Political reality for Boehner: He can’t cave on the sequester

Why are tax deductions legitimate?
Aren’t they just a way to reward one type of activity while punishing anyone not willing to participate in that activity?
Tax deductions are how we get to the point that 50% of the tax filers pay 0 federal income taxes. This leads to these people not feeling the cost of the government they demand. This leads to them demanding more government, which they pass the cost of onto other people again.

astonerii on February 26, 2013 at 2:11 PM

Let me explain this one to you in a way even you may understand.

Let’s use this example. Suppose a manufacturing company, and for simplicity, let’s say it is not a public company, but a private one, buys a $10 million dollar machine needed to make their best selling widget. Let’s say the other machine they were using is just completely worn out and obsolete at this point.

Normally, when a business buys something, they can expense that purchase at the end of the year. A business adds up all of its sales, subtracts all of its expenses and figures out if there is a profit at the end and pays taxes owed on that profit. And with the leftover money, if there is any, is the owner’s choice whether or not to pay him or herself or themselves, or reinvest all or part of the funds to grow their business.

Let’s say that $10 million machine has a life cycle to make 10 million widgets over 10 years. Technically each widget uses up about $1 worth of that machine cost as part of that widget’s cost of being produced. In addition to machine time, that widget uses some human labor time (the machine operator) and raw material.

The owner of that company has to factor in the machine cost of the time the widget was using that machine to be built. In this example it is $1. This is where the concept of “Depreciation” comes into play. In a straight line method, the owner of this company would write off $1 per widget per year against the cost of that original machine purchase.

So in year 1, the owner what a write off of $1,000,000 of the cost of that machine. Over 10 years, the true cost of that machine has properly been captured against the actual production of those widgets and all is well in the world.

Well enter the tax man. The government likes to incentivize the private market through the tax code. To help the manufacturing of that $10 million widget machine, over time, the tax code has been modified to allow for faster depreciation of the cost of a new machine. There are several different ways to do it, double declining balance, special IRS percentages that speed up the depreciation in the early years, etc.

So the owner of the company that makes the widgets actually can write off more than $1,000,000 in the first year of that machine because of the tax code. If they are doing the double declining balance, he can writeoff $2,000,000 instead of $1,000,000.

You could consider this a loophole. What it does, is save the owner of the widget company some taxes where they can invest that money in other things to grow their business.

You would consider even the legitimate $1,000,000 writeoff a loop hole, probably. But how else does the owner of the machine get the cost of that machine recognized in his widget costs? He has to know what it costs to make a widget and thus price the widgets accordingly.

If the tax man was not involved and the owner of the widget company could writeoff actual expenses each year, rather than have to depreciate capital goods and equipment, he could have written off the entire $10,000,000 in year 1 of purchasing the widget production machine. That would obviously save him oooodles of money in that first year of owning the machine.

Instead, he has to parcel out the cost of that machine over several tax years. He is out the initial cost of the machine in year one, but he doesn’t get to expense those costs all in year one, but has to do it over several years.

So I really have to ask you, what loophole?

Legitimate business expenses are not loopholes.

karenhasfreedom on February 26, 2013 at 4:15 PM