Depreciation as a Tax Shield The term tax shield refers to the amount of income tax saved by deducting depreciation for

Question

Depreciation as a Tax Shield The term tax shield refers to the amount of income tax saved by deducting depreciation for income tax purposes. Assume that Supreme Company is considering the purchase of an asset as of January 1, 2017. The cost of the asset with a five-year life and zero residual value is $93,000. The company will use the straight-line method of depreciation. Supreme's income for tax purposes before recording depreciation on the asset will be $49,600 per year for the next five years. The corporation is currently in the 35% tax bracket. Required: Calculate the amount of income tax that Supreme must pay each year if the asset is and is not purchased. 1. Amount of taxes paid if asset is not purchased is: 2a. Amount of depreciation if asset is purchased is: b. Amount of taxes paid if asset is purchased is: 3. What is the amount of the depreciation tax shield?

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1). Computation of the amount of taxes paid if asset is not purchased:- Amount of taxes paid = Income before depreciation * Tax rate = $49,600 * 35% = $17,360 2-a). Computation of the amount of depreciation if asset is purchased:- Depreciation = (Cost - Salvage value) / Estimated useful life = ($93,000 - 0) / 5 = $18,600 b). Computation of the amount of taxes paid if asset is purchased:- Amount of taxes paid = (Income before depreciation - Depreciation) * Tax rate = ($49,600 - $18,600) * 35% = $31,000 * 35% = $10,850 3). Computation of the amount of the depreciation tax shield:- Amount of depreciation tax shield = Depreciation expense * Tax rate = $18,600 * 35% = $6,510

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Depreciation as a Tax Shield The term tax shield refers to the amount of income tax saved by deducting depreciation for income tax purposes

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