Impact of Tax on Investment and Business Decisions

1040 Form
Taxes May Impact Business

Taxes are a fact of life... but what is the impact of tax on investment and business decisions? The answer to this question depends on the type of business you run and the specific decision you are making.

Impact of Tax on Investment and Business Decisions

Every individual and corporation within the United States is taxed on income earned. Taxes must be filed by April 15 of every year, and failure to file or pay taxes can subject you or your company to penalties including fines, interest and even possible jail time. For most companies and businesses, paying taxes is a necessary evil and the aim is to reduce the amount of taxes owed as much as possible. Thus, the impact of tax on investment and business decisions usually comes down to how to reduce taxes as much as possible on income earned.

Income of Tax on Investment Decisions

The taxes you pay on your investments can reduce the amount of money you actually make from a given investment. For example, if you invest in a stock and make 15 percent on your money, you may be taxed on those gains. If you are taxed on the investment at 10 percent, then you really only made 13.5 percent on your money.

How are Investments Taxed

In reality, most people pay more than 10 percent on their gains. The rate a person pays on an investment depends on whether the investment is taxed as ordinary income or not. If the investment is taxed as ordinary income, the amount you pay in taxes depends on your tax bracket. For example, you may be in the 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent tax bracket. Investments taxed as ordinary income include stocks you have held for less than one year.

Capital Gains

Certain other investments are taxed as capital gains taxes. The capital gains rate as of 2010 is 15 percent, but in 2011 the gains will revert to 15 percent, 28 percent, 31 percent, 36 percent, and 39.6 percent. If you buy a stock and hold that stock for at least a year, then gains from the investment are taxed as capital gains.

Real Estate

For real estate investments, a whole different set of rules apply. If, for example, you have lived in the home for two of the past five years before you sell it, you may be exempt from taxes on the first $250,000 of taxes ($500,000 if you are a married couple). If you didn't live in the home and it was just a rental property, you may be able to sell the property and use the proceeds to buy another, deferring taxes entirely using something called a 1031 exchange.

How This Impacts Your Investment Choices

The different tax rates can have an impact on how you choose to invest. For example, you may decide not to hold a stock because you do not want to be subject to capital gains taxes, or you may on the other hand opt to avoid day trading to avoid income from your trades being taxed as ordinary income. You may also prefer to consider real estate investments, if you want a more tax-free way of earning income.

Other individuals may also try to take advantage of tax deferred investments or investments that offer certain tax advantages. For example, you may opt to open an IRA, which allows you to invest tax free, or a Roth IRA, which allows you to enjoy tax free gains, depending on whether you believe your tax bracket is likely to rise or fall.

The impact of taxes on your investments generally depends on how much you have to invest and how sophisticated an investor you are. You should consider speaking to a financial planner or accountant or tax attorney, if you have a lot of money to invest and are concerned about how taxes will affect your gains.

Impact of Tax on Business Decisions

Tax can also impact business decisions in a number of ways. Since businesses can deduct expenses of running a business, the company may wish to make a purchase within a given year in order to get the tax benefit for that year. Businesses can also take depreciation on certain property, so this can impact how and when new items are purchased.

The biggest impact on taxes on business decisions, however, normally focuses on how the business is structured. There are several major ways in which businesses can be structured, each of which have different tax impacts. A sole proprietor is taxed as an individual, and the individual normally files a personal tax return that includes business profits and losses. For partnerships and limited liability companies (LLCs) the individual members of the organization can also claim business profits and losses on personal tax returns.

More complex business structures, however, have different tax structures. S-corporations and C-corporations allow for different deductions and the business generally files taxes separately and then pays a salary to the business owners employees who declare profits on their personal tax returns. Incorporating a business can thus dramatically change your tax picture. To make this decision, you should speak with a tax professional who can help determine which business structure is right for you.

Understanding the Impact

For most investors and small business people, taxes play a role in how business and investment decisions are made, but ultimately the most important thing is to determine which investments or business decisions will have the best affect on your personal or businesses value. As you gain more money and become a more sophisticated investor, the impact of tax on investment and business decisions becomes more important and getting help from a professional to reduce your tax liability is usually advisable.

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Impact of Tax on Investment and Business Decisions