depreciation conclusion. taxable income + gross income - depreciation allowance - interest on...
TRANSCRIPT
Depreciation Conclusion
Taxable Income
+ Gross Income - Depreciation Allowance - Interest on Borrowed Money - Other Tax Exemptions = Taxable Income
Corporate Tax Rate
Taxable Income Tax Rate Income Tax 0 < TI < 50,000 0.15 .15(TI)50,000 < TI < 75,000 0.25 7,500 + .25(TI - 50,000)75,000 < TI < 100,000 0.34 13,750 + .34(TI - 75,000)100,000 < TI < 335,000 0.39 22.250 + .39(TI - 100,000)
335,000 < TI < 10,000,000 0.34 113,900 + .34(TI - 335,000)10,000,000 < TI < 15,000,000 0.35 3,400,000 + .35(TI - 10,000,000)15,000,000 < TI < 18,333,333 0.38 5,150,000 + .38(TI - 15,000,000)
TI > 18,333,333 0.35 .35(TI)
Corporate Tax
Ex: Suppose K-Corp earns $5,000,000 in revenue above manufacturing and operations cost. Suppose further that depreciation costs total $800,000 and interest paid on short and long term debt totals $1,500,000. Compute the tax paid.
Corporate Tax
Gross Income $ 5,000,000Depreciation - 800,000Interest - 1,500,000Taxable Income $ 2,700,000
Corporate Tax
Gross Income $ 5,000,000Depreciation - 800,000Interest - 1,500,000Taxable Income $ 2,700,000
Tax = $ 113,900 + .34(2,700,000 - 335,000)
= $ 918,000
Methods of Depreciation
Straight Line (SL) Declining Balance (DB)
Prior to 1981 Modified Accelerated Cost Recovery
(MACRS) Depletion Sum-of-Years Digits (SYD)
Time Value of Tax Savings(Tax Rate = 40%)
Time Value of Tax Savings (40%)SL Tax DDB Tax
t Dt Save Dt Save
01 20,000 8,000 40,000 16,0002 20,000 8,000 24,000 9,6003 20,000 8,000 14,400 5,7604 20,000 8,000 8,640 3,4565 20,000 8,000 4,320 1,7286 0 0 8,640 3456
Sum = 100,000 40,000 100,000 40,000Present Value = 30,326 32,191
9
MACRSMACRSMACRSMACRS
• Prior to 1981, taxpayers could choose among several methods when depreciating assets for tax purposes.
• With the Economic Recovery Act of 1981, ACRS was required and MACRS was instituted in 1986.
• MACRS is a simpler, more rapid depreciation method.
MACRS Percentages 3,5,7, & 10 are 200% DB/SL15 & 20 are 150% DB/SL
t 3-Yr. 5-Yr. 7-Yr. 10-Yr. 15-Yr. 20-Yr.
1 33.33% 20.00% 14.29% 10.00% 5.00% 3.75%2 44.45% 32.00% 24.49% 18.00% 9.50% 7.22%3 14.81% 19.20% 17.49% 14.40% 8.55% 6.68%4 74.10% 11.52% 12.49% 11.52% 7.70% 6.18%5 11.52% 8.93% 9.22% 6.93% 5.71%6 5.76% 8.92% 7.37% 6.23% 5.29%7 8.93% 6.55% 5.90% 4.88%
8 4.46% 6.55% 5.90% 4.52%9 6.56% 5.91% 4.46%10 6.55% 5.90% 4.46%11 3.28% 5.91% 4.46%12 5.90% 4.46%13 5.91% 4.46%14 5.90% 4.46%15 5.91% 4.46%16 2.95% 4.46%17 4.46%18 4.46%19 4.46%20 4.46%21 2.23%
MACRS Tables
MACRS Percentages 3,5,7, & 10 are 200% DB/SL15 & 20 are 150% DB/SL
t 3-Yr. 5-Yr. 7-Yr. 10-Yr. 15-Yr. 20-Yr.
1 33.33% 20.00% 14.29% 10.00% 5.00% 3.75%2 44.45% 32.00% 24.49% 18.00% 9.50% 7.22%3 14.81% 19.20% 17.49% 14.40% 8.55% 6.68%4 74.10% 11.52% 12.49% 11.52% 7.70% 6.18%5 11.52% 8.93% 9.22% 6.93% 5.71%6 5.76% 8.92% 7.37% 6.23% 5.29%7 8.93% 6.55% 5.90% 4.88%8 4.46% 6.55% 5.90% 4.52%9 6.56% 5.91% 4.46%10 6.55% 5.90% 4.46%11 3.28% 5.91% 4.46%12 5.90% 4.46%13 5.91% 4.46%14 5.90% 4.46%15 5.91% 4.46%16 2.95% 4.46%17 4.46%18 4.46%19 4.46%20 4.46%21 2.23%
Modified Accelerated Cost
Property Classes3 yr. - useful life < 4 yrs.
autos, tools5 yr. - 4 yrs. < useful life < 10 yrs.
office epuipment, computers, machinery7 yr. - 10 < UL < 16
office furniture, fixtures, exploration10 yr. - 16 < UL < 20
vessels, tugs, elevators (grain)15 yr. - 20 < UL < 25
data communication, sewers, bridges, fencing
MACRS (Cont.)
