Using Tax Logic to Manage the Value of your Business

In the real world of business management ownership you can only create income in 2 basic ways. These two income methods are taxed differently by good ‘ol Uncle Sam.

The first method income is “earned” income. Let’s say I’m a graphic artist and you hire me to create a logo. I design the logo and you pay me $250. That is earned income to me (assuming it goes to me and not into a corporation). The $250 goes into my gross income and I pay tax on it as high as 35% federal and depending on what state you live in, it could be over 45%. So your $250 of earned income (assumes no state tax) is worth only $162.50 in your pocket.

The second method is capital gains income. Capital Gains can be generated in many ways. Let’s look at a simple example. You get on Ebay and find a great bike for $100, you buy it. Then a year later you’re riding around the block on your $100 bike and a guy stops you and offers you $350 on the spot. You take it and walk home! You made $250 (same as if you designed a logo above) but this is capital gains and your tax on that is only 15% of your gain ($350 rec’d ¬†– $100 paid = $250 gain). Your tax for this is $37.50 and your net in pocket is $212.50.

You get to keep $50 more if you earned your money through capital gains income. ¬†This is just another reason why accumulating capital is important to long term wealth…if you have capital you can manage your taxes a lot better than if you only have earned income.

When running your business think of all the ways to build value that is taxed at 15% instead of 35%…over time it could be a lot more money in your pocket. Talk to your CPA to see if you have opportunities to maximize the availability of the capital gains tax rates.

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