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Collection of tutorials and a guide for using TGJU & Financial Markets
Depreciation is a method used to allocate the cost of tangible assets or fixed assets over the assets’ useful life. In other words, it allocates a portion of that cost to periods in which the tangible assets helped generate revenues or sales. By charting the decrease in the value of an asset or assets, depreciation reduces the amount of taxes a company or business pays via tax deductions.
A company’s depreciation expense reduces the amount of earnings on which taxes are based, thus reducing the amount of taxes owed. The larger the depreciation expense, the lower the taxable income and the lower a company’s tax bill. The smaller the depreciation expense, the higher the taxable income and the higher the tax payments owed.
Indicated in the form of depreciation expenses on the income statement, depreciation is recognized after all revenue, cost of goods sold (COGS) and operating expenses have been indicated, and before earnings before interest and taxes, or EBIT, which is ultimately used to calculate a company’s tax expense.
The total amount of depreciation expense is recognized as accumulated depreciation on a company’s balance sheet and subtracts from the gross amount of fixed assets reported. The amount of accumulated depreciation increases over time as monthly depreciation expenses are charged against a company’s assets. When the assets are eventually retired or sold, the accumulated depreciation amount on a company’s balance sheet is reversed, removing the assets from the financial statements.
There are a few different methods to calculate depreciation:
Each method recognizes depreciation expense differently, which changes the amount in which the depreciation expense reduces a company’s taxable earnings, and therefore its taxes.
Straight-line basis, or straight-line depreciation, depreciates a fixed asset over its expected life. In order to use the straight-line method, taxpayers must know the cost of the asset being depreciated, its expected useful life and its salvage value – the price an asset is expected to sell for at the end of its useful life.
For example, suppose company A buys a production machine for $50,000, the expected useful life is five years and the salvage value is $5,000. The depreciation expense for the production machine is $9,000, or $50,000 – $5,000 ÷ 5, per year.
The declining balance method applies a depreciation rate that is higher in the earlier years of the useful life of an asset. It requires that taxpayers know the cost of the asset, its expected useful life, its salvage value and the rate of depreciation.
For example, suppose company B buys a fixed asset has a useful life of three years, the cost of the fixed asset is $5,000, the rate of depreciation is 50% and the salvage value is $1,000.
To find the depreciation value for the first year, use the following formula: (net book value – salvage value) x (depreciation rate). The depreciation for year one is $2,000 ($5000 – $1000 x 0.5). In year two, the depreciation is $1,000 ($5000 – $2000 – $1000 x 0.5).
In the final year, the depreciation for the last year of the useful life is calculated with this formula: (net book value at the start of year three) – (e…
Every year, thousands of people travel to gambling hot spots such as the Nevada cities of Las Vegas and Reno with the hope of winning big in a casino. While most of these dreamers’ wallets are thinner on the return trip than when they arrived, a lucky few carry home a lot of money. If you win big while gambling in Las Vegas or Reno, you do not get to keep every penny, alas. Gambling winnings are taxable, and the Internal Revenue Service (IRS) wants its share of your casino loot. Before embarking on your Vegas trip seeking riches, make sure you understand the tax law as it relates to gambling to avoid a mess with the IRS down the road.
The good thing about gambling tax law for big winners is that, unlike income taxes, gambling taxes are not progressive. Whether you win $1,500 at the slot machine or $1 million at the poker table, the tax rate you owe on your gambling winnings always remains at 25%. When you win a big slot machine jackpot, the casino is required to withhold the 25% itself when you claim your prize; it also provides you with an IRS form, called a W2-G, to report your winnings to the government.
The threshold for which gambling winnings must be reported to the IRS varies based on the type of game. At a horse track, you must report any winnings that exceed either $600 or 300 times your initial wager. For slot machines and bingo, you are required to report all winnings in excess of $1,200. In a poker tournament, you must report winnings above $5,000.
