Chp 11
S corporation tax year
Must adopt calendar year tax year ~unless Corporation has a business purpose for electing a fiscal year -taxpayers who are willing to make required payments or distributions may choose a fiscal year
Partnerships and S corporations making the section 444 election
Must make annual required payments by April 15th of the following year.
Partnership tax year
Must use tax year of partner who owns majority of the partnership income and capital (>50%) -if majority of partners have different tax years partnership must use the tax year of its principal partners( those with more than 5% interest in the partnership) - if principal partners have different tax yrs partnership must use the tax year with the least aggregate deferral of income - may use fiscal year if have acceptable business purpose outlined by IRS
When is the tax year elected
The first tax return year that is filed by a taxpayer ~cannot be changed without consent from IRS
taxpayer changes accounting periods
must annualize their income for the resulting short period - prevents income earned during the resulting short period from being taxed at lower rates.
cash method for fixed assets capitalization requirements
required to capitalize cost and recover cost thru depreciation and amortization
Accounting method definition
system of rules and procedures used to determine the year in which income is reported and expenses are deducted for tax purposes
how long does most inc tax ret cover an acg period
12 months
Form 1128
- Application that is used request permission to change accounting. -Application for change in accounting period must be made on or before the due date of the return including extensions - the application must be sent to the Commissioner of the IRS Washington DC -The IRS may establish certain conditions for the taxpayer to meet before it approves the change to a new tax year.
What allows c corps and partnerships w/corp partner to use cash method if they sale invoentory
- C corporations and partnerships with a corporate partner may use the cash method only if their average annual gross receipts for the three past tax years do not exceed $5 million - or - if the business meets the requirements associated with providing personal services (majority of owners provide personal srvc thru biz) than can use cash method even if gross rcpts exceed 5 mil
Annual accounting period definition
- The basis used to compute taxable income -an ordinary 12 months either - a calendar year or - a fiscal year
installment sale
- any disposition of property where at least one payment is received after the close of the taxable year in which the disposition occurs - computed under sec 453 -form 6252 reports inc from installment sale -not applicable to sales of: c inventory, or c marketable securities
accrual
- inc rec when earned (when goods or services have been provided) -must be used for sales and cost of goods sold if inventories are an income-producing factor to the business. ~exception: - businesses with inventories can use the cash method if their average annual gross receipts for the three past years do not exceed $1 million - 10 mil if biz principal sale is not inventory
completed contract method
- income from a contract is reported in the taxable year in which the contract is completed. ~doesnt matter if contract price is collected in advance, upon completion of the contract, or in installments.
capitalization req for pre paid exp cash method
- must be capitalized and deducted over the life of the asset if the life of the asset extends (include int in cost of the assets) substantially beyond the end of the tax year ~1 yr rule- cap is generally req only if life of the assets extends beyond 1 yr of the following yr of pymt Exception to prepaid ex capitalization is for prepaid interest: -1 yr rule dose not apply - must capitalize even if less that 1 yr by allocating int over the prepayment period UNLESS amounts are points paid on mortgage to purchase or improve home- then points are ded
installment method
- tax law permits taxpayers to spread the gain from installment sales over the collection period -only allowed for gains
cash method
- taxpayer is required to report income for the tax year in which payments are actually or constructively received. (MUST BE REPORTED IN GROSS INC) THIS INCLUDES THE RCPT OF CASH, PROP OR SRVC AS PYMT - most used by bizs - cant be used for biz primarily involved w inventory -Rcvbls or other promise to pay are not rec until collected -expenses are ded when paid - checks and credit card = cash pymt
Methods for lT contracts
-% of comp -modified % of comp -completed contract method - must be used for all lt contracts in same trade
Taxpayers filing an initial tax return and executors filing a taxpayer's final return or corporations filing their last return
-are not required to annualize the year's income, nor are personal exemptions or tax credits prorated. - returns are prepared and filed, and taxes are paid as though they are returns for a 12-month period ending on the last day of the short period ~ An exception permits the final return of a decedent to be filed as though the decedent lived throughout the entire tax year. (return is not duen until april 15; ignoring ext of 6 month)
economic perf test
-is satisfied when product, serv has been actually provided - eco perf occurs in yr item is provided
accrual prepaid inc exception
-recognized when rcvd -exception to exception: ~ can defer recognition of prepayments for goods if taxpayer use the sam acg method for tax ret as the do for financial acg of books and rec ~prepaid exp can be defereed if pymt is for srvcs - must rec rev associated w/ srvc provided in yr 1 - remainder must be recognized in yr 2 whether or not srvc are provided.
