Session 25

Income Taxes

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Types of Taxes
Income taxes are assessed as a function of gross revenues minus
allowable expenses.
Property taxes are assessed as a function of the value of property
owned.
Sales taxes are assessed on the basis of purchase of goods or services.
Excise taxes are federal taxes assessed as a function of the sale of
certain goods or services often considered nonnecessities.
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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Income Taxes
Up to this point, we have not considered income taxes in our
discussion of engineering economy.
We will now observe how income taxes affect a projects estimated
cash flows.
Income taxes resulting from the profitable operation of a firm are taken into
account in evaluation engineering projects.

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

After-tax MARR
Taking taxes into account changes our expectations of returns on
projects, so our MARR (after-tax) is lower.

Going forward, we will primarily use and be given after-tax MARR

values.

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Taxable Income
Depreciation is not a cash flow, but it affects a corporations taxable
income, and therefore the taxes a corporation pays.
Taxable Income = gross income
all expenses except capital investments
depreciation deductions

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Taxable Income (example)

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Taxable Income (example)

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Federal vs. State Tax

Federal taxes are calculated using a set of income brackets, each
applying a different tax rate on the marginal value of income.
State taxes vary widely, but usually are in the range of 6 12%.

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Federal Tax Rates

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Income Taxes (example)

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

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Income Taxes (example)

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

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Effective Tax Rate

Corporations need to know their effective tax rate, which is a
combination of federal and state taxes according to either formula
below.

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

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Effective Tax Rate (example)

Find the taxable income of a corporation given the information below.
If you assume a state tax of 9%, what is the effective tax rate?
Gross income = $5,270,000
Expenses (excluding capital) = $2,927,500
Depreciation deductions = $1,874,300

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

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Effective Tax Rate (example)

Taxable Income = $468,200
Effective tax rate = .34 + (1 .34)(.09) = 40%

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IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

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Gain (Loss) on Disposal of an Asset

When a depreciable asset is sold, it is rare that the market value and
book value are equal.
When the sale results in a gain, it is referred to as depreciation recapture.
When the sale results in a loss, it is referred to as capital gain.

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