Casinos are not required to withhold taxes or issue a W2-G to players who win large sums at certain table games, such as blackjack, craps and roulette. It is not entirely clear why the IRS has differentiated the requirements this way; slot machines are games of pure chance, while table games require a level of skill. When you cash in your chips from a table game, the casino cannot determine with certainty how much money you started with.
Even if you do not receive a W2-G or have taxes withheld from blackjack winnings, this does not absolve you of the obligation to report what you won to the IRS. You simply do it yourself when you file your taxes for the year rather than at the casino when you claim your winnings.
You are allowed to deduct any money you lose gambling from your winnings for tax purposes. However, gambling losses in excess of what you win may not be claimed as a tax write-off. When you lose your shirt in Vegas, there is no silver lining in the form of a reduced tax liability.
This question was answered by Denise Appleby.
A deferred tax liability is the result of differences in the way a company does its financial accounting for reporting purposes according to generally accepted accounting principles (GAAP) versus tax accounting. The deferred tax liability represents an obligation to pay taxes in the future. The obligation originates when a company delays an event that would cause it to also recognize tax expenses in the current period.
Essentially, a deferred tax liability is a tax expense a company would otherwise have to recognize but has postponed to a later period due to accommodations in the tax code. It is important to note that the existence of a deferred tax liability does not indicate a company underpaid on its tax bill. It simply acknowledges the accounting differences in timing between when the tax was recognized in the company’s financial statements relative to when the tax is effective via the tax code.
Why would a company account for taxable events, such as recognizing income, differently when reporting to shareholders versus taxing authorities? Varying motivations underlying the alternative presentations precipitates this behavior. A company wants to position itself in the best light to shareholders. At the same time, it is advantageous for a company to portray a muted position to taxing authorities because less income means less taxes. As such, it is in the company’s best interest to take advantage of differences in the tax code relative to how it reports to shareholders.
One of the most common causes of deferred tax liabilities comes from varying asset depreciation schedules. For example, suppose a company uses an accelerated depreciation method to depreciate certain assets for tax reasons; more depreciation reduces income, which subsequently reduces taxes. Now, also suppose the company uses straight-line depreciation when reporting to shareholders. Because accelerated depreciation is front-loaded and straight-line is evenly distributed, straight-line depreciation results in greater income and greater taxes when reporting to shareholders. The company needs to account for the difference in tax expenses under the two reporting methods. It does so by creating a deferred tax liability on its balance sheet for the difference.
Taxpayers who receive more than $1,500 in taxable interest and/or ordinary dividends during the year are required to fill out IRS Form Schedule B, which accompanies IRS form 1040. Schedule B requires the taxpayer to provide the name of each payer (such as an investment firm or bank) and the amount of interest or dividends received from each payer. The information taxpayers must report on form Schedule B is typically reported to the IRS by the payer, with a copy sent to the taxpayer, using form 1099-INT for interest and form 1099-DIV for dividends. Taxpayers must report the interest and dividends they receive to the IRS because these sources of income are taxable.
Other, less common reasons why taxpayers might need to fill out a Schedule B include the following:
Schedule B should not be used to report any tax-exempt interest shown on form 1099-INT; that information should be reported on form 1040.
Tax software can simplify the process of determining whether Schedule B is required and completing the form correctly if it is required. The totals from Schedule B are transferred to form 1040, where they are included in the computation of taxable income.
Some of the circumstances that require a taxpayer to file Schedule B also require the filing of other forms. For example, taxpayers with foreign accounts or trusts may be required to submit Form 8938, Statement of Specified Foreign Financial Assets.
The manner in which a parent company structures the spinoff and divests itself of a subsidiary or division determines whether the spinoff is taxable or tax-free. The taxable status of a spinoff is governed by Internal Revenue Code (IRC) Section 355. The majority of spinoffs are tax-free, meeting the Section 355 requirements for tax exemption because the parent company and its shareholders do not recognize taxable capital gains.
While a company’s first responsibility in determining how to conduct a spinoff is its own continued financial viability, its secondary legal obligation is to act in the best interests of its shareholders. Since the parent company and its shareholders may be subject to sizable capital gains taxes if the spinoff is considered taxable, the inclination of companies is to structure a spinoff so that it is tax-free.
