L25: Corporate Taxes

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L25 Corporate Taxes

• ECON 320 Engineering Economics
• Mahmut Ali GOKCE
• Industrial Systems Engineering
• Computer Sciences

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Taxable Income and Income Taxes
Item
Gross Income Expenses Cost of goods sold
(revenues) Depreciation Operating
expenses Taxable income Income taxes Net income
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U.S. Corporate Tax Rate (2005)
Taxable income 0-50,000 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 18,3
33,334 and Up
Tax rate 15 25 34 39 34 35 38 35
Tax computation 0 0.15(D) 7,500 0.25
(D) 13,750 0.34(D) 22,250 0.39 (D) 113,900
0.34 (D) 3,400,000 0.35 (D) 5,150,000
0.38 (D) 6,416,666 0.35 (D)
(D) denotes the taxable income in excess of the
lower bound of each tax bracket
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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
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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 840,000 Depreciation
58,000 Leasing warehouse 20,000 Question
Taxable income?
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• 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 _at_ 15 7,500
• 25,000 _at_ 25 6,250
• 25,000 _at_ 34 8,500
• 232,000 _at_ 39 90,480
• Total taxes 112,730

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• Average tax rate
• Total taxes 112,730
• Taxable income 332,000
• Marginal tax rate
• Tax rate that is applied to the last dollar
  earned
• 39

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Disposal of Depreciable Asset

• If a MACRS(Modified Accelerated Cost Recovery
  System) 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.

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Disposal of a MACRS Property and Its Effect on
Depreciation Allowances
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Depreciation recapture
Depreciation recapture is taxed as ordinary
income.
Gains Salvage value book value
(Salvage value - cost basis)
IF ASSET SOLD FOR MORE THAN THE COST BASIS
Capital gains
(Cost basis book value)
Ordinary gains
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Capital Gains and Ordinary Gains
Capital gains
Total gains
Ordinary gains or depreciation recapture
Book value
Salvage value
Cost basis
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Gains or Losses on Depreciable Asset
Example 8.11 A Drill press 230,000 Project
year 3 years MACRS 7-year property
class Salvage value 150,000 at the end of
Year 3
Total Dep. 230,000(0.1439 0.2449 0.1749/2)
109,308 Book Value 230,000 -109,308
120,693 Gains Salvage Value - Book Value
150,000 - 120,693 29,308 Gains Tax
(34) 0.34 (29,308) 9,965 Net Proceeds from
sale 150,000 - 9,965 140,035
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Calculation of Gains or Losses on MACRS Property
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Summary
The entire cost of replacing a machine cannot be
properly charged to any one years 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 assets value
over its depreciable life.
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Accounting depreciation can be broken into two
categories 1. Book depreciationthe method of
depreciation used for financial reports and
pricing products 2. Tax depreciationthe
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.
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• 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.

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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.
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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
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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-line Accelerated 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.
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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.
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• 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.

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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.