A basic rule of U.S. income tax is that a business pays tax on its net income and an individual pays tax on their gross income.
Any business takes its revenue — expenses, and pays tax on the difference (net income) while business expenses are tax-deductible on any investment, appreciable or not. While an individual takes their paycheck and pays taxes based on the earned income amount.
Unless you own a business, personal expenses are not tax-deductible. Being able to depreciate an investment, most notably real estate as it appreciates is a rewarding feeling.
Due to these loopholes, individuals pay 8x more tax than corporations since over 80% of multinational corporations have tax shelters and havens. There’s no doubt your favorite FAAMG has set up a fund somewhere in the remote Bahamas to park their money tax-free.
As a result, this leads to greater wealth inequality and imbalance as the government needs to heavily rely on the majority of the American population as part of the middle class to provide them with funding equivalent to what a couple billionaires could pay out of pocket for.
Unlike a business, a progressive tax system hurts those who trade their time for money, especially at a higher level.
Being employed by a reputable stable company is important and a terrific way to earn economic stability and success early on. Down the road, up to a certain income though, many economists and analysts argue it may not be worth your time, energy and effort anymore when considering the more one earns, the higher their marginal tax rate is and they may end up earning much less than what they expected to fund their lifestyles with.
For example, if you earn more than $520k, above that figure puts you in the highest tax bracket and you’re expected to pay 37% tax, not to mention have enough left over for a family, living expenses, housing, etc. that are all soaring to 41-yr highs with inflation. Without passive income or mature investments on the side, you fall into the trap of relying on earned income which you have less control over instead of on yourself.
The Carried Interest Loophole And How You Can Take Part In It
For financial firms and investment funds such as hedge funds, private equity and venture capital firms, etc., the general tax rules are much more favorable given they control a lot of these systems on their own! To no surprise, the more you create and own through calculated risk taking, the more flexibility and freedom you have down the road. Since taxes are Americans largest ongoing liability in their lives, finding a financially savvy way to benefit from the tax-incentives that are available to all who want to go and get them is a major boost.
The carried interest loophole allows the income generated from these investment managers to be taxed as if they earned it by investing their own money. This allows them to reinvest their earnings without having to pay their dues and entails the tax threshold on income earned through work is only up to ~20%. For small business owners, this is a similar approach that they can take especially if their income comes as cash e.g. plumber or handyman, they only need to declare they earn up to the yearly minimum income threshold to be able to reinvest everything back into the business and save on virtually every penny that way.
Many proponents of this loophole such as Arizona Democratic Senator Kyrsten Sinema who received a generous $2 million in donations from the securities and investment industry believed this loophole should stay in place to benefit the Inflation Reduction Act. FYI The Inflation Reduction Act is more geared towards climate change than actually curbing inflation which won’t be resolved by pumping more money into the economy when the Fed is trying to counteract it. Sinema believed closing the loophole would hurt small businesses more than anything and ultimately allow investment managers to profit the most.
When politics and money collide, it’s never fun however with this tax loophole still in place, there’s something we can learn about the power of owning intellectual property, generating passive income, and maintaining a physical tangible asset. The best time is now!