11 Your company has decided to purchase two compressors for

11) Your company has decided to purchase two compressors for $150,000 each. The first will be depreciated using MACRS and the other is being depreciated by the sum of digits with a $o salvage value. Assume your company pays federal income taxes each year and the tax rate is constant. Will the firm pay more taxes because the two compressors are being depreciated differently?

Solution

Yes; the firm has to pay higher taxes for the asset using MACRS depreciation, since its rates are lower. Such lower rates charge depreciation at lower amounts, which ultimately increases taxable incomes in each year; therefore, taxes would be higher for higher taxable incomes.

Example:

Suppose the asset has a useful life of 3 years.

Sum of years’ digits method of depreciation

Year

Proportion (P)

Depreciation rate

1

3/6

(3/6) × 100 = 50%

2

2/6

(2/6) × 100 = 33.33%

3

1/6

(1/6) × 100 = 16.67%

Total = 6

1

100%

Now for MACRS depreciation, 3-year property class has 4 years of recovery. The rates of depreciations are predetermined (could be found in text book or internet); the rates are 33.33%, 44.45%, 14.81%, and 7.41%.

MACRS depreciation

Year

Rates (R)

1

33.33%

2

44.45%

3

14.81%

4

7.41%

Total

100%

As per the above example, most of the rates under sum-of-digits method are higher than MACRS; this indicates paying higher taxes in case of MACRS.

Year	Proportion (P)	Depreciation rate
1	3/6	(3/6) × 100 = 50%
2	2/6	(2/6) × 100 = 33.33%
3	1/6	(1/6) × 100 = 16.67%
Total = 6	1	100%