Necessary Expenses in Korean Income Tax

Imagine you open a stand selling bungeoppang, Korea's fish-shaped pastries filled with sweet red bean paste. In one month you sell 1,000,000 won (about $750) worth. It looks like you earned 1,000,000 won, but the owner doesn't keep all of it. You had to buy red bean paste and flour batter. You also paid for the gas to heat the pastry molds.

Suppose the beans and flour cost 600,000 won. Then the money you actually hold is only 400,000 won. If the National Tax Service of Korea told you to pay tax on the full 1,000,000 won, that would feel very unfair. In tax law, the 600,000 won you had to spend to earn that money is called 'necessary expenses.'

Tax is only fair if it's charged only on the pure profit a person actually earns. So total income is reduced by necessary expenses first. Tax is then based on what's left, the true profit (called 'income amount').

Not every purchase counts as an expense. The most important test is a direct link to your business activity. A cafe owner's coffee beans, the shop's monthly rent, and wages paid to employees all clearly qualify.

For a freelance designer, the cost of a work computer, design books, and even the coffee you drink in a meeting with a client count too. But a meal on a weekend outing with your family, or shopping for your own clothes, has nothing to do with work, so it's left out.

To have spending counted as an expense, you need to keep proof that you really spent the money for your business. The standard qualifying proof is a tax invoice, a credit card sales slip, or a cash receipt. For transactions over a set amount (30,000 won), if you don't get one of these, you may owe an additional tax penalty even if you can show the spending with other records.

Many small business owners and new freelancers find it hard to collect every receipt and keep careful books. For them, the National Tax Service of Korea provides preset ratios by industry. The idea is, 'at this level of income, you probably had about this much in expenses.'

This is called estimated calculation using expense rates. Say your industry's simple expense rate is 70%. If you earned 10,000,000 won (about $7,500), 7,000,000 won is accepted as expenses without proof. But the simple rate is only for businesses whose income is below the limit for their industry. Above that, the standard expense rate applies, and you must prove major costs, such as purchases, rent, and wages, with documents.

By the way, office workers on a salary don't collect receipts to prove necessary expenses. Instead, they get the earned income deduction (geunro-sodeuk-gongje). The state automatically subtracts a set amount based on salary range, which has the same effect as having spent on necessary expenses.