Chapter 9 – Taxes and Foreign Investment Differences in Income Accrual Book income:
Chapter 9 – Taxes and Foreign
Investment
Differences in Income
Accrual Book income:
Based on GAAP
Different timing of revenues and expenses
Accrual tax income:
Based on IRS code
Biggest difference is generally depreciation
Tax rates
Different types of income:
Ordinary income
Capital Gains - Sale of financial instruments
1245 Gains - Sale of equipment
1250 Gains - Sale of Buildings
Ordinary:
Very progressive
Federal rate goes to 35% quickly
All income taxes eventually at ordinary rates
Taxes at the Acquisition Stage
Some outlays are treated as expenses
Common examples -- training and advertising
Entire amount taken to the income statement in year 0
After tax cost = Before tax cost * (1- marginal tax rate)
Most outlays are capitalized -- taken to the balance sheet
Some are written-off over time -- depreciation
Some never written-off -- land, cash balances
Taxes at the Operating Stage
Depreciation
MACRS and older rules
Choosing a depreciation method
MACRS’s rapid depreciation is best if you have the income
If you do not have the income use slower straight-line depreciation
Taxes at the Operating Stage
Alternative minimum tax
If you have too many tax preference items like rapid depreciation you may be subject to a 20 percent minimum tax
Operating loss carry-back
Operating losses can be carried back 3 years and matched against prior income
Operating loss carry-forward
Maximum of 15 years
Taxes at the Disposition Stage
Capital gains, 1245 gains, 1250 gains,
(and losses) are netted together within classes, then the classes are netted together
Ordinary corporate rates apply
Replacement Decision with Taxes
Replacement where the worn out asset’s trade-in value is different than the sale value
Depreciable cost
What you paid for it
Initial outlay
Depreciable cost plus after tax opportunity cost of foregone sale
Replacement Decision with Taxes
Replacement where one usable asset is replaced with another
Do not net the two assets together
Calculate the after-tax foregone sale value
Calculate the net after-tax repair cost
Add together to get the initial outlay
Work the alternatives as equivalent annuities
Corp orate Taxation -- Owners
Income
Dividend exclusion rule
own less than 20 % -- exclude 70%
own 20 to 79 % -- exclude 80%
own 80% or more -- exclude 100%
Small family owned businesses can be subject to the accumulated profits tax
Businesses Not Taxed as
Corporations
Proprietorships
Partnerships
Limited partnerships
S Corporations
Personal Income Taxes
Not as quick to progress as corporation rates
Hit higher rates than corporation rates
Vastly different treatment of 1245 gains and losses versus 1250 gains and losses
Can deduct a maximum of $3000 in capital losses each year
Choice of Tax Form
Make the choice to maximize the after tax cash flow to the investor after consideration of both corporate and individual taxes
Timing of Tax Payments
Slightly different than individuals
Pay estimated payments throughout the year
Corporate returns due by March 15
Foreign Capital Investment --
Taxes
Taxation allowance made by the US government for taxes paid to foreign countries
No dividend exclusion rule from foreign subsidiaries
Coordination of taxes between countries
Foreign Capital Investment --
Cash Flows
Exchange rates influence cash flows
Repatriations agreements can hinder cash flows
