ACTG 422 Chapter One
Each of the following cases involves a taxable year of less than 12 months. In which situations is annualization required? A new corporation formed in September elects a calendar year. A calendar-year individual dies on June 15. Jean, who has been using a calendar year, marries Hank, a fiscal-year taxpayer. Soon after the marriage, Jean changes her tax year to coincide with her husband's tax year. A calendar-year corporation liquidates on April 20.
no no yes no
What transactions are subject to the long-term contract method of reporting?
Long-term contracts include building, installation, construction, or manufacturing contracts that are not completed in the same taxable year in which they are entered into.
How does a taxpayer's tax accounting method affect the amount of tax paid?
The accounting methods used by a taxpayer can accelerate or defer the recognition of income, and, thereby, change when the tax must be paid. Also, because of the progressive tax rate structure, taxes can be saved by spreading income over several years, rather than having income bunched into one year, pushing the taxpayer into higher brackets.
What is the primary impact of the imputed interest rules on installment sales?
The imputed interest rules may convert a favorably taxed capital gain into interest, which is taxed at ordinary rates. The imputed interest rules may reallocate the amount received from an installment sale between selling price and interest if the stated interest rate is below the applicable federal rate. The result is to increase the amount of interest (versus principal reported) in early years under an installment sale. All of the interest is taxable versus only a portion of the principal. As a result the amount of income reported in the early years is greater. Less income is reported in later years.
Is there any instance in which a change in tax years is required? Explain.
A subsidiary corporation filing a consolidated return with its parent is required to change its accounting period to conform with its parent.
Under what conditions is a taxpayer required to annualize income?
Annualization is required when a change in the accounting period occurs.
When are expenses deductible by a cash method taxpayer?
A cash-method taxpayer deducts expenses when they are paid. A cash-method taxpayer is, however, required to capitalize fixed assets and recover the cost through depreciation or amortization. Section 179 does, however, permit many taxpayers to currently deduct up to $1,080,000 of equipment. Prepaid expenses must also be capitalized and deducted over the term of the prepayment if that term extends substantially beyond the end of the tax year. Typically, capitalization is required only if the term of the prepayment extends beyond the close of the tax year following the year of payment.
Who may use the completed contract method of reporting income from long-term contracts?
Companies whose average gross receipts for the three preceding years were $27 million or less may use the completed contract method for construction contracts that are expected to take two years or less to complete. In addition, the completed contract method may be used for home construction contracts
Does annualizing income increase or decrease the taxpayer's tax liability? Explain.
Due to our progressive tax rates, annualization generally increases the taxpayer's tax liability.
Do accounting rules determine the amount of income to be reported by a taxpayer?
In the long run, the amount of income reported by a taxpayer will generally be the same regardless of the accounting methods used by the taxpayer. In a given year the amount of income reported by a taxpayer can vary significantly depending on the accounting method used by the taxpayer.
Are the rules that determine when interest is deductible by a cash method taxpayer the same as for other expenses?
No. Prepaid interest is not deductible. An exception permits a cash-method taxpayer to deduct points paid on a home mortgage if the property is the taxpayer's principal residence and the mortgage was for the purchase or improvement of the residence.
Is an accrual method taxpayer permitted to deduct estimated expenses? What about prepaid expenses? Explain.
No. The all events and economic performance tests prevent the deduction of estimated expenses. The expense becomes deductible once the actual cost is known. Prepaid expenses are deductible as long as the exception to the economic performance test is met.
What conditions must be met in order to use the installment method? Why would a taxpayer elect not to use the installment method?
One reason to elect out of the installment method could relate to the application of lower tax rates in the current year where higher tax rates are anticipated during the installment period. Also, a taxpayer with current operating and/or capital losses or expiring loss carryovers may prefer to offset a gain against the losses in the current year.
What constitutes a payment in determining when a cash-basis taxpayer is entitled to deduct an expense?
Payment can be by check that is honored in due course. Payment can be by use of a credit card. Payment by credit card is considered to be the equivalent of borrowing funds and using the borrowed funds to pay the expense. Therefore, the taxpayer is entitled to deduct the expense.
Can the IRS require a taxpayer to change accounting methods?
The IRS can require a taxpayer to change accounting methods if the method that has been used does not clearly reflect income.
Most individuals use the calendar year as their tax year. What requirement, if any, in the tax law causes this?
The tax year must coincide with the year used to keep books and records. Taxpayers who do not have books must use the calendar year.
In what situations will a tax year cover a period of less than 12 months?
When a taxpayer files his or her first or final return or when the taxpayer changes accounting periods.
Is a cash method taxpayer subject to the same rules for depreciable assets as accrual method taxpayers?
Yes. Cash-method taxpayers are subject to the same rules as other taxpayers.
