Why are people and businesses taxed differently?

Factual Questions
1

A corporation is taxed on their profit. If they pay $5000/month for offices, buy a private plane, or spend $10,000,000 for naming rights to a stadium, they expense it off their tax basis. With spending a lot of money and use of accounting practices, a corporation can have multi-million dollar revenue but can end up paying no taxes.

People, on the other hand, pay taxes on revenue. Yes we get some deductions, but I can’t expense out my rent or car payments or grocery bill.

How did this inequity come into existence and are there any movements in Congress to increase taxes by making corporations pay taxes based on revenues and profit?

2

Business taxes is general make little sense, because they reward mediocrity and punish success. Here’s an example:

You and I both start businesses. Let’s say they’re restaurants. We put in the same initial funding and build equivalent facilities. We both make $1,000,000 in gross sales in our first year.

You are a brilliant strategist. Your hiring is just right, you have little or no waste, and your negotiating skills are excellent. You make $100,000 in profit.

I screw up completely. I lose $100,000.

What happens? The government rewards my failure by exempting me from paying taxes, and punishes your success by making you pay.

Of course, the really smart business owners spend the profit…

3

Corporations already pay taxes on profit. Taxing business revenue is a really bad idea, because two businesses with the same revenue can have wildly different (legitimate) expenses, wildly different profit, and wildly different ability to pay taxes without going out of business. You can’t get blood from a turnip.

Keep in mind that business taxes aren’t paid by Mr. Business, they’re paid by people–employees, customers, and share holders, in varying proportions depending on the elasticity of supply and demand for the company’s product and for its factor inputs.

4

Could it have anything to do with businesses having heavily organized efforts to influence the tax code… and in some cases probably being given the opportunity to write the law themselves by lazy lawmakers?

5

This doesn’t really answer the question - why are corporations taxed on profit while individuals are taxed on revenue?

6

If you have a Scd C Small Business- not a corporation, a Sole Prop- you will also be taxed on the profit.

If you have legit business expenses you can deduct them, so you- as a W-2 employee- are also taxed on your “profit”, not your revenue. It’s just that a business has far more business deductions that an individual does.

Neither corporations nor individuals can deduct most “personal expenses”. If you were to start a small corporation for your profession- like a Dentist, you’d also be unable to deduct your personal expenses from your revenue.

Your rent or car payments or grocery bill are personal expenses. If you use your car for business you could deduct that portion, but a corporation can’t deduct their “grocery bill” either. You can deduct the rent for your Office, but not your home (except as an “Office in the Home”), same with them.

Trust me, corporations get audited and get in trouble for trying to deduct “Personal expenses” of the owners etc all the time.

So there is no disparity or contradiction. You can deduct “business expenese” just as a corporation can, but they are not allowed to deduct “personal expenese” either.

(Of course, some “personal expenses” are deductable- taxes, Mort Int, Charitable Contibutions, Medical and so forth)

7

Let’s see if I can explain the basis of the system.

Take two businesses–this time both run by smart people. A small-town bookstore and a small-town videogame store. They both do $200,000 in sales per year. If they were both paying taxes based on income alone at the same rates as individuals, then they might pay $70,000 each in taxes.

The bookstore, on the average, buys books at a 40% discount. To buy enough books to sell for $200K, they spent $120K. If rent is $1,000 per month, then with no employees, office supplies, phone, Internet, or other expenses, the taxes would take all of the profit and still leave them with a loss.

Okay, let’s adjust the percentage for corporations, and make it 10%. The bookstore pays $20K in taxes, $12K in rent, $120K for books, and that leaves $48K for all of the other expenses. Looks like the owner won’t be able to pay himself much, but he could survive.

But what about the videogame store? On the average, they’re buying games at a 15% discount (many are even lower than that). At our special lowered tax rate, they’re paying $20K on income alone. The games for the year cost them $170,000, and rent is $12K. They’re losing $2K a year before even factoring in phone, employees, and so forth.

