An important part of corporate record keeping is determining the appropriate depreciation method for an asset. Great care should be given to match the revenue benefits of the asset with the expenses associated with the asset. For example, if an asset generates revenues steadily throughout its anticipated life, a straight-line depreciation method would be used. If the same asset were expected to generate it most revenues early in it’s life an accelerated method of depreciation should be used for the asset to best match the expenses of the asset with it’s generated revenues.
The MACRS depreciation formula, or Modified Accelerated Cost Recovery System, is one type of accelerated depreciation that is approved by the Internal Revenue Service for tax reporting. The accelerated depreciation yields a high depreciation expense in early years, therefore, reducing a company’s taxable income and the amount it must pay in taxes. MACRS encourages companies to invest in modern assets through tax incentives. MACRS is generally not considered acceptable for financial reporting purposes. It is used for tax reporting.
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The MACRS Depreciation Formula
Because MACRS is a depreciation method used for solely for tax reporting, the calculation is determined by IRS tax tables each year and can be changed by the IRS. To look up your MACRS percentage on a table, the IRS publishes Appendix A of IRS Publication 946. Let’s use the example of equipment costing $10,000 with a 3-year life. According to the table, an asset with a 3-year life placed in service in the first quarter of the fiscal year, would be depreciated at the following rates:
- Year 1 - 58.33%
- Year 2 - 27.78%
- Year 3 - 12.35 %
- Year 4 - 1.54%
The first year, the asset would be depreciated at $5,833 ($10,000 x 58.33%). The second year the asset would be expensed at $2,778 ($10,000 x 27.78%). The third year the asset would be expensed at $1,235 ($10,000 x 12.35%). Finally, in the fourth year, the asset would be expensed at $154 ($10,000 x 1.54%). MACRS assumes that assets are never placed in service at exactly the beginning of the first fiscal quarter, hence the small amount of depreciation in the 4th year. MACRS can assume a mid-quarter, or half-year convention depending on when the asset is placed in service. IRS form 4562 is used for reporting the depreciation derived from the MACRS tax table.
The MACRS depreciation formula is a method of accelerated depreciation that is accepted by the Internal Revenue Service. It is a beneficial depreciation method for deferring taxes until future years. This tax deferral gives companies an incentive to purchase modern equipment that can, in turn, give the company a competitive advantage in the marketplace.