Why are business expenses deductible from income, but someone’s basic living expenses aren’t deductible from personal income?
In: Economics
Say you earn $50k working as a full time employee at a company. Yes you get taxed on the full $50k (it’s more complicated than that , but ELI5)
Now you decide to quit and start a coffee shop. You sell $200k in coffee. But you also have to pay your baristas. Pay rent, utilities, insurance, uniforms, marketing, cleaning supplies. There’s also costs to buy the stuff to make and hold the coffee. After all the costs, let’s say you had a net profit of $50k that you can put in your pocket, same as if you would have stayed as a full time employee at your company.
In this scenario, I’m sure most people would agree it does not make sense to tax the business owner at $200k. They should get to deduct their **business specific** expenses and get taxed on the $50k net profit. After that , they’ll be in the same spot as far as what they can or cannot deduct on their personal taxes.
Your living expenses don’t contribute to you earning income. Or at least not most of them.
I mean some are, which are what you can deduct (like a laptop you use for work, or clothes, or whatever).
But you grabbing 8 pints and 4 burritos at 3am on Saturday aren’t really for work purposes.
A business basically doesn’t have personal expenses (because it’s a business) so basically all expenses are deductible (and even more depending how good your accountants are).
At some level, the answer here is going to be “it is this way because Congress decided to make it this way”. Creating a tax code is rather challenging and so you have to make trade-offs and balance a lot of different competing factors.
But yeah, the standard deduction is essentially supposed to represent basic living expenses. It’s much more efficient to just say “here’s the standard deduction and it’s the same for everyone” than it would be to allow everyone to itemize individual expenditures from the cost of daily living. You’d have to figure out what was or wasn’t a “basic” living expense. There would be challenges. What if someone has a lot more living expenses for any number of reasons? What if someone’s rent is higher because they live in a more expensive area? You’d end up needing to cap “basic living expenses” somehow…which would just be a broad standard deduction.
The biggest reason that you don’t tax business expenses is because if you do, you create a huge incentive for vertical integration.
Imagine two companies selling the same thing and both have revenue of a million dollars. Company A is vertically integrated, meaning it does everything from mining raw materials to production to selling to consumers, so it pays 200,000 in taxes. Company B is not vertically integrated, it pays 200,000 in taxes, it’s supplier pays 100,000 on its 500,000 in revenue, and it’s supplier pays 50,000 in taxes on 250,000 in revenue. So both companies with otherwise identical supply chains both different levels of integration produce wildly different taxes. Company A patys 200,000, and Company B and it’s suppliers pay 350,000 in taxes, on the same 1,000,000 in total revenue. Company A actually produces a profit and Company B and it’s suppliers loose money and go out of business. The more suppliers in your supply chain, the more expensive your production is purely because of taxes.
Now the barrier to entry to produce a competitive business goes through the roof, so only large, vertically integrated and likely inefficient business are able to survive, purely from government policy.
What people seem to be beating around the bush is that the government has given corporations favorable treatment. This isn’t some conspiracy or even necessarily a bad thing. Business deductions encourage businesses to spend money now rather than save the money for later (or not spend at all).
This same incentive doesn’t really exist for most individuals. Tax deductions are about encouraging a specific activity. For businesses, it’s to encourage spending. And in actuality, there are many tax incentives for individuals—FSA accounts, medical premiums paid by your employer, retirement contributions, child care expenses, student loan interest etc.
because even though they are the same word, they are not the same things. a business expense is for writing off the costs associated with earning income. salaries, rent for your office space, materials, etc. personal expenses are things you use your income to purchase. stuff like a home office, uniforms, or supplies you personally buy for work can be written off just like a business expense provided it’s sole purpose is for work.
The government already accounts for your living expenses. at least ~$25k of your income is already not taxed……..the first $11k you earn you pay no taxes on, and you get to deduct almost $14k on top of that. So, you owe $0 in taxes until you’ve made at least $25k. For context, that’s like 40% of the average salary in the US. If you file HoH you don’t pay any taxes on almost $32k (more than half the average income).
businesses don’t get that break. They have to account for every single expense, because they pay taxes on every cent they earn in profit.
EDIT: not to mention, they’d be getting taxed on money multiple times. Expenses in one time period are generally profits from a previous time period. if i tax the full amount of your revenue, i’m essentially taxing money i just taxed last year already.
Business expenses are expenses you had to generate your income, living expenses are not. You’d still need some place to live and you’d still need to eat even if you didn’t have an income.
They are deducted. For a couple, filing jointly, you can automatically deduct ~29k (this number increases a little every year) from your taxable income when you file.
It basically represents the money you need for some life necessities
Everyone here is making this more complicated than it needs to be. The baseline for taxes is that all income is taxable. Tax deductions and credits exist because the government is trying to get you to do something. They want you to buy houses, go to college, and save for retirement. They can’t force you to do those things, but they can give you a tax deduction/credit as an incentive. Business deductions are no different. They want you to start a business and succeed, so they offer a bunch of deductions to help you do that. There’s no need to incentivize you to pay for basic living expenses, so they won’t.
Also, remember, business expenses are deductible because they are not “income,” they are reimbursements.
If I buy an item for $3.00, and I sell it for $5.00, I had $2.00 of income, and was reimbursed $3.00 for the money I spent to purchase the item. I am taxed on the actual money that I made.
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