Income Tax Question

Can someone explain the big picture of why one would use different depreciation or amortization methods on the income statement and when filing tax returns? I know the result is a deffered tax liability or asset, but what is the rationale for the different methods? In other words, why a difference in tax base and carrying cost? Am I right in saying that a greater tax base will result in a deffered tax asset (because you are paying more taxes now than you recognized on the I/S) and a greater carrying cost will result in a deffered tax liability? (Because you are paying less taxes now than what you recorded on the I/S)

Thanks!

accelerated depreciation method - on the tax statement - gives you more of a deduction - so you can deduct those expenses from your revenue - results in lower income before taxes - and therefore lower taxes.

but this creates the “deferred tax liability”. You actually owe a bigger tax amount, but are paying lower. you are deferring your payment to the future - a liability is created as a result.

On the regular income statement - a straight line depreciation - is lower expense - more income - more bottom line for the company (profits).

another thing to note - in the initial years - accelarated depreciation is a bigger number - so higher depreciation expenses in the earlier years, but lower towards the later years of life of the asset. And overall - the total amount of depreciation that you can take from the asset will be the same - whether it is accelarated or straight line.

Thanks for the quick reply. It was my understanding that net income and taxes even out to the same number despite the method of depreciation used, and the only differences / advantages to one over the other is how much you pay now vs later, or how much your net income is now vs later. Obviously, some depr is more accurate, and that’s why you choose it rather than influencing your net. (DDB will generate a lower net income now, but higher later vs. straight line, or capitalization)

Missed your last paragraph there… Ok, I understand this now. After working through a couple practice problems I see the end results are essentially deffering the tax liability to another year. Thanks for your clarification!

I have a different income tax question…

Reported effective tax rate is equal to:

A. Taxes payable / Taxable income

B. Income tax expense / Taxable income

C. Income tax expense / Accounting profit


May someone please help me understand the difference between A and C

It’s primarily a time value of money thingy.

Lower taxes early and higher taxes later save you cash early: early cash is better than later cash.

Taxes payable and taxable income are numbers that appear on a tax return.

Income tax expense and accounting profit are numbers that appear on an income statement.

Thanks S2000magician. So after doing a little more studying I have come up with the following…

The effective tax rate is derived from the income statement (i.e. Income tax expense / Accounting profit).

Whereas the statutory tax rate is derived from the tax return (i.e. Taxes payable / Taxable Income).

Is my thinking accurate on that or am I totally off base?

You’re safe at third base, just like Flynn.

Basically, tax depreciation is based on IRS rules, and financial statement depreciation is based on GAAP (or IFRS), and these two are not the same.

EG - If you buy a new tractor-trailer for $50,000, then GAAP says that you write the vehicle off in any way that accurately portrays the economic transaction. That is, if you plan to scrap it in three years, then you depreciate it straight-line to zero over three years. Pretty easy.

However, the tax treatment is very different. First, if the item is new, then it qualifies for an immediate expensing of 50% of the item’s cost, also known as “bonus depreciation”. (You don’t get this if it’s used.) After the bonus depreciation, you are able to take a Section 179 election on the remainder of all the of the equipment (whether it’s new or used), up to a maximum of $2m worth of equipment, or $500k of 179 depreciation, and also limited to taxable income. After you have taken bonus and 179, then you use the MACRS tables to depreciate the equipment. Of course, some equipment (like luxury automobiles) have special rules, where you still get to take bonus but 179 is limited to $11,160, plus any applicable MACRS depreciation.

Clear as mud?