There are two basic structures, or means, for a parent company to conduct a tax-free spinoff. Both result in the spinoff becoming its own legal entity, a publicly traded company separate from the parent company, although the parent may hold a substantial amount of stock – up to 20% by IRC guidelines – in the newly created company.
The first method of conducting a tax-free spinoff is for the parent company to distribute shares in the new spinoff to existing shareholders in direct proportion to their equity interest in the parent. If a stockholder owns 2% of the shares of the parent company, he receives 2% of the shares of the spinoff company.
The second tax-free spinoff method is for the parent company to offer existing shareholders the option to exchange their shares in the parent company for an equal proportion of shares in the spinoff company. Thus, shareholders have the choice of maintaining their existing stock position in the parent company or exchanging it for an equal stock position in the spinoff company. The shareholders are free to choose whichever company they believe offers the best potential return on investment (ROI) going forward. This second method of creating a tax-free spinoff is sometimes referred to as a split-off to distinguish it from the first method.
A taxable spinoff, with potentially substantial capital gains tax liability for both the parent company and its shareholders, results if the spinoff is done by means of outright sale of the subsidiary company or division of the parent company. Another company or an individual might purchase the subsidiary or division, or it might be sold through an initial public offering (IPO).
There are any number of reasons why a company might wish to spin off a subsidiary company or division, ranging from the idea that the spinoff can be more profitable as a separate entity to the need to divest the company to avoid antitrust issues.
There are detailed requirements in IRC section 355 that go beyond the basic spinoff structure outlined above. Spinoffs can be quite complicated, especially if transfer of debt is involved. Therefore, shareholders may wish to seek legal counsel on the possible tax consequences of a proposed spinoff.
The Cayman Islands are one of the most well-known tax havens in the world. Unlike most countries, the Caymans don’t have a corporate tax, making it an ideal place for multinational corporations to base subsidiary entities to shield some or all of their incomes from taxation.
A tax haven is any location that has very lenient or even non-existent tax laws. There are numerous tax havens around the globe, including Switzerland, the British Virgin Islands, Bermuda and Dominica. The specific tax laws in each location vary. While some simply tax income at lower rates, sometimes as low as 2%, others have virtually no taxes. The British Virgin Islands, for example, has no corporate tax, estate tax, inheritance tax, gift tax or sales tax, and it has an effective income tax rate of zero.
Tax havens provide offshore banking services to foreign individuals and businesses that allow them to avoid paying income taxes in their countries of residence. For example, a large corporation might establish an offshore subsidiary in the Cayman Islands and direct all sales through the subsidiary rather than through the parent company based in the United States.
In this case, the shell corporation earns the company’s profits and is subject to the tax laws of the Cayman Islands rather than the United States. Instead of being subject to the U.S. corporate tax rate, which stood at 38.9% in 2017, the company’s profits are subject to whatever corporate or income taxes apply in the Caymans.
The Caymans have become a popular tax haven among the American elite and large multinational corporations because there is no corporate or income tax on money earned outside of its territory. This includes interest or dividends earned on investments, making the Caymans especially popular among hedge fund managers.
Instead of taxes, offshore corporations pay an annual licensing fee directly to the government. This fee is based on the amount of authorized share capital the company has.
Like all tax havens, privacy laws are paramount. The Caymans make it easy for individuals and business owners to shield their assets and identities from prying eyes.
Andorra is one of many locations around the globe considered a tax haven because of its relatively lenient tax laws. However, as of 2015, pressure from the European Union has prompted the Andorran government to increase taxation, making it less of a haven than it was a decade ago.
A tax haven is a locale, or a country, state or territory, that is popular among wealthy individuals and businesses because its tax laws allow them to legally reduce their tax liabilities. Typically, this is done by allocating assets to offshore bank accounts or shell companies, or by taking up residency to benefit from lower tax rates.