% of completion
-taxpayer reports a percentage of the gross income from a long-term contract based on the portion of work that has been completed a. %- currnt cost/est tot cost b. portion of cont cost rep in given yr= % x contract price
anualization formula
1) Determine modified taxable income a. use itemized ded (stnd ded not allowed) b. personal exemp is prorated by % of year (#month/12) 2) modified inc x 12/#months= annual income 3) compute tax using tax rate sched 4)multiply tax by % of year (#months/12)= gross tax
5 things that do not need IRS approval in order to change accounting period
1) newly married person may change tax year to conform to spouses tax year so that a joint return may be filed -election must be made in first or second year after marriage date 2) change to 52 to :53 week year that ends with reference to the same calendar month in which the former tax year ended 3) tax returns filed in error using an accounting period Other than that on which their books are kept are not required to obtain permission to file returns for later years based on the way the books are kept 4) corporations that meets the four requirements -there has been no change in its accounting period Within the past 10 calendar years - the resulting year does not have an NOL - the taxable income for the resulting short text yr when annualized is at least 90% of the taxable income for the preceding full tax year - there is no change in status of the corporation such as S corporation election 5) partnerships may change tax yr w/o consent if the partners w/majority interest have the same tax yr of partnership o - if the principal partners change their tax years to the same tax year as partnership
when can a taxpayers tax ret be shorter than 12 months
1) when the taxpayer's first or final return is filed 2)and when the taxpayer changes accounting periods
Fiscal year definition
A 12 month period that ends on the last day of any month other than December ~ must coincide with the year used to keep the taxpayer's books and records ~calendar year must be used if taxpayer does not have books (strictly wage income) ~advantageous for seasonal year business owners
Section 444 election
Allows partnerships S corporation in personal service corporations to elect a taxable year that results in a tax deferral of 3 months or less
Individual tax year
Calendar year basis for almost all individuals
Improper filing election of tax year
Calendar year is automatically selected if tax returns are filed or not filed properly ~ thus losing chance to elect fiscal year
Changes in accounting period
Changes in tax election cannot be made unless approved by IRS ~must meet required business purposes established by IRS to be changed
computation of installment sale
Compute the gross profit from the sale. Selling price $xx,xxx Minus: Adjusted basis (x,xxx) Selling expenses (x,xxx) Depreciation recapture53 (x,xxx) Gross profit $ x,xxx steP 2: Determine the contract price. Contract price (greater of the gross profit from above or the selling price reduced by any existing mortgage assumed or acquired by the purchaser) $xx,xxx steP 3: Compute the gross profit percentage. Gross profit = Gross profit = xx%percentage Contract price steP 4: Compute the gain to be reported in the year of sale. Collections of principal received during year (exclusive of interest) $xx,xxx Plus: Excess mortgage (if any)a x,xxx Total $xx,xxx Times: Gross profit percentage × xx% Net gain recognized in year of sale $ x,xxx Plus: Depreciation recapture x,xxx Gain reported in year of sale $ x,xxx steP 5: Compute the gain to be reported in subsequent years. Collections of principal received $ x,xxx Times: Gross profit percent × xx% Gain reported in each of the subsequent years $ x,xxx a Mortgage − Basis − Selling expense − Depreciation recapture = Excess mortgage
Things not included in LT contracts
Contracts for services (architectural, accounting, legal, and so on) - property normally carried in finished goods inventory
Effects of accounting methods
Does not necessarily affect the amount of income however does affect the tax burden by either 1) accelerating deductions or deferring income recognition in order to postpone tax payments or 2) by saving taxes by spreading income over several accounting periods rather than having income bunch into
Accounting method used to compute taxable income and accounting method used to keep tax payers books and records
Generally Should be the same - and determines when a taxpayer should report their income an exp ~not whether they're reported
C corporation tax year
Have flexibility in choosing an accounting period -other than a personal service corp.
all events test
Income is reported when: -all events have occurred that allows the taxpayer to rcv the right to the item of inc and -amount can be reasonably estimated Exp are ded when: - all events have occured that provdes taxpayer w/a liability to pay -amount can be determined w/reasonable accuracy -exp can only be ded when eco perf test is met
2 test for accrual method used to determine when an item of income must be reported or an expense deducted:
all events test economic performance test
3 acg methods
cash receipts nd disbursements accrual hybrid -New taxpayers may generally choose any of the accounting methods listed above - methods do not have to be consistent in diff lines of biz and for non biz inc (dividends, etc)
how individuals report under cash method
do not have the same opportunity to determine the year in which income is recognized due to the constructive receipt rule ~ inc must be recognized when pymnt is available, even if pymt has not been rcvd
modified % of completion
election to defer reporting any income from a contract until they have incurred at least 10% of the estimated total cost
long term contract
include building, installation, construction, or manufacturing contracts that are not completed in the same tax year in which they began -manufacturing contracts are only LT contracts if mfg unique items (not nrom carried in finished good inv) that req more than 12 months for completion
Personal service corporation definition
incorporated medical practices and other businesses owned by individuals who provide their services through the corporation