How to Calculate Tax Savings Associated With Depreciation

by Chirantan Basu

Depreciation is the allocation of a fixed asset's costs over its useful or serviceable life. Fixed assets, such as office furniture and buildings, have useful lives that usually are significantly longer than a year. Companies typically use Internal Revenue Service guidelines for estimating the useful lives of fixed assets. Depreciation expense is an operating expense that reduces taxable income. The tax savings are a function of the depreciation expense and the applicable corporate income tax rate.

1. Estimate the depreciation expense for the year. Companies often use the straight-line method for estimating depreciation expenses. In this method, the annual depreciation expense is the ratio of the depreciable cost of an asset to its useful life. The depreciable cost is the difference between the acquisition cost and the salvage value, which is the market value of an asset at the end of its useful life. For example, if you buy $40,000 worth of office furniture with a salvage value of $5,000 after an estimated useful life of seven years, the depreciable cost is $35,000 ($40,000 - $5,000) and the annual straight-line depreciation expense is $5,000 ($35,000/7).

2. Get the corporate tax rate. According to the February 2006 version of Internal Revenue Service publication 542 titled "Corporations," U.S. corporate tax rates are between 15 and 35 percent, before applicable credits and exemptions. You may use the historical tax rate for your business. If you are expecting significant changes in sales and operating expenses, then project the taxable income and estimate the new corporate tax rate. Taxable income is sales minus the sum of cost of goods sold, operating expenses and interest expense. Dividend payments are not part of operating expense.

3. Multiply the estimated depreciation expense by the corporate tax rate to calculate your tax savings associated with depreciation. To conclude the example, if your corporate tax rate is 35 percent, your tax savings are $1,750 (0.35 x $5,000).


  • Companies may deduct a limited amount of the cost of certain fixed assets in the year they place the assets in service. Congress has authorized higher depreciation allowances for limited periods to encourage business purchases. With the exception of qualified small businesses, a company may need to pay an alternative minimum tax if its minimum tax is more than its regular tax. The AMT provision ensures that corporations pay at least some tax and are not able to use credits and other provisions to significantly reduce or eliminate taxes.

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