Which Method of Depreciation Gives the Highest Net Income?

by Steve Lander Google

When you claim depreciation, it reduces your tax liability by reducing your taxable net income. Although paying less in taxes is usually desirable, there are times that you might want to avoid having your net income appear too low. Based on this, you can strategize how you claim the depreciation on the assets your business buys to minimize its impact on your bottom line.

Depreciation Options

The Internal Revenue Service offers two types of depreciation as well as the Section 179 deduction. The section 179 deduction lets you claim some capital asset purchases as expenses in the year you buy them, saving you from having to depreciate them. Most assets get depreciated using the general depreciation system, although you can opt to use the alternate depreciation system, if you wish. Generally, the general depreciation system lets you write off assets over a shorter period of time. You can also choose to accelerate depreciation under the general depreciation system, while the alternative depreciation system only lets you use the straight-line method.

Current Year Net Income

If you're looking to maximize your net income this year, stretch your depreciation out as much as possible. For example, you could depreciate assets instead of claiming the Section 179 deduction for them. Depreciating $20,000 of computer purchases will reduce a $20,000 hit to your net income to just $4,000, given the general depreciation system's five-year recovery life for data processing equipment. You can also choose to depreciate purchases using the alternative depreciation system, but once you've done this, you'll be stuck using that system for the entire life of the asset.

Future Net Income

If you want to maximize your net income in the future, take as much depreciation as you can now. No matter what schedule you choose, every depreciable asset that you buy will eventually be written down to a zero value. For example, if you take the Section 179 deduction on a $20,000 computer purchase this year, it'll be a big hit to your company's net profit, but you won't have to claim any more depreciation over the next four years. This also has the secondary benefit of giving you more tax savings up front.

Income or EBITDA

While it can be a good thing to increase your net income, some businesses place more focus on EBITDA (earnings before interest, taxes, depreciation and amortization). Since net income can include factors that don't really measure how well a business is doing in the present, they feel that EBITDA more closely tracks a business's actual cash flow. Given that your business's sales and actual costs are the same regardless of how you choose to depreciate the assets you buy, there is a strong case for not worrying too much about your net income and instead focusing on whichever depreciation method is best for your overall goals.

About the Author


Photo Credits

  • Jupiterimages/Comstock/Getty Images
Suggest an Article Correction