Immediate Expensing Is The Removal Of A Tax Accelerant, Not A Tax Break

8
96

Some peeps just don’t get it, do they?

The tax laws generally allow companies to write off their capital investments faster than the assets actually wear out. This “accelerated depreciation” is technically tax deferral, but as long as a company continues to invest, the tax deferral tends to be indefinite.

Err, no. Depreciation of assets is in fact tax acceleration. The accelerated depreciation is the reduction in that acceleration. Immediate expensing is the elimination of it.

Think on it. A company buys an asset for $100. It’s going to last 10 years.

With no depreciation schedules for tax the company claims the expense of the $100 in that first year. It is, after all, an expense. The company has paid out the money, the $100. The shareholders don’t have the $100 any more, do they, they’ve got the asset. In year two the profits to be had from that asset are taxed normally, in year 3 and so on.

Now we have tax depreciation. Decade asset, $100, so, $10 each year (straight line for the purists). So, the company takes $10 off revenue in year one, $10 in year two etc before calculating the profit upon which tax is paid. Sure, it’s more complex, but this is the essence.

So, company pays tax on more of the profit in year 1, 2 , 3 etc as a result of the depreciation schedule. Over the decade the amount is entirely the same.

Without depreciation schedules the tax comes later, with the depreciation schedules the tax comes earlier. The depreciation schedules are thus a tax accelerant. And the immediate expensing is thus a removal of the tax accelerant.

If people just aren’t able to grasp these simple concepts about the tax system they’re not going to tell us much of use about the tax system, are they?

This is also particularly twattish:

Accounting rules require a company to, at the time a stock option is granted to an employee, estimate the value of that option on the date it will be exercised, which is difficult to predict. Unlike the accounting rules, the tax rules allow the company to wait until the employee exercises the option, which could be several years later, and claim a tax deduction equal to the value of the stock option at that time, which can be much larger than the value reported to investors.

It does not make sense for companies to treat stock options inconsistently for tax purposes versus shareholder-reporting or “book” purposes.

Why?

The accounts must reflect what they think the cost is going to be, thus the estimate of the future cost. Both the investor and the tax accounts should reflect what the actual cost is. Which we know only when the option matures. At which point we report the correct figure to the taxman and then also adjust that figure to shareholders. And yes, that last does indeed happen.

Do also note that if the company waits then it’s the opposite of a tax deferral, as complained about concerning depreciation allowances. They are waiting 3 to 5 years to report the expense. So, they’re paying tax as if the expense doesn’t exist for 3 to 5 years. This is something to complain about, right?

But, you know, for some people the answer just always is MOAR TAX.

8
Leave a Reply

avatar
4 Comment threads
4 Thread replies
6 Followers
 
Most reacted comment
Hottest comment thread
7 Comment authors
john77Michael van der RietJimdjcTim Worstall Recent comment authors
  Subscribe  
newest oldest most voted
Notify of
Spike
Guest
Spike

No, getting $100 back (actually, getting back the tax payable on $100 of profit) is of greater value this year than if paid one-tenth each year for the next ten years, so it is a tax break. Especially as tax law might change over those ten years, including in ways that would not preserve the deduction.

Jim
Guest
Jim

Um, depreciation is not an allowable expense for UK personal taxation, certainly not if you are a sole trader (how it works for corporates I couldn’t say). Depreciation gets added back in for tax purposes. For example if your business accounts show a profit of £25k with £8k of depreciation, you will be taxed on £33k of income, less any capital allowances for new capital investments.

Wack
Guest
Wack

I believe what they are trying to say is that the capital allowances can be bigger than the depreciation charge . If you buy an asset for £100 with a 10 year life in the UK in year 1 the depreciation charge is £10 (assuming the straight line method) the capital allowance is £18 (18% of the balance) Year 2 the depreciation charge is still £10 and the capital allowance is £14.76 (18% of the balance of £82). The capital allowances drop 18% each year. However if the life is only 5 years the depreciation charge would be £20 and… Read more »

djc
Guest
djc

So you may gain if you keep some old kit well into obsolescence but will lose if you need to keep your high tech up to date?

Michael van der Riet
Guest
Michael van der Riet

Most tax regimes have different amort periods for different classes of asset. The lathe in the factory might be five years, the confuser three years, and the liquor cabinet in the boss’s office is ten years.

john77
Guest
john77

You are omitting the debasement of the currency (sometimes called “inflation”). In your example of straight line 10% depreciation allowance, the value of the tax relief is dependent upon the rate of inflation and at the 2% target rate is just under 90% of the initial value of the investment. Under the reducing balance system prior to 2015 I was gradually depreciating equipment some of which was more than twenty years old so the value of the tax allowance was on the same nominal amount but less than half the real value of the purchase price.