Accounting Conservatism

Finance allah shmoop shmoop What is a tax deduction Uh

taxes Love him Hate him You can't leave him but

you can lower them legally by being you know thoughtful

about how you spend your earnings All right How do

we do this Well let's start with the largest tax

deduction in america the home mortgage And you you the

dentist who makes one hundred fifty grand a year for

putting your fingers in wet mouth Well remember that for

individuals versus corporations we pay a graduated or quote progressive

unquote tax rate Like almost nothing On the first fifteen

grand we earned on about ten percent from fifteen to

thirty grand And then about twenty percent from thirty to

sixty grand And so on That's progressive So on the

last twenty grand of earnings you make well you might

pay say forty percent in taxes and yeah we know

the numbers own exact We're just illustrating a point Here

you have a mortgage of three hundred thousand dollars on

a home you bought for four hundred thousand dollars right

So you put a hundred grand down and borrow three

hundred The mortgage costs you six percent per year in

interest or eighteen thousand dollars to rent that three hundred

thousand before you owned the home The irs thought of

you as one hundred fifty grand a year earner but

one hundred percent of the interest on the home is

fully tax deductible So what about that last twenty grand

iii The money you earn from one hundred thirty k

to one hundred fifty k Well as faras the irs

is concerned now that you have a home you get

taxed as if you earned just one hundred thirty two

grand not one hundred fifty k actually earned Why Because

that eighteen thousand dollars in interest comes right off the

top of your earnings See there's the math right there

one hundred fifty minutes eighteen hundred thirty two taxable earnings

it's as if you didn't earn that money ever can't

all right well if you'd had no deductions on that

last twenty thousand dollars of earnings you'd have paid forty

percent or eight thousand dollars in taxes But now on

that last twenty thousand dollars thanks to your mortgage deduction

well you only have taxable income of two thousand dollars

And yes you pay forty percent on that two thousand

Or eight hundred bucks And you mumbled thank you government

for largely splitting the cost of my mortgage with me

The american dream is alive and well that's what you

say Okay And thank you jay There are other deductions

beyond home mortgages of course but well you get the

gist here of how they work from a taxpayer's perspective

Deductions like those from your home mortgages are a good

thing Common personal deductions also include things like prepaid healthcare

costs and the cost of feeding quote dependent unquote children

Aii those noisy things sleeping in your spare bedrooms until

they're eighteen Okay so those air personal deductions things that

individual citizens take But what if you're a corporation Well

in a way it's kind of easier Think of most

corporations is having a flat thirty percent tax from the

first dollar they make just keep things simple Participation trophy

company in kameda one hundred million dollars last year and

paid thirty million in taxes They netted seventy million after

tax The company really needs a new trophy smelting machine

because with so much demand for participation trophies of late

while the old one is running dullah with mediocrity the

company spends forty million box on the new machine knowing

that it will be worthless in ten years either because

it wears out or because the country gets riel or

you know simply remembers to you know have a nice

day participation trophy land Welcome to it They'd appreciate forty

million dollars in equal parts of four million box each

year over ten years so that in the next year

when they again or in one hundred million dollars well

they now get to deduct four million bucks and appreciation

from their smelting machine against their hundred million dollars in

earnings So again as faras the irs is concerned they

didn't really earn one hundred million dollars even though they

did They earned quote on ly unquote ninety six million

and yes they still pay their thirty percent tax Only

now instead of paying it on a hundred million bucks

it's paid on ninety six million of earnings or point

three times ninety six or twenty eight point eight million

in taxes they did Abducted from their taxes The four

million box expected value decline from their smelting machine Right

It goes down four million a year in value from

the forty they paid They received essentially a credit on

their taxes of one point two million dollars So instead

of that year's depreciation costing the company four million bucks

well it really cost them more like two point eight

million If you ignore a bunch of other things like

the original capital cost of the machine what else they

might have done with that money oven you know via

smelting machine Think think Corporate jet Yeah those g sixes 00:04:52.774 --> [endTime] are surprisingly tasteful