ENG3615-Engineering Economics Individual income taxes Corporate
income taxes Income tax rates at federal and state levels Capital
gains and losses for non-depreciated assets After-tax cash flows
and after-tax rate of return Spreadsheets and after-tax cash flows
Chapter Outline 2
Slide 3
ENG3615-Engineering Economics Taxes and tax tables Calculate
taxes for both individuals and corporations Determine the combined
income tax rates and marginal income tax rates Develop after-tax
cash flows for a project Evaluate an investment on an after-tax
basis including asset disposal Use spreadsheet in solving after-tax
economic analysis problems Learning Objectives 3
Slide 4
ENG3615-Engineering Economics Technology for renewable energy
has been available for many years. Transition to greater use of
wind power requires a significant investment. Vignette: On with the
Wind Federal tax law in the Energy Policy Act of 1992 allowed
utilities a production tax credit of 1.5 per kWh. With the tax
credit and the advances in technology, many wind plants can now
produce power for less 5 per kWh. 4
Slide 5
ENG3615-Engineering Economics Should government support wind
energy through tax credit? What are the costs and benefits of wind
technology from the perspectives of the producers, consumers, and
society in general. Are there any ethical issues? What is the
effect on wind energy investment if the wind power production tax
credit is allowed to expire, or is extended for only a few years?
Using internet, can you determine how tax rates changed throughout
the course of the 20 th century? How has this affected the value of
tax credits to industry? Vignette: On with the Wind 5
Slide 6
Income Taxes An give an overview of federal income taxes. Taxes
are very complex. Lifetime task No realistic economic analysis can
ignore taxes. Tax laws change regularly. E.g. Table 12-1, 2007 Tax
Rates for individuals, does not apply for 2010. Sources of
information on taxes include: http://www.irs.gov Your Federal
Income Taxes, free from IRS by mail TurboTax (PC software for doing
individual taxes) Individuals and corporations pay taxes.
6ENG3615-Engineering Economics
Slide 7
U.S. Government is a partner in every business activity
Government shares profits through income taxes Government shares
losses through income taxes A Partner in the Business Related Point
of View: Think of taxes as one more disbursement (like operating
costs, maintenance, labor and materials, etc.) 7
Slide 8
ENG3615-Engineering Economics Taxable Income of Individuals
-Personal Exemption(s) -Itemized or Std. Deduction Wages, salary,
etc Interest Income Dividends Capital Gains Unemployment
Compensation +Other Income Gross Income -Retirement Contribution
-Other Adjustments Adjusted Gross Income (AGI) Taxable Income
8
Slide 9
ENG3615-Engineering Economics Itemized Deduction: Medical and
dental expenses (exceeding 7.5% of AGI) State and local income,
real estate, and personal property tax Home mortgage interest
Charitable contributions Casualty and theft losses (exceeding $100
+ 10% of AGI) Job expenses and certain miscellaneous deductions
(some categories must exceed 2% of AGI) Personal Exemption: One
exemption per dependent ($3400 for 2007 returns) Standard
Deduction: Single taxpayers, $5,350 for 2007 returns Married
taxpayers filing jointly, $10,700 for 2007 returns Taxable Income
of Individuals (2007) 9
Slide 10
ENG3615-Engineering Economics Itemized Deduction: Medical and
dental expenses (exceeding 7.5% of AGI) State and local income,
real estate, and personal property tax Home mortgage interest
Charitable contributions Casualty and theft losses (exceeding $100
+ 10% of AGI) Job expenses and certain miscellaneous deductions
(some categories must exceed 2% of AGI) Personal Exemption: One
exemption per dependent ($3650 for 2009 returns) Standard
Deduction: Single taxpayers, $5,700 for 2009 returns Married
taxpayers filing jointly, $11,400 for 2009 returns Taxable Income
of Individuals (2009) 10
Slide 11
Classification of Business Expenditures There are three
distinct types of business expenditures: for depreciable assets
(e.g. equipment, buildings); for non-depreciable assets (e.g.,
land, minerals); all other business expenditures (e.g., labor,
materials). Expenditures for depreciable assets. See Chapter 11.
ENG3615-Engineering Economics11
Slide 12
Classification of Business Expenditures Expenditures for
non-depreciable assets. Non- depreciable assets include: land (land
has no finite life); properties not used either in a trade,
business, or for the production of income (e.g., home, automobile).
Assets subject to depletion (Chapter 11 again). Since firms usually
acquire assets for use in the business, their only non-depreciable
assets normally are land and assets subject to depletion.
