Question

Equipment associated with manufacturing small railcars had a first cost of $210,000 with an expected salvage value of $30,000 at the end of its 5-year life. The revenue was $650,000 in year 2, with operating expenses of $98,000. If the company’s effective tax rate was 37%, what would be the difference in taxes paid in year 2 if the depreciation method were straight line instead of Modified Accelerated Cost Recovery System (MACRS)? The MACRS depreciation rate for year 2 is 32%.

The difference in taxes paid is determined to be_____ $ .

Answer 1

Depreciation as per straight line method = (cost - salvage value)/useful life = ($210,000 - $30,000)/5 = $180,000/5 = $36,000

Depreciation as per MACRS = [cost*(1 - MACRS depreciation rate for year 1)]*MACRS depreciation rate for year 2

MACRS depreciation rate for year 1 is 20% for asset with 5-year life.

Depreciation as per MACRS = [$210,000*(1-0.20)]*0.32 = ($210,000*0.80)*0.32 = $168,000*0.32 = $53,760

difference in taxes paid = (Depreciation as per MACRS - Depreciation as per straight line method)*tax rate

difference in taxes paid = ($53,760 - $36,000)*37% = $17,760*37% = $6,571

difference in taxes paid in year 2 would be $6,571 if the depreciation method were straight line instead of Modified Accelerated Cost Recovery System (MACRS). in other words $6,571 more taxes needed to be paid in year 2 if the depreciation method were straight line instead of Modified Accelerated Cost Recovery System (MACRS).