In some business, cost of goods sold is negligible (service-based businesses), and in some it’s even worse than the videogame example. A straight sales-based tax would destroy some businesses instantly, and be a big advantage to others.

So if income-based taxation for business doesn’t work, and straight profit-based taxation benefits mediocrity (and crooks), what do we do?

Fix all of the current loopholes and base it on gross profits rather than net profits–like a value-added tax. It ain’t perfect, but it beats what we have.

8

What would the alternative be? Define ‘profit’ in terms of an individual.

As has already been pointed out, businesses vary in profit margins for the same revenue. The restaurant example above is a little unfair. If everything was equal otherwise then yes, they would be rewarding the inept and punishing the succesful business but more often that not things aren’t all equal. Profit margins in different types of business are not equal, grocery supermarkets work on a high revenue low profit margin basis for example, other businesses quite the opposite. Even in the restaurant example different cities or even neighbourhoods market forces may force different operating models. Taxing every business on revenue would make that grossly unfair and in practice, nobody would go into the low margin businesses and the consumer would end up suffering thorugh either higher prices or less choice or both.

Business expenses are expenses occured in order to generate profit. How does that fit into indivuduals? OK, you could argue that in order to generate profits personally you need a house and stuff to keep your job etc. But wouldn’t you need all that stuff anyway? What personal expenses do you incur in the generation of profit that you wouldn’t incur if you weren’t making profits?

You could make the case that education costs could be netted off against income as it is an expense incurred in order to generate more profit. I’d buy that, but pretty much everything else is for your own pleasure and does not equate at all with business expenses.

9

So then the definition of “Costs” which is required to calculate “Gross Profit” would be the main issue… and the definitions of “overhead” and “applying labor” and “burden” and …

10

If you have your own corporation, your goal should be to have no profits. Then, no taxes. How do you make money with no profits? Well, pay yourself a salary and pay income tax on that.

11

Yep. And of course the legislated definitions can be pages and pages long…

12

Well, if you taxed what corporations spent on labor, then taxed the payroll after it was distributed to the employees, wouldn’t that essentially amount to double-taxation on your salary?

You sure you want that? :wink:

13

Retail businesses in most states are also taxed on revenue. In San Diego this tax is the 7.75% sales tax. There is very little difference between listing a product at $10.78 and paying $10.78 at the register and listing a product at $10.00 and paying $10.78 at the register. Some European countries do similar things with value added taxes the main difference being at which step along the distribution chain the tax is assessed.

I believe that sales from one business to another business have sales tax applied. This tax is waved only if the items are destined for resale.

14

I don’t see how that equates to a tax on retailers revenues. Sales tax (VAT over here) is a tax on consumers. Don’t retailers do all their profit/loss calculations to take tax into account and simply pass sales tax effectively directly from consumer to gov’t? Like in your example $10 is what revenue the retailer counts as his and uses to calculate profit. The $0.78 is just him collecting taxes for gov’t.

Not an accountant, i’m prepared to stand corrected but thats the way i always thought of it.

15

Isn’t that kind of what the tax brackets and standard deductions are for in personal income tax; i.e. trying to earmark a portion of your income as non-taxable, and a portion as taxable? In other words, they’re trying to identify what’s “profit” and what’s not, but in a kind of roundabout way?

I get the impression that if you don’t make a lot of money, and have a lot of expenses (home, kids, etc…) then you pay less taxes than a guy who made the same amount of cash, yet didn’t have the kids would pay. In other words, they’re acknowledging in a sense that the guy with no kids has lower living expenses, and therefore more “profit” to tax.

16

I’m still not buying it and I’ll tell you why. If the argument is that corporations spend money to make money, then the percentage of taxes on the revenue is part of the equation. For example: let’s say I spend $50,000 on a new advertising campaign (let’s assume a tax rate of 15%). Then I need to find X such that 0.85X=50000. This means that my new ad campaign needs to generate $58,823.53 to turn a profit.

Second, the one thing that should be expensed out for corporations is payroll - I didn’t put that in originally because the question (maybe I’ll start a thread in GD) was not about creating an equitable tax system.

