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.