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In some cases, it may be that taxes owed are less than the amount of the tax credit. The federal government will allow the company to carry the unused portion of the credit forward to the following year (carryover). For example, suppose a company invests in a solar technology to sell electricity to the grid. Theinitialinvestmentis$2million. Afterthefirstyearofoperation,thecompanyowesfederalincome taxes in the amount of $150,000. The tax credit allows .a reduction in taxes owed in the first year of operation equal to 10% of the initial investment cost, or $200,000. Thus, taxes owed are reduced to a negative$50,000,whichcouldbecarriedovertothefollowingyear. However,theserulesmaynotapply at the state level. Qepreciation It is difficult to talk about income taxes without talking about depreciation. For tax purposes, depreciation is a means of recovering, through an income tax deduction, the cost of property used in a bade or business or of property held for the production of income (land is not depreciable). The capital sum to be recovered by depreciation is the "depreciable base," which when adjusted annually by the amount depreciable, becomes the "adjusted base." It is a bookkeeping entry and does not involve the outlay of cash; nor does it involve the actual deterioration of the physical asset. If federal investment tax credits are available, the depreciable base for federal tax purposes must be decreased by half of the tax credit. Internal Revenue Service (IRS) rules for depreciation have gone through changes over the last couple of decades, the most recent of which was the 1986 Tax Reform Act. Given the complicated nature of the subject, only the current tax rules (i.e., enacted with the 1986 Tax Reform Act) are reviewed in this manual. TheIRSrulesshouldberevisitedoftentoassurethattherulesreviewedherearestillinpractice. Itisalsoimportanttonotethatonlythecurrentfederalrulesarediscussed. Ifananalysisrequiresmore accuracy or detail, state depreciationrules shouldbe examined. Another important point is that given the natureof depreciation,annualdepreciationallowancesarealwayscalculatedincurrentdollarsandassuch, a nominal discount rate should be used when discounting depreciation cash flows. The Modified Accelerated Cost Recovery System (MACRS) is the name given to the federal tax rules for recovering costs through depreciation. MACRS rules apply to most tangible property placed in service after 1986. MACRS consists of two systems, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). MACRS provides the following ways to depreciate property: .Both the 200% and 150% declining balance (DB) methods over a GDS recovery period The 150% DB method over an ADS recovery period The straight line (defined later) method over an ADS or GDS recovery period. The depreciation method used depends on the system used (GDS or ADS) and the class and type of property. The major differences between GDS and ADS are the recovery period and method of depreciation used to figure the deduction. The GDS is most commonly used and is the recommended system for EE analysts because it permits use of the declining balance method over a shorter recovery period, resulting in a greater deduction in the earlier years (IRS 1993). The ADS is used when it is desirabletoextendanasset'sdepreciationperiod. ForADSthestraightlinemethodisusedoveranADS recoveryperiod. Forexample,considerabusinessinwhichtaxablerevenueisexpectedtobegreaterin futureyearsthaninearlieryears. Inthiscase,agreaterdeductionintheearlieryearsisnotasbeneficial as an extended depreciation period. The straight line (SL) anmud depreciation method is calculated using the following formula: D, = (C, - NSV) / N (2-15) 19PDF Image | A Manual for the Economic Evaluation of Energy Efficiency and Renewable Energy Technologies
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