ENG3615-Engineering Economics12
Slide 13
Classification of Business Expenditures All other business
expenditures. This is probably the largest category. It includes
all the ordinary and necessary expenditures of operating a
business, including the following: 1. labor costs; 2. materials; 3.
all direct and indirect costs; 4. facilities and productive
equipment with a useful life of one year or less. These are all
routine expenditures. ENG3615-Engineering Economics13
Slide 14
Classification of Business Expenditures Recall there are three
distinct types of business expenditures: for depreciable assets;
for non-depreciable assets; all other business expenditures.
Entering capital expenditures into the accounting records of the
firm (the books) is called capitalizing them. Entering all other
business expenditures into the accounting records is called
expensing them. ENG3615-Engineering Economics14 Capital
Expenditures Expense Expenditures
Slide 15
15 Example: A firm has the following results (in millions of
dollars) for a 3-year period. Compute the taxable income for each
of the 3 years. Since the special tooling has a 3-year useful life,
it is a capital expenditure. Year 1Year 2Year 3 Gross income from
sales$200 Purchase of special tooling (useful life: 3 years) -$60
All other expenditures-$140 Cash results for the year$0$60 Example
12-1 Taxable Income ENG3615-Engineering Economics
Slide 16
16 Since the special tooling has a 3-year useful life, it is a
capital expenditure. For SL depreciation and no salvage value: the
annual depreciation charge is (P-S)/N = (60-0)/3 = $20 million;
taxable income = 200 140 20 = $40 million for each of the three
years. Year 1 Year 2 Year 3 Gross income from sales$200 Purchase of
special tooling (useful life: 3 years) -$60 All other
expenditures-$140 Cash results for the year$0$60 Example 12-1
Taxable Income ENG3615-Engineering Economics
Slide 17
Example 12-1 Taxable Income Year 1Year 2Year 3 Gross income$200
Purchase of special tooling-6000 All other expenditures-140 Cash
flows for the year$0$60 Actual cash flows: Taxable Income: Year
1Year 2Year 3 Gross income$200 All other expenditures-140
Depreciation charges-20 Cash flows for the year$40 17
Slide 18
ENG3615-Engineering Economics Maximum Federal Income Tax Rates
for Individuals 18
Slide 19
2007 Individual Tax rates ENG3615-Engineering Economics19 Tax
RateSingleMarried/JointMarried/Separate Head of Household 10%$0
15%$7,825$15,650$7,825$11,200 25%$31,850$63,700$31,850$42,650
28%$77,100$128,500$64,250$110,100
33%$160,850$195,850$97,925$178,350 35%$349,700
$174,850$349,700
Slide 20
ENG3615-Engineering Economics 2007 Federal Income Tax Rates for
Individuals Single Taxpayers Taxable IncomeTax OverBut Not OverBase
TaxPlus On Income Over $07,825$0.0010%$0 7,82531,850782.5015%7,825
31,85077,1004,386.5025%31,850 77,100160,85015,698.7528%77,100
160,850349,70039,148.7533%160,850 Over 349,700101,469.2535%349,700
20
Slide 21
ENG3615-Engineering Economics 2007 Federal Income Tax Rates for
Individuals Married Individuals Filing Jointly Taxable IncomeTax
OverBut Not OverBase TaxPlus On Income Over $0$15,650$0.0010%$0
15,65063,7001,565.0015%15,650 63,700128,5008,772.5025%63,700
128,500195,85024,972.5028%128,500 195,850349,70043,830.5033%195,850
Over 349,70094,601.0035%349,700 21
Slide 22
2009 Individual Tax rates ENG3615-Engineering Economics22 Tax
RateSingleMarried/JointMarried/Separate Head of Household 10%$0
15%$8,350$16,700$8,350$11,950 25%$33,950$67,900$33,950$45,500
28%$82,250$137,050$68,525$117,450
33%$171,550$208,850$104,425$190,200 35%$372,950
$186,475$372,950
Slide 23
ENG3615-Engineering Economics 2009 Federal Income Tax Rates for
Individuals Married Individuals Filing Jointly Taxable IncomeTax
OverBut Not OverBase TaxPlus On Income Over $0$16,700$0.0010%$0
16,70067,9001,670.0015%16,700 67,900137,0509,350.0025%67,900
137,050208,85026,637.5028%137,050 208,850372,95046,741.5033%208,850
Over 372,950100,894.5035%372,950 23
Slide 24
2011 Individual Tax rates ENG3615-Engineering Economics24 Tax
RateSingleMarried/JointMarried/Separate Head of Household 10%$0
15%$8,500$17,000$8,500$12,150 25%$34,500$69,000$34,500$46,250
28%$83,600$139,350$69,675$119,400
33%$174,400$212,300$106,150$193,350 35%$379,150
$189,575$379,150
Slide 25
ENG3615-Engineering Economics Example 12-2 - Taxable Income of
Individuals $1000 (itemized deductions) < $5350 (standard deduc)
Taxable Income = AGI - Exemption Standard Deduction = $16,000 3,400
5,350 = $7,250 Gross Income = Adjusted Gross Income (AGI) =
$10,000+6000 = $16,000 An unmarried student earned $10,000 in the
summer plus another $6000 during the rest of 2007. He is allowed
one exemption and he spent $1000 on allowable itemized deductions.
