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Contrast the tax effects of "expensing a cost" versus "capitalizing a cost"?

User Syon
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Final answer:

Expensing a cost allows for a full deduction in the year incurred, lowering tax liability, while capitalizing a cost spreads out the deduction over multiple years.

Step-by-step explanation:

The tax effects of 'expensing a cost' and 'capitalizing a cost' refer to how an expense is treated for tax purposes. When a cost is expensed, it is fully deducted in the year it is incurred, reducing taxable income and therefore lowering the tax liability. On the other hand, when a cost is capitalized, it is not fully deducted in the year it is incurred, but rather depreciated or amortized over its useful life, resulting in a smaller deduction each year.

For example, let's say a business purchases a piece of equipment for $10,000. If the business chooses to expense the cost, it can deduct the full $10,000 in the year of purchase, reducing its taxable income by $10,000. However, if the business chooses to capitalize the cost and depreciate it over 5 years, it can deduct $2,000 ($10,000 divided by 5) each year for 5 years.

In short, expensing a cost provides a larger immediate tax benefit, while capitalizing a cost spreads out the tax benefit over multiple years.

User Amudhan
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