Question

Incorrect Depreciation and Recognized Gain

A staff accountant for a large international com-pany is calculating the tax gain from a disposition of business equipment. The equipment was seven-year MACRS property and has been fully depreciated for tax purposes. The staff accountant notices that the equipment was used in Germany, not the United States, although it is listed as an asset of the U.S. company for which the staff accountant works. Because the property was used outside the United States, it should have been depreciated using straight-line over a nine-year life. Con-sequently, the tax depreciation has been overstated, and the tax basis should be greater than zero, causing a smaller gain. What should the staff accountant do?

What dilemma is the staff accountant facing?

What procedures does tax law provide on how this issue must be dealt with and why?

What disclosure must the accountant provide to the tax client, if any?

How could this issue be prevented in the future?

Answer 1

1.Dilemma is the staff accountant facing:

As the property was used outside the United States, it should have been depreciated using straight-line method of depreciation ,over a nine-year life

But it had been treated as used in the United States & depreciated as a seven-year MACRS property & had been fully depreciated for tax purposes

Now the asset is disposed

The capital gains will be smaller , if it had been depreciated under straight-line method, as the asset will still have some carrying value ---also annual tax expense will be more

as against

that under MACRS method, as the asset's carrying value is 0(zero)& the capital gains will be larger---annual tax expense is less because of greater depn. Charge against income

ie.under MACRS, more depreciation had been claimed each year,thus taxes would have been under-paid, than what should have been paid.

2.Procedures provided by tax law provide on how this issue must be dealt with and why

To set the records straight,

the difference in tax expense (due to decreased actual st.line depn.)in all the years, over the eight years (7-yr MACRS), need to be calculated & paid along with the tax on capital gains

3.Disclosure must the accountant provide to the tax client, if any?

The tax client must be informed of the change in the method depreciation that should have been adopted --as it will decide the tax due to the IRS as well as the net proceeds of the disposal transaction and also the correct amount of gain that is to be recognised.

4.Prevention of such issues in future:

To make sure about the depreciation method to be followed , by consulting proper professional such as a tax consultant.