Equipment associated with manufacturing small railcars had a

Equipment associated with manufacturing small railcars had a first cost of $190,000 with an expected salvage value of $30,000 at the end of its 5-year life. The revenue was $612,000 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 $ _____ .

Solution

In year 2,

If SLM method is used,

Straight-Line (SLM) depreciation ($) = (Cost - Salvage value) / Useful life = (190,000 - 30,000) / 5 = 160,000 / 5

= 32,000

Taxable income ($) = Revenue - Operating expense - Depreciation = 612,000 - 98,000 - 32,000 = 482,000

Taxes paid ($) = Taxable income x Tax rate = 482,000 x 37% = 178,340

If MACRS method is used,

MACRS depreciation ($) = Cost x 32%** = 190,000 x 32% = 60,800

Taxable income ($) = Revenue - Operating expense - Depreciation = 612,000 - 98,000 - 60,800 = 453,200

Taxes paid ($) = Taxable income x Tax rate = 453,200 x 37% = 167,684

Difference in tax paid ($) = 178,340 - 167,684 = 10,656

**MACRS ignores salvage value