corporate taxes lecture no.25 professor c. s. park fundamentals of engineering economics copyright...
Post on 20-Dec-2015
221 Views
Preview:
TRANSCRIPT
Corporate Taxes
Lecture No.25Professor C. S. ParkFundamentals of Engineering EconomicsCopyright © 2005
Taxable Income and Income Taxes
Gross IncomeExpenses Cost of goods sold (revenues) Depreciation Operating expensesTaxable incomeIncome taxes
Net income
Item
U.S. Corporate Tax Rate (2005)
Taxable income0-$50,000$50,001-$75,000$75,001-$100,000$100,001-$335,000$335,001-$10,000,000$10,000,001-$15,000,000$15,000,001-$18,333,333$18,333,334 and Up
Tax rate15%25%34%39%34%35%38%35%
Tax computation$0 + 0.15($7,500 + 0.25 ($13,750 + 0.34($22,250 + 0.39$113,900 + 0.34$3,400,000 + 0.35$5,150,000 + 0.38$6,416,666 + 0.35
(denotes the taxable income in excess of the lower bound of each tax bracket
Marginal and Effective (Average) Tax Rate for a Taxable Income of $16,000,000
Taxable income Marginal Tax Rate
Amount of Taxes
Cumulative Taxes
First $50,000 15% $7,500 $7,500
Next $25,000 25% 6,250 13,750
Next $25,000 34% 8,500 22,250
Next $235,000 39% 91,650 113,900
Next $9,665,000 34% 3,286,100 3,400,000
Next $5,000,000 35% 1,750,000 5,150,000
Remaining $1,000,000
38% 380,000 $5,530,000
Average tax rate =$5,530,000
$16, ,.
000 00034 56%
Example 8.10 - Corporate Income Taxes
Facts:Capital expenditure $100,000(allowed depreciation) $58,000
Gross Sales revenue $1,250,000
Expenses:Cost of goods sold $840,000Depreciation $58,000Leasing warehouse $20,000
Question: Taxable income?
Taxable income:Gross income $1,250,000- Expenses:
(cost of goods sold) $840,000(depreciation) $58,000(leasing expense) $20,000
Taxable income $332,000
• Income taxes:First $50,000 @ 15% $7,500
$25,000 @ 25% $6,250$25,000 @ 34% $8,500$232,000 @ 39% $90,480
Total taxes $112,730
• Average tax rate:
Total taxes = $112,730Taxable income = $332,000
• Marginal tax rate:Tax rate that is applied to the last dollar earned
39%
Average tax rate =$112,730
$332,000
33 95%.
Disposal of Depreciable Asset• If a MACRS asset is disposed of during the recovery period,
• Personal property: the half-year convention is applied to depreciation amount for the year of disposal. • Real property: the mid-month convention is applied to the month of disposal.
Depreciation recapture
Gains = Salvage value – book value = (Salvage value - cost basis)
Capital gains
+ (Cost basis – book value)
Ordinary gains
Depreciation recapture is taxed as ordinary income.
Capital Gains and Ordinary Gains
Cost basis Book value Salvage value
Capital gains
Ordinary gainsor
depreciation recapture
Total gains
Gains or Losses on Depreciable Asset
Example 8.11: A Drill press: $230,000Project year: 3 yearsMACRS: 7-year property classSalvage value: $150,000 at the end of Year 3
14.29 24.49 17.49 12.49 8.92 8.92 8.92
Full Full Half
Total Dep. = 230,000(0.1439 + 0.2449 + 0.1749/2) = $109,308Book Value = 230,000 -109,308 = $120,693Gains = Salvage Value - Book Value = $150,000 - $120,693
= $29,308Gains Tax (34%) = 0.34 ($29,308) = $9,965Net Proceeds from sale = $150,000 - $9,965 = $140,035
Summary The entire cost of replacing a machine cannot be
properly charged to any one year’s production; rather, the cost should be spread (or capitalized) over the years in which the machine is in service.
The cost charged to operations during a particular year is called depreciation.
From an engineering economics point of view, our primary concern is with accounting depreciation; The systematic allocation of an asset’s value over its depreciable life.
Accounting depreciation can be broken into two categories:1. Book depreciation—the method of depreciation used for financial reports and pricing products;2. Tax depreciation—the method of depreciation used for calculating taxable income and income taxes; it is governed by tax legislation.
The four components of information required to calculate depreciation are:(a) cost basis, (b) salvage value, (c) depreciable life , and (4) depreciation method.
•Because it employs accelerated methods of depreciation and shorter-than-actual depreciable lives, the MACRS (Modified Accelerated Cost Recovery System) gives taxpayers a break: It allows them to take earlier and faster advantage of the tax-deferring benefits of depreciation.
•The total amount of taxes to pay remains unchanged regardless of depreciation methods adopted. It only changes the timing of the payment.
•Many firms select straight-line depreciation for book depreciation because of its relative ease of calculation.
Given the frequently changing nature of depreciation and tax law, we must use whatever percentages, depreciable lives, and salvage values mandated at the time an asset is acquired.
Component of Depreciation
Book Depreciation Tax depreciation (MACRS)
Cost basis Based on the actual cost of the asset, plus all incidental costs such as freight, site preparation, installation, etc.
Same as for book depreciation
Salvage value Estimated at the outset of depreciation analysis. If the final book value does not equal the estimated salvage value, we may need to make adjustments in our depreciation calculations.
Salvage value is zero for all depreciable assets
Component of
Depreciation
Book Depreciation Tax depreciation (MACRS)
Depreciable life
Firms may select their own estimated useful lives or follow government guidelines for asset depreciation ranges (ADRs)
Eight recovery periods– 3,5,7,10,15,20,27.5,or 39 years– have been established; all depreciable assets fall into one of these eight categories.
Method of depreciation
Firms may select from the following: Straight-lineAccelerated methods (declining balance, double declining balance, and sum-of- years’ digits)Units-of-proportion
Exact depreciation percentages are mandated by tax legislation but are based largely on DDB and straight-line methods. The SOYD method is rarely used in the U.S. except for some cost analysis in engineering valuation.
Explicit consideration of taxes is a necessary aspect of any complete economic study of an investment project.
Once we understand that depreciation has a significant influence on the income and cash position of a firm, we will be able to appreciate fully the importance of utilizing depreciation as a means to maximize the value both of engineering projects and of the organization as a whole.
• For corporations, the U.S. tax system has the following characteristics:
1. Tax rates are progressive: The more you
earn, the more you pay.
2. Tax rates increase in stair-step fashion:
four brackets for corporations and two
additional surtax brackets, giving a total
of six brackets.
3. Allowable exemptions and deductions
may reduce the overall tax assessment.
Marginal tax rate is the rate applied to the last dollar of income earned;
Average (effective) tax rate is the ratio of income tax paid to net income; and
Incremental tax rate is the average rate applied to the incremental income generated by a new investment project.
Capital gains are currently taxed as ordinary income, and the maximum rate is capped at 35%.
Capital losses are deducted from capital gains; net remaining losses may be carried backward and forward for consideration in years other than the current tax year.
top related