Third, the argument that both people and corporations get to deduct business expenses (implying it’s fair) is a fallacy because almost all expenses for a corporation are for business while almost none are for a person. It would be like giving a tax credit for every car sold in the US and then telling McDonalds that it’s fair because they get the credit for every car THEY sell as well.

I guess what I’m looking for is how the current system got in place. For example, I know that there was a SCOTUS decision that ruled that “income” for a corporation was profit. What’s the logic given in the ruling. Does that mean that at one time corporations were taxed on revenue. Why can’t it apply to individuals? Etc.

I’ll hop over to GD and start a thread there for discussing SHOULD corporations be taxed on revenue or profit.

17

That’s because those are already figured into the standard deduction everyone gets. The IRS knows you have to eat, wear clothes, get to work, etc. The standard deduction and the tax rates are figured with that in mind. As others have suggested, there’s a world of difference between an individual living daily life and a company operating a business. They aren’t the same sort of entities, they don’t do the same sort of things, and there’s really no way to tax them in the same manner.

18

I don’t understand why it makes any sense to you to tax revenue rather than profit. This would, as has already been pointed out, effectively increase the tax rates at high-volume low-margin businesses, which includes most “staple” (grocery, drug, and other necessities) retail stores. If you want to shift more of the tax burden to the poor (who of course spend proportionally more of their incomes there than the rich), this would be a good way of doing it sneakily; but I get the impression that that’s not your intent.

It’s not at all the case that individuals can only deduct business expenses. Other adjustments include medical expenses, thefts and other losses, investment losses, charitable contributions, mortgage payments, and various incentive credits (look, for example, at 1040 lines 23-56 and Schedule A). There are also

A better description, ISTM, would be that both individuals and businesses are allowed to deduct expenses which are reasonable and necessary. Thus businesses are allowed to deduct, from their revenue, reasonable expenses such as labor and raw-material costs; they are not allowed to deduct expenses which don’t directly relate to the business.

Individuals are similarly allowed to deduct reasonable expenses. The situation is complicated by the desire to keep individual tax forms to a manageable length, so rather than completely itemizing all “reasonable” expenses (like your 200 grocery receipts and 30 gas receipts for the year, but of course with all of the luxury items and vacation-travel mileage removed, prorated, or replaced by their staple equivalents–you might see how adding an extra 20 pages of supporting documentation to your tax form might be a minor annoyance to those who don’t dream of becoming accountants) some sort of standard value is estimated and used in computing the standard deduction and the progressive tax rates.

Freddy the Pig already pointed out a puzzle about the whole idea of “taxing business,” which is that in the end you (the worker and consumer) pay the taxes either way. Of course the distribution of taxes may differ. If, for example, a corporate tax is structured with higher “luxury” or “sin” tax rates, more of the tax burden will fall on the workers in these businesses and the buyers of these goods; similarly for other types of “incentives” or tax structures. But you seem to be making a generic distinction between “personal” and “business” taxes that really does not exist in the macroeconomic sense. All taxes are paid, fundamentally, by having every individual earner (laborer, investor, whatever) getting reduced value for the money he earns. Structuring the tax code is merely a way of making some workers (e.g., those who make more money, or those who buy cigarettes or yachts, or those who rent a home instead of making mortgage payments) pay proportionally more than others.

19

In general the basic expenses that a person has is somewhat constant. They typically have housing, food, commuting expense (medical issues aside here). Now if someone wants a expensive house or food or vehicle that is a want- not a need. So it’s easy for the tax collector just to take a part of what comes in.

Corporations OTHO vary widely in their profit margin, some make perhaps 5% over cost, others make 100’s% or even 1000’s% over their cost. A revenue tax system would dramatically increase the cost of commodities, which are the basic necessities, of food, fuel, etc. which would throw personal income out of whack.

20

The tax is a percentage of sales. For retailers there is not a whole lot of other money coming in so sales are most of the revenue. If the business is profitable the consumers buying the products are ultimately paying all the taxes the sales tax or the tax on the profits because they are the ones giving the businesses money.