Taxation TYPES OF TAXES TYPES OF TAXES. 1. Income taxes: 2. Property taxes: By: Magdy Akladios, PhD, PE, CSP, CPE, CSHM

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1 Taxation By: Magdy Akladios, PhD, PE, CSP, CPE, CSHM TYPES OF TAXES 1. Income taxes: Assessed as a function of gross revenues minus allowable deductions Levied at federal, most state, and some municipal government levels TYPES OF TAXES 2. Property taxes: Assessed as a function of owned property value; Independent of income or profit of firm Levied at municipal, county, and/or state level

2 TYPES OF TAXES 3. Sales taxes: Assessed on purchases of goods and services Independent of gross income or profits Relevant to engineering studies as added cost TYPES OF TAXES 4. Excise taxes - assessed on sale of certain nonessential goods/services Independent of business income and profit Cost ultimately to consumer, despite original target BEFORE-TAX MARR Before tax MARR > After tax MARR (Before Tax MARR) [(1- Effective Income Tax Rate)] After Tax MARR Before-Tax MARR After-Tax MARR/(1 - Effective Tax Rate)

3 NET INCOME BEFORE TAXES (NIBT) CALCULATING TAXABLE INCOME 1. Calculate Gross Income: Gross Profits (revenues from sales - cost of goods sold) + income from dividends, interest, rent, royalties, and gains/losses from sale or exchange of capital assets 2. Deduct all ordinary and necessary operating expenses to conduct business Include interest but exclude capital investments 3. Deduct depreciation: Taxable Income = gross income - all expenses - depreciation NET INCOME AFTER TAXES (NIAT) The net income after taxes have been deducted from the taxable income or Net Income Before Taxes Net Income After Taxes = NIBT - income taxes Example A company generates $1,500,000 of gross income. Operating expenses = $800,000 Interest payments on borrowed money = $48,000 Depreciation deductions = $114,000 Find NIBT

4 Solution NIBT = $1,500,000 - $800,000 - $48,000 - $114,000 = $538,000 EFFECTIVE (MARGINAL) CORPORATE INCOME TAX RATE As personal income tax rates are based on income brackets, so, too, is corporate income tax Depending on the bracket a firm s income falls within, the marginal federal rate can vary from 15% to a maximum of 39% (for incomes between $100,000 and $335,000) Incomes above $18,333,333 are taxed at a flat rate of 35% TRA 86 responsible for lowering maximum rate from 46% to 35% Also created alternative minimum tax (AMT) Example If a firm s gross income = $5,270,000 Expenses = $2,927,500 Depreciation deductions = $1,874,300 How much should this company pay in taxes for that year?

5 Solution Taxable income (NIBT) = gross income expenses depreciation deductions Taxable income = $5,270,000 - $2,927,500 - $1,874,300 = $468,200 Income tax (based on Table 9-6) = $113, % of the amount above $335,000 = $113, ($468,200 $335,000) = $159,188 State Income Tax State income tax is usually 6% 12% State taxes are taken out first Federal taxes are taken out on the remainder of the profits of the firm Total tax paid by a firm due to federal and state income tax, t = State rate + Federal rate (1 - state rate) t is typically, around 40% t is the firm s effective corporate income tax Gain/Loss on Disposal of a Depreciable Tangible Asset For capital asset sold or exchanged, gain/loss referred to as capital gain/loss Capital assets include: Stocks Bonds Gold, silver, or other metals, and Real property If gain, referred to as: Depreciation Recapture [GAIN/LOSS ON DISPOSAL] N = MV N -BV N

6 Example A firm sold a piece of equipment for $78,600 B was $190,000 Accumulated depreciation = $139,200 Assume t = 40% Find: 1. The gain on disposal 2. The tax liability Solution First, part 1: BV = $190,000 - $139,200 = $50,800 Gain = $78,600 - $50,800 = $27,800 Second, part 2: The tax owed = 40% X $27,800 = $11,120 Tax Economic Analysis Before- and After-Tax

7 First, some definitions: R k = Revenues (and savings from the project): cash inflow from project during year k E k = Expenses or cash outflows during year k d k = Depreciation/Depletion during year k t = effective income tax rate on ordinary income (federal, state and other); assumed to remain constant during the study period T k = income taxes paid during year k Table R k E k d k NIBT k T k NIAT k Before-Tax formulas: BTCF k = R k E k Taxable Income, or net income: = NIBT k = (R k E k d k ) Tax liability: = T k = t (NIBT k ) = t (R k E k d k )

8 After-Tax formulas: NIAT k, or NOPAT k = NIBT k T k = (R k E k d k ) t (R k E k d k ) = (1 t)(r k E k d k ) ATCF k = BTCF k T k = (R k E k ) t (R k E k d k ) = (R k E k ) t R k + t E k + t d k = (R k E k ) t (R k t E k )+ t d k = (1 t)(r k E k ) + t d k Example Revenues = $10,000 Expenses = $4,000 Depreciation = $2,000 t = 40% Find: ATCF NIAT Solution First, ATCF: ATCF = (1 t)(r k E k ) + td k ATCF = (1 0.4)($10,000 $4,000) + 0.4($2,000) = $4,400 Second, NIAT: NIAT = ATCF d k = $4,400 - $2,000 = $2,400 Or, NIAT = NIBT - Income Tax Income Tax = t (R k E k d k ) = $1,600 NIAT = $4,000 - $1,600 = $2,400

9 Example of Table Yr (A) BTCF GDS Factor (B) dk BVk (C)=(A)-(B) Taxable income (D) = t(c) Tax liability (T) (E)=(A)+(D) ATCF (BTCF + T) 0 $-100,000 $-100,000 1 $45, % $33,330 $66,670 $11,670 $-4,668 $40,332 2 $45, % $44,450 $22,220 $550 $-220 $44,780 3 $45, % $7,405 $14,815 $37,595 $-15,038 $29,962 3 $25,000 $10,185 $4,074 $20,926 Some Notes: Before Tax MARR > After Tax MARR Before Tax IRR > After Tax IRR Before Tax PW > After Tax PW Accelerated Depreciation produces higher PW of tax savings than does the same amount of depreciation claimed later in an asset s life.