Friday, May 31, 2013

Before you slam the evil tax-dodging also have to slam the evil tax-dodging small businesses

In certain circles, it is taken as fact that corporations are evil. They are not people, but pretend to be people - people who are literally soullless.

One of the main criticisms of corporations is their practice of avoiding taxes wherever possible. While I believe that a corporation is legally mandated to maximize its profit in any legal way possible, even I have had a little fun with this corporate practice.

There have been a number of tax reform suggestions that address various tax issues related to corporations. But Steve Wozniak - who helped to found one of the corporations that has gotten a lot of criticism about its tax avoidance strategies - has proposed something that I've never seen proposed before.

"People are not taxed on profit; they are taxed on income," [Wozniak] said. "Corporations should be taxed the same as people, in my mind that is how it should be, that would make things fair and right.

"That means corporations pay taxes on all of their revenues or people only pay it on a tiny amount called profit and until we rectify that, the whole problem is just with us forever."

It's a distinction that I've never really thought about before, and even the maniacal devotees of Jimmy Wales apparently have missed it.

Company income subject to tax is often determined much like taxable income for individuals.

Um, not exactly.

Take Widget Company, which (in my immensely simplified example) received revenues of $50,000,000 in 2012. Widget Company had transportation expenses of $10,000,000, uniform expenses of $5,000,000, and building lease costs of $10,000,000. Widget Company pays tax on the NET income, or $25,000,000.

Meanwhile, John Doe is a valued employee at Widget Company and received a salary of $50,000 in 2012. John drives to work every day and racks of $10,000 in transportation expenses. He also has to do a lot of laundry and dry cleaning to make himself presentable for work, so he racks up clothing expenses of $5,000. Oh, and John pays $10,000 a year in rent. But John is unable to deduct the transportation expenses, clothing expenses, or rent, so he pays tax on the TOTAL income, or $50,000.

But before you complain that corporations are evil, consider this - similar tax rules apply to businesses that are NOT corporations.

Let's say that John Doe, rather than working for Widget Company, starts a small business and calls it DoeCo. DoeCo earned $50,000 in income in 2012. Assume that 100% of DoeCo's transportation expenses are business-related (Doe the person NEVER goes out at night); that means that $10,000 is deductible. Now assume that 100% of DoeCo's uniform expenses are business-related (in his personal life, Doe is a nudist); that means that another $5,000 is deductible. I can't think of a way to dodge at least some housing expenses, so let's assume that DoeCo's business office takes up 10% of John Doe's home. DoeCo can therefore deduct 10% of the rent, or $1,000.

So compare the individual John Doe, who has to pay tax on $50,000, and DoeCo, which only has to pay tax on $34,000.

And that has nothing to do with the evil corporations; it's just the way that business taxes work, as opposed to personal taxes.

Now Woz's radical proposal certainly deserves some thought - and if you want to share some thoughts on it, please visit Alex Scoble's Google+ thread on the topic. But just remember that this goes well beyond the corporations.
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