Tax = 10%(7,250) = $725 25
Slide 26
ENG3615-Engineering Economics Problem 12-4 Taxable Income of
Individuals Solution $4000 (itemized deductions) < $11400
(standard deduc) Taxable Income = AGI - Exemption Standard
Deduction = $75,000 2(3,650) 11,400 = $56,300 A married couple
filing jointly had a combined total adjusted gross income (AGI) of
$75,000, and allowable itemized deductions of $4,000 in 2009.
Compute their 2009 federal income tax. Tax = 10%(16,700) +
15%(56,300 16,700) = $7,610 26
Slide 27
ENG3615-Engineering Economics 27 Tax Year 2010 2009 2008 2007
2006 2005 2004 and 2003 Federal United States (USA) Corporate Tax
Rates Personal service corporations pay a flat rate of 35% Taxable
income overBut not overYour tax isOf the amount over $0$50,00015%$0
$50,000$75,0007,500 +25%$50,000 $75,000$100,00013,750 +34%$75,000
$100,000$335,00022,250 +39%$100,000 $335,000$10,000,000113,900
+34%$335,000 $10,000,000$15,000,0003,400,000 +35%$10,000,000
$15,000,000$18,333,3335,150,000 +38%$15,000,000 $18,333,333flat
rate 35% Federal Corporate Income Tax Rates
Slide 28
ENG3615-Engineering Economics 2007 Federal Corporate Income Tax
Rates Taxable Income Tax RateCorporate Income Tax Not over
$50,00015%15% over 0 $50,000-75,00025%7,500 + 25% over 50,000
$75,000-100,00034%13,750 + 34% over 75,000
$100,000-335,00039%22,250 + 39% over 100,000 $335,000-10
million34%113,900 + 34% over 335,000 $10 million-15
million35%3,400,000 + 35% over 10 mil. $15 million -
18,333,33338%5,150,000 + 38% over 15 mil. over
$18,333,33335%6,416,667 + 35% over 18,333,333 28
Slide 29
ENG3615-Engineering Economics Example 12-3 Federal Corporate
Income Tax Chemical Equipment d 1 = $650000(14.29%) = $92,885
Federal Income Tax = $22,250+39%(240,744-100,000) = $77,140 Taxable
Income = Gross Income Expenditures Depr. = $450,000 100,000 109,256
= $240,744 The French Chemical Corp. bought land for $220,000,
built a $900,000 factory building, and installed $650,000 worth of
chemical equipment. The plant was completed and operation begun on
April 1. Gross income for the calendar year was $450,000. All
expenses amounted to $100,000. The firm used MACRS for
depreciation. Total first year depreciation =$109,256 Building d 1
= $900,000(1.819%) = $16,371 29
Slide 30
Table 11-3 MACRS GDS Percentage Rate Recovery Year 3-Year Class
5-Year Class 7-Year Class 10-Year Class 15-Year Class 20-Year Class
133.3320.0014.2910.005.003.750 244.4532.0024.4918.009.507.219
314.81*19.2017.4914.408.556.677 4 7.41 11.52*12.4911.527.706.177
511.528.93* 9.226.935.713 65.768.92 7.376.235.285
78.936.55*5.90*4.888 8 4.466.555.904.522 96.565.914.462*
106.555.904.461 113.285.914.462 12-155.904.461 162.954.461
17-204.462 212.231 30 ENG3615-Engineering Economics
Slide 31
Table 11-4 MACRS GDS Percentage Rate Residential Rental
Property Recovery YearMonth Placed in Service 123456789101112 1
3.4853.1822.8792.5762.2731.9701.6671.3641.0610.7580.4550.152 2-27
3.636 28 1.9702.2732.5762.8793.1823.4853.636 29
0.1520.4550.7581.0611.3641.667 Recovery YearMonth Placed in Service
123456789101112 1
2.4612.2472.0331.8191.6051.3911.1770.9630.7490.5350.3210.107 2-39
2.564 40
0.1070.3210.5350.7490.9631.1771.3911.6051.8192.0332.2472.461
Nonresidential Real Property 31 ENG3615-Engineering Economics
Slide 32
Example 12-5 Before-tax and After-tax Cash Flows Initial Cost =
$3000; Useful life = 5 years; Annual net saving= $800; Salvage
value = $750; Assume 34% incr. tax rate Year (a) Before-tax Cash
Flow (b) Straight-Line Depreciation (c)=(a)-(b) (Taxable Income)
(d) Income Tax (34%) (e)=(a)-(d) After-tax Cash Flow 0 -$3000 1 800
$450$350$119681 2800450350119681 3800450350119681 4800450350119681
5800450350119681 5750 IRR BT =15.7% IRR AT =10.6% (B-S)/N=
(3000-750)/5 = 450 32
Slide 33
ENG3615-Engineering Economics Year (a) Before-tax Cash Flow (b)
