Chapter 9 Taxes and Foreign

Investment
Differences

in Income
Accrual Book income:
Based

on GAAP
Different timing of revenues and expenses
Accrual
Based

tax income:

on IRS code
Biggest difference is generally depreciation

Tax rates
Different

types of income:
Ordinary income
Capital Gains - Sale of financial instruments
1245 Gains - Sale of equipment
1250 Gains - Sale of Buildings
Ordinary:
Very progressive
Federal rate goes to 35% quickly
All income taxes eventually at ordinary rates

Taxes at the Acquisition Stage

Some

outlays are treated as expenses

Common examples -- training and advertising
Entire amount taken to the income statement in year 0
After tax cost = Before tax cost * (1- marginal tax
rate)
Most outlays are capitalized -- taken to the balance sheet
Some are written-off over time -- depreciation
Some never written-off -- land, cash balances

Taxes at the Operating Stage

Depreciation
MACRS

Choosing

and older rules

a depreciation method

MACRSs

rapid depreciation is best if you

have the income
If you do not have the income use slower
straight-line depreciation

Taxes at the Operating Stage

Alternative

minimum tax

If

you have too many tax preference items like

rapid depreciation you may be subject to a 20
percent minimum tax

Operating

loss carry-back

Operating

losses can be carried back 3 years and

matched against prior income

Operating

loss carry-forward

Maximum

of 15 years

Taxes at the Disposition Stage

Capital

gains, 1245 gains, 1250 gains,

(and losses) are netted together within
classes, then the classes are netted
together
Ordinary corporate rates apply

Replacement Decision with Taxes

Replacement

where the worn out assets

trade-in value is different than the sale
value
Depreciable cost
What

Initial

you paid for it

outlay

Depreciable

cost plus after tax opportunity

cost of foregone sale

Replacement Decision with Taxes

Replacement

where one usable asset is

replaced with another
Do not net the two assets together
Calculate

the after-tax foregone sale value

Calculate the net after-tax repair cost
Add together to get the initial outlay
Work

the alternatives as equivalent

annuities

Corporate Taxation -- Owners

Income
Dividend

exclusion rule

own

less than 20 % -- exclude 70%

own 20 to 79 % -- exclude 80%
own 80% or more -- exclude 100%
Small

family owned businesses can be

subject to the accumulated profits tax

Businesses Not Taxed as

Corporations
Proprietorships
Partnerships
Limited

partnerships
S Corporations

Personal Income Taxes

Not

as quick to progress as corporation

rates
Hit higher rates than corporation rates
Vastly different treatment of 1245 gains
and losses versus 1250 gains and losses
Can deduct a maximum of $3000 in
capital losses each year

Choice of Tax Form

Make

the choice to maximize the after

tax cash flow to the investor after
consideration of both corporate and
individual taxes

Timing of Tax Payments

Slightly

different than individuals

Pay estimated payments throughout the
year
Corporate returns due by March 15

Foreign Capital Investment -Taxes

Taxation

allowance made by the US

government for taxes paid to foreign
countries
No

dividend exclusion rule from foreign

subsidiaries

Coordination

of taxes between countries

Foreign Capital Investment -Cash Flows

Exchange

rates influence cash flows

Repatriations agreements can hinder cash
flows