Unlike most other tax havens, Andorra does not provide for the easy creation of offshore companies, so it is better suited to wealthy individuals in need of offshore banking services than to businesses looking to squirrel away assets in Andorran-based subsidiaries. To own more than 10% of an Andorra-based company, nonresidents must request approval from the Ministry of Economy, which can prove difficult. It is possible for a foreigner to form a company after attaining residency, but the company’s net profits are subject to the 10% corporate tax applicable to resident businesses.
Historically, Andorra has had no income, capital gains, sales, gift or inheritance tax, and gaining residency was relatively simple. The Andorran government implemented a 4.5% value-added tax (VAT) and a set of relatively stringent residency requirements, primarily based on an investment of no less than 400,000 euros. A capital gains tax will be introduced in 2016 that taxes profits from the sale of Andorran property at a maximum rate of 15% depending on how long the property has been held. Most other investment income remains tax-free.
In addition, a new income tax rate is set to take effect in 2016. The tax is still extremely low by U.S. standards, topping out at 10% for those who earn more than 40,000 euros per year, and it only applies to income for which tax has not been paid elsewhere, preventing any double taxation.
It is more beneficial to use net operating profit after tax, or NOPAT, as opposed to net income when making an investment decision because a company’s NOPAT is a measure of profit that excludes the cost and tax benefits of debt financing in that company’s capital structure.
NOPAT is essentially a company’s earnings before interest and taxes, or EBIT, adjusted for the impact of tax structure. The equation for NOPAT is as follows:
Net Operating Profit After Tax = (operating income) x (1-tax rate)
If, for example, a company has $100 of NOPAT but also has a $100 monthly interest payment, it looks unprofitable to an investor. It is possible, however, that the company could be actively paying down its debt or plans to take on an interest payment of this amount, meaning the operations might be fine, and thus worth a long-term investment.
Current tax laws do not allow the vast majority of capital expenditures to be fully tax-deducted for the year in which the expenditures occur. Businesses may be opposed to such tax regulations, preferring to be able to deduct the full amount of their cash outlays for all expenses, whether capital or operational.
For tax purposes, capital expenditures are generally defined as the purchase of assets whose usefulness, or value to a company, exceeds one year. Operational expenses are for assets that are expected to be purchased and fully utilized within the same fiscal year. Office supplies and wages are two examples of operational expenses. Capital expenditures are commonly more expensive outlays for things such as facilities, computer equipment, machinery or vehicles, but they can also include less tangible assets, such as research and development or patents. Operational expenditures can be fully tax-deducted in the year they are made, but capital expenditures must be depreciated, or gradually deducted, over a period of years considered as constituting the life of the asset purchased. Different types of assets are depreciated on a percentage basis over different time spans – three, five or 10 years or more.
It is advantageous for businesses to be able to deduct expenses in the year in which they occur. More deductions translates to a lower tax bill for the year, which leaves more cash on hand available for the business to expand, make further investments, reduce debt or make payouts to stockholders.
From the tax agency’s point of view, since capital expenditures purchase assets that continue to provide value or income for several years beyond the purchase year, it makes sense to have a multiyear taxation plan. Depreciation allowances can be looked at as a company gradually recovering the full cost of an item over its useful lifespan. Rules govern the number of years over which an asset is to be depreciated. For example, computer hardware is commonly depreciated over a period of five years, whereas office furniture is depreciated over a seven-year period.
The IRS has made some concessions to business owners through section 179, which allows 100% same-year tax deductions for some capital expenditures. There are rules on the total amount that can be deducted for capital expenses in a single year, and regarding what types of property qualify for the 100% deduction. For instance, only tangible property, not real estate, qualifies for the 100% deduction. S corporations are not allowed to pass the deduction on to stockholders unless the company has net income. Section 179 is designed to be of primary benefit to small or new businesses that need to make substantial outlays of capital to grow and develop.
Capital expenditures are usually substantial amounts of money that significantly reduce a company’s cash flow or require it to take on additional debt. Because businesses cannot completely deduct these expenditures in the year they are incurred, careful planning is required so that a company does not financially overextend itself through capital expenses.