Straight-Line Depreciation (c)=(a)-(b) (Taxable Income) (d) Income
Tax (34%) (e)=(a)-(d) After-tax Cash Flow 0 -$3000 1 800
$450$350$119681 2800450350119681 3800450350119681 4800450350119681
5800450350119681 5750 IRR BT =15.7% IRR AT =10.6% (B-S)/N=
(3000-750)/5 = 450 33 Example 12-5 Before-tax and After-tax Cash
Flows Initial Cost = $3000; Useful life = 5 years; Annual net
saving= $800; Salvage value = $750; Assume 34% incr. tax rate
Slide 34
ENG3615-Engineering Economics Example 12-6 After-tax Cash Flows
Initial Cost (inventory) = $20,000; Useful life = 4 years; Annual
net saving= $1,000, $1,500, $2,000, $2,500; Salvage value =
$20,000; Year (a) Before-tax Cash Flow (b) Depreciation (c)=(a)-(b)
(Taxable Income) (d) Income Tax (39%) (e)=(a)-(d) After-tax Cash
Flow 0 -$20000 1 1000 $1000$390610 21500 585915 32000 7801220 42500
9751525 420000 IRR BT = 8.5% IRR AT = 5.2% 34
Slide 35
35 Non-depreciable assets: land, minerals, stocks, bonds.
Example. a) Suppose you buy a stock for $1,000, keep it for two
years, and sell it for $1,200. The difference $1200 - $1,000 = $200
is called a capital gain. b) Suppose you buy a stock for $500, keep
it for two years, and sell it for $400. The difference 400-500 =
-$100 is called a capital loss (a negative capital gain).
Generalization: A firm sells or exchanges a capital asset. Entries
in the firms accounting records (the books) reflect this change. If
Selling Price > Original Cost Basis, then Capital gain = Selling
price Original Cost Basis ( > 0) If Selling price < Original
Cost Basis, then Capital loss = Selling price Original Cost Basis
(< 0) Capital Gains and Losses: Non-depreciated Assets
ENG3615-Engineering Economics
Slide 36
36 Capital Gains and Losses: Non-depreciated Assets Tax laws
for treating capital gains change over time. Currently, assets held
less than six months produce short-term gains or losses. Capital
assets held for more than six months produce long-term gains or
losses. The current tax law sets the net capital gains tax at 15%
for assets held more than 12 months by individuals. See a tax
accountant or an attorney for advise here. ENG3615-Engineering
Economics
Slide 37
Table 12-5 Tax Treatment of Capital Gains & Losses For
Individuals Capital Gain For most assets held for less than 1 year,
taxed as ordinary income For most assets held for more than 1 year,
taxed at 15% tax rate Capital Loss Subtract capital losses from any
capital gains; balance may be deducted from ordinary income, but
not more than $3000 per year Excess capital losses may be carried
forward indefinitely For Corporations Capital Gain Taxed as
ordinary income Capital Loss Deduct capital losses only to the
extent of capital gains Excess capital losses may be carried back 2
years, and, if not completely absorbed, is then carried forward for
up to 20 years 37
Slide 38
ENG3615-Engineering Economics Investment Tax Credit (ITC) ITC
has been used to stimulate capital investments. Businesses were
able to deduct a percentage of their new equipment purchases as a
tax credit. Depending on the specific ITC provisions, the credit
might or might not be subtracted from the basis for depreciation.
Tax Reform Act of 1986 eliminated ITC for most assets, although
credits are allowed in some specialized cases, such as historical
building preservation and in the development of alternate energy
sources. 38
Slide 39
ENG3615-Engineering Economics Estimating the After-Tax Rate of
Return For nondepreciable assets After-tax rate of return = (1
Incremental tax rate) (Before-tax rate of return) 39
Slide 40
ENG3615-Engineering Economics Example 12-7 Calculation of the
After-Tax Rate of Return =Salvage BV =750.00 345.60 =IRR(J2..J7)
=Taxed BTCF Depr. + Recap. Depr. =800.00 172.80 + 404.40 40
Slide 41
ENG3615-Engineering Economics End of Chapter 12 41