advantages, including (1) depletion based on cost rather than sales, (2) deduction of expenses against other income, and (3) selling your product at tax-favored capital gain rates. Generally, the tax advantages of timber also apply to growers of Christmas trees.
Farming. Farming, like real estate, has a long history of being favored by the tax laws. While the 1976 Tax Reform Act eliminated some of the really esoteric tax shelters related to farming, the professional farmer still enjoys many obvious and many subtle tax benefits. It's confusing, but it's worth studying if you enjoy the country life.
Home Businesses. While the tax law recently clamped down on office-in-home deductions by employees, it did little to hurt the business that is operated from your home. While the tax advantages of a home business aren't quite as attractive as for farming, the home business does enjoy a few advantages over the business that is conducted from a store or office.
Mail order. Essentially, the mail order business permits a successful operator to reinvest his profits without paying income taxes until his growth starts to level off. There is also a small possibility of converting ordinary income into capital gains, but this is a tricky maneuver, with only moderate odds of being successful.
Publishing Periodicals. Selling subscriptions to a magazine, newsletter, or newspaper offers an opportunity to deduct as a current expense the cost of getting new subscribers while simultaneously deferring taxes on your subscription receipts until they have been earned.
Nonprofit Ventures. From a tax point of view, what better business could you have than one that doesn't have to pay income taxes at all? Many types of "businesses" are organized as (a) clubs, (b) business trade associations, or (c) public charities. While there are some rules you have to satisfy, a nonprofit venture can sell memberships or fellowships without paying a tax, can receive contributions from supporters, etc. For example, assume you have an idea for a way to prevent the theft of bicycles. Instead of organizing as a regular business, you might organize as a nonprofit organization performing a public service. How would you benefit? Just pay yourself a salary.
We have just brushed the surface of these nine tax-favored businesses. Each one tends to be something of a specialty with its own tricks of the trade. We don't recommend jumping into any of these businesses without careful investigation and extensive discussion with experienced tax advisors. Nonetheless, these are businesses that offer an extra bonus in the form of tax breaks. If you have ever wondered how people can still get rich, the answer is that most of them are in one or more of these nine businesses.
Copyright 1977 by Kephart Communications, Inc.
Vernon K. Jacobs is a CPA specializing in tax matters. He is also the editor of Tax Angles (P.O. Box 2311, Landover Hills, MD 20784, $24/year), from which this article is reprinted.
This article originally appeared in print under the headline "For Extra Profit Potential…Pick a Tax-Favored Business".