ACCT512 Exam 2

Why is the cash method usually preferred to the accrual​ method?

is simpler to use. It frees the taxpayer from having to make the​ year-end accruals associated with the accrual method.​ Also, it enables taxpayers to accelerate deductions by prepaying expenses.​ Similarly, earned income is not taxable until it is collected.​ Thus, the​ cash-method taxpayer does not have to report uncollected receivables.

What is the significance of the Thor Power Tool Co. ​decision?

The Regulations state that inventory methods used by a taxpayer must conform to the best accounting practice in the trade or business and it must clearly reflect income. In Thor Power Tool Co.​, the Supreme Court held that the clear reflection of income standard shall prevail in cases where the two standards conflict. Regulation Sec.​ 1.471-4(b) states that obsolete and other slow moving inventory cannot be written down unless the selling price is also reduced. Thor Power Tool Co.​ wrote-off the cost of obsolete inventory. The Supreme Court held this practice was not acceptable as it conflicted with the clear reflection of income requirement.

When is a final tax return due for an individual who uses a calendar year and who dies during the​ year?

The due date of the tax return does not change because of the​ taxpayer's death. Final returns are​ filed, and taxes are​ paid, as if they were returns for a​ 12-month period ending on the last day of the short period.

What impact does the gifting of an installment obligation have on the​ donor?

The gifting of an installment obligation is a taxable event. The donor must recognize gain equal to the difference between the face of the obligation and its adjusted basis.

Does the term method of accounting refer only to overall methods of​ accounting? Explain.

The term method of accounting is used to refer not only to overall methods of accounting but also the accounting treatment of any item. Examples of accounting methods for specific items include Sec. 174 relating to research and​ experimentation, Sec. 451 relating to​ long-term contracts, and Sec. 453 relating to installment sales.

How can the use of an accounting method affect the total amount of tax paid over​ time?

The use of an accounting method affects the total amount of tax paid over time because an accounting method determines when income is reported. This can change the total amount of tax paid because tax brackets differ over time.

An individual has increasing levels of income each year and is uncertain regarding the amount of his estimated taxable income for any given year. What tax planning strategy can be used to avoid the penalty for underpayment of estimated​ tax?

To avoid the estimated tax underpayment​ penalty, the taxpayer should make combined estimated payments and withholdings that are equal to or exceed the required percentage of the preceding​ year's tax liability. A taxpayer must prepay 100​% of the preceding​ year's tax liability if his AGI was $150,000 or less in the previous year. If the​ taxpayer's previous year AGI exceeded $150,000​, to avoid the​ penalty, for the current​ year, the taxpayer would need to prepay 110​% of his previous year tax liability.

Discuss the difference between a refundable tax credit and a nonrefundable tax credit. Give at least one example of each type of credit.

A refundable tax credit resembles a direct subsidy. Because it can fully offset an income tax liability and generate a tax​ refund, it is a type of negative income tax. A nonrefundable tax credit may only be used to offset the​ taxpayer's tax liability. If the credit exceeds the tax​ liability, the taxpayer receives no refund​ and, at​ best, can only carryback or carryforward the excess credit. The earned income credit is a refundable tax credit. Dependent care credits are nonrefundable credits.

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.

When is a cash method taxpayer allowed to deduct​ deposits?

A taxpayer cannot deduct a deposit as long as he has a right to receive a refund.

Does a​ taxpayer's accounting method affect the total amount of income reported over an extended time​ period?

Accounting methods generally affect when income is reported not whether it is reported.​ Thus, the total amount of income reported over time is not affected by a​ taxpayer's accounting method.

If a taxpayer changes the method of accounting used for financial reporting​ purposes, must the taxpayer also change his or her method of accounting for tax​ purposes?

Although the answer is not​ clear, it would seem to be no. Book and tax accounting methods must be the​ same, but the term​ "books" seems to include a supplemental reconciliation of income.​ Hence, if the two methods are​ reconciled, a taxpayer is presumably complying with the requirement.

Why would an individual claim fewer​ allowances?

An individual might claim fewer allowances to increase the amount of tax​ withheld, if they anticipate that taxes will be owed at the end of the year and they do not wish to make quarterly estimated tax payments. For​ example, this situation occurs for taxpayers earning both wage and nonwage income.

Under what conditions is a taxpayer required to annualize​ income?

Annualization is required when a change in the accounting period occurs.

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 $26 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.

What is meant by economic​ performance?

Economic performance of services or property to be provided to a taxpayer occurs when the property or the services is actually provided by the other party. If a taxpayer is obligated to provide property or​ services, economic performance occurs in the year the taxpayer provides the property or service.

What treatment is given to an installment sale involving related​ people?

In a case of an installment sale where the property is resold by the related​ purchaser, the first seller is required to treat amounts received by the related person as having been received personally. The acceleration provision is applicable only if the resale takes place within two years after the initial sale to the related party.Installment sales to related persons are generally subject to the same rules as other installment sales except when the property is resold by the related purchaser.

What is the impact of having the entire gain on an installment sale consist of ordinary income from depreciation​ recapture?

In​ effect, the installment sale method is not available because the entire amount of ordinary income must be reported in the year of the sale.

What other restrictions apply to taxpayers who are choosing an overall tax accounting​ method?

In​ general, other taxpayers may choose any accounting method they want.​ This, of​ course, assumes that the method chosen clearly reflects income.

​Jane's estimated tax payments for the current year total​ $14,000, and federal income taxes withheld from her salary amount to​ $12,000. Jane's actual tax liability for the current year is​ $30,000. Her income was earned evenly throughout the current year.​ Jane's AGI for the prior year was​ $160,000 and her tax liability was​ $25,000.

Jane is subject to the underpayment penalty because her​ $26,000 in current year prepayments are less than both​ 110% of last​ year's tax liability and​ 90% of this​ year's tax liability. She must meet the​ 110% exception because her prior year AGI was more than​ $150,000.

Zap Company manufactures computer hard drives. The cost of hard drives has been declining for years. Sales totaled​ $4,000,000 last year.​ Zap's ending inventory was valued at​ $300,000 under FIFO. The​ company's new president is trying to cut taxes and asks you whether the company should switch to LIFO. What do you​ recommend?

LIFO is undesirable because it will​ lock-in older, higher costing inventory layers. If the company is not doing so​ now, it might consider electing the​ "lower of cost or​ market" in conjunction with FIFO. This would enable the company to write down inventory on hand as prices are lowered.

How are overhead costs treated in determining a manufacturing​ company's inventory?

Manufacturing overhead​ (such as factory repairs and​ maintenance, utilities, rent and other costs