Reverse loopholes and other nonsense
"On April 13th, 2016, I wrote the federal government a check for $170,000
for the overage on my taxes. The reason for the overage? A “reverse
loophole” that makes it harder for businesses to manage cash flow during
tax time."
This was the first paragraph of an opinion piece I just read, by an entrepreneur I'm not familiar with. He says much of the same stuff in a Youtube video you can view in that first paragraph if you follow the link to the written version.
I want to address some misnomers and misinterpretations in his piece.
"At the end of 2015, we placed a major purchase order for inventory of our products. If you sell physical products in your business, the government does not allow you to write it off until it is sold, because it considers that purchase to be an asset, rather than an expense.
As a result, we drained the bank account to pay off the inventory, and then were hit with a larger than expected tax bill. In other words, the business was fully invested in inventory and people, and then we had to pay tax on money that was not yet earned."
This is not an accurate statement. Yes, the Internal Revenue Code does not allow a business to claim an expense for inventory that is in the year end inventory. But to claim the balance due on income taxes (not an "overage") was unexpected means that someone involved in the accounting of this business does not understand the basics of a simple tax calculation. That being the Cost Of Goods Sold (GOGS). Stated simply it is this:
Opening inventory + purchases - items withdrawn for personal use - ending inventory = COGS.
An example would be a big screen TV business. It opens for business in 2015. It buys $100,000 in TVs. The owner takes a $5,000 TV home for personal use. At the end of 2015, there are $45,000 worth of TVs in inventory.
$0 + $100,000 - $5,000 -$45,000 = $50,000. The COGS for the year is $50,000. The numbers work.
The remaining $45,000 in the store's inventory are an asset. The expense of purchasing them is not recognized until they are actually sold.
This leads us to another simple equation.
Gross revenues - allowable expenses = net income. Another label might be taxable income, although we're oversimplifying here. Again, the rules regarding how inventory purchases are expensed are very well known. To claim one was caught by surprise by these rules indicates one is unaware of the reality of business and taxes.
Let's move on to these specious claims from this opinion piece:
"For one thing, the rhetoric which assumes that “the rich don’t pay taxes” is oversold and needs to stop."
"Meanwhile, 45% of the country pays no taxes at all, while telling me that I should pay more"
No one I know of is claiming the rich pay no taxes at all. There are many people claiming the wealthy don't pay enough taxes, Bernie Sanders being most vocal on this point at the moment. There is also no truth to the assertion that 45% (the author of that opinion piece) or 47% (Mitt Romney) pay no taxes at all. President and Secretary Clinton paid over 35% in federal taxes in 2014. Nearly one-tenth of their total tax bill was over $1 million in self-employment and added Medicare taxes on their nearly $28 million in income.
But there's a much similar way to look at this reverse loophole. Let's suppose for a moment the author of the opinion piece were allowed to have claimed the year end inventory as an expense. This would mean that when it was sold in 2016, the expense for COGS would have been zero. You can't claim the expense of buying something for resale in one year and then claim it again the following year when it is sold. So the sale of this inventory would have been almost pure profit in 2016 and the tax bill would have come due at the end of that year. So there wouldn't have been $170,000 freed up for hiring three new people. It would have to be used for paying taxes in the following year.
This was the first paragraph of an opinion piece I just read, by an entrepreneur I'm not familiar with. He says much of the same stuff in a Youtube video you can view in that first paragraph if you follow the link to the written version.
I want to address some misnomers and misinterpretations in his piece.
"At the end of 2015, we placed a major purchase order for inventory of our products. If you sell physical products in your business, the government does not allow you to write it off until it is sold, because it considers that purchase to be an asset, rather than an expense.
As a result, we drained the bank account to pay off the inventory, and then were hit with a larger than expected tax bill. In other words, the business was fully invested in inventory and people, and then we had to pay tax on money that was not yet earned."
This is not an accurate statement. Yes, the Internal Revenue Code does not allow a business to claim an expense for inventory that is in the year end inventory. But to claim the balance due on income taxes (not an "overage") was unexpected means that someone involved in the accounting of this business does not understand the basics of a simple tax calculation. That being the Cost Of Goods Sold (GOGS). Stated simply it is this:
Opening inventory + purchases - items withdrawn for personal use - ending inventory = COGS.
An example would be a big screen TV business. It opens for business in 2015. It buys $100,000 in TVs. The owner takes a $5,000 TV home for personal use. At the end of 2015, there are $45,000 worth of TVs in inventory.
$0 + $100,000 - $5,000 -$45,000 = $50,000. The COGS for the year is $50,000. The numbers work.
The remaining $45,000 in the store's inventory are an asset. The expense of purchasing them is not recognized until they are actually sold.
This leads us to another simple equation.
Gross revenues - allowable expenses = net income. Another label might be taxable income, although we're oversimplifying here. Again, the rules regarding how inventory purchases are expensed are very well known. To claim one was caught by surprise by these rules indicates one is unaware of the reality of business and taxes.
Let's move on to these specious claims from this opinion piece:
"For one thing, the rhetoric which assumes that “the rich don’t pay taxes” is oversold and needs to stop."
"Meanwhile, 45% of the country pays no taxes at all, while telling me that I should pay more"
No one I know of is claiming the rich pay no taxes at all. There are many people claiming the wealthy don't pay enough taxes, Bernie Sanders being most vocal on this point at the moment. There is also no truth to the assertion that 45% (the author of that opinion piece) or 47% (Mitt Romney) pay no taxes at all. President and Secretary Clinton paid over 35% in federal taxes in 2014. Nearly one-tenth of their total tax bill was over $1 million in self-employment and added Medicare taxes on their nearly $28 million in income.
But there's a much similar way to look at this reverse loophole. Let's suppose for a moment the author of the opinion piece were allowed to have claimed the year end inventory as an expense. This would mean that when it was sold in 2016, the expense for COGS would have been zero. You can't claim the expense of buying something for resale in one year and then claim it again the following year when it is sold. So the sale of this inventory would have been almost pure profit in 2016 and the tax bill would have come due at the end of that year. So there wouldn't have been $170,000 freed up for hiring three new people. It would have to be used for paying taxes in the following year.
posted by me at 3:56 PM
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