20 yr. - UL > 25
farm buildings, electric generation27.5 - residential rental property31.5 - non-residential real property
Depreciationclass (3, 5, 7, 10 yr.) uses 200% declining balance switching to straight-line @ optimal yearclass (15, 20) 150% DB switch to SLDclass (27.5, 31.5) use straight-line
Class Problem
A company plans to invest in a water purification system (5 year property) requiring $800,000 capital. The system will last 7 years with a salvage of $100,000. The before-tax cash flow for each of years 1 to 6 is $200,000. Regular MACRS depreciation is used; the applicable tax rate is 34%. Construct a table showing each of the following for each of the 7 years.
Solution
Tax Rate = 34%MARR = 20%
Taxablet BTCF MACRS % Depr. Income Tax ATCF
0 (800,000) (800,000)1 200,0002 200,0003 200,0004 200,0005 200,0006 200,0007 300,000
NPV = ($51,173)
Solution
Tax Rate = 34%MARR = 20%
Taxablet BTCF MACRS % Depr. Income Tax ATCF
0 (800,000) (800,000)1 200,000 20.0% 160,000 40,000 13,600 186,4002 200,000 32.0% 256,000 (56,000) (19,040) 219,0403 200,000 19.2% 153,600 46,400 15,776 184,2244 200,000 11.5% 92,160 107,840 36,666 163,3345 200,000 11.5% 92,160 107,840 36,666 163,3346 200,000 5.8% 46,080 153,920 52,333 147,6677 300,000 0 300,000 102,000 198,000
NPV = ($51,173) ($136,824)
Depletion Method
Allows for equal depreciation for each unit of output
whereVt = volume extracted during the year
V = total volume available in reserve(I-S) = depreciable amount allowed
V
VSID t
t )(
Example
Ex: NorCo Oil has a 10 year, $27,000,000 lease on a natural gas reservoir in western South Dakota. The reservoir is expected to produce 10 million cubic ft. of gas each year during the period of the lease. Compute the expected depletion allowance for each year.
Example
Ex:
000,700,2$
000,000,1010
000,000,10000,000,27$
x
Dt
Percentage Depletion
Depletion is taken as a constant percentage of gross income
Allowable PercentagesOil/Gas 15%Natural Gas 22%Sulphur/Uranium 22%Gold, silver, … 15%Coal 10%
Example
Ex: NorCo Oil has a 10 year, $27,000,000 lease on a natural gas reservoir in western South Dakota. The reservoir is expected to produce 10 million cubic ft. of gas each year during the period of the lease at $1.50 per cubic ft.
Gross Income = 1.5(10,000,000)= 15,000,000
Depletion = 15,000,000 (0.22)= $3,300,000
22
Sum of Years Digits Sum of Years Digits MethodMethod
Sum of Years Digits Sum of Years Digits MethodMethod
SOYD = 1 + 2 + 3 + … + N
= N(N+1) 2
Dn = ( N – n + 1 ) ( I – S )
SOYD
Bn = Bn–1 – Dn
Depreciation Recapture
Ex: K-Corp purchases a Loader for $250,000 which has a 7 year property class life. After 3 years, $140,675 has been depreciated and the book value is now $109,325. K-Corp now sells the loader for $150,000.
Depreciation Recapture
Ex: K-Corp purchases a Loader for $250,000 which has a 7 year property class life. After 3 years, $140,675 has been depreciated and the book value is now $109,325. K-Corp now sells the loader for $150,000.
Recapture = 150,000 - 109,325 = $40,675
Depreciation Recapture
Ex: K-Corp purchases a Loader for $250,000 which has a 7 year property class life. After 3 years, $140,675 has been depreciated and the book value is now $109,325. K-Corp now sells the loader for $150,000.
Recapture = 150,000 - 109,325 = $40,675
$40,675 taxed as ordinary income
Depreciation Recapture
Ex: Suppose K-Corp were able to sell this same loader for $ 275,000.
Capital Gain = 275,000 - 250,000 = $25,000
Depr. Recapture = 250,000 - 109,325 = $140,675
Depreciation Recapture
Ex: Suppose K-Corp were able to sell this same loader for $ 275,000.
Capital Gain = 275,000 - 250,000 = $25,000
Depr. Recapture = 250,000 - 109,325 = $140,675
$ 25,000 taxed at 28%$140,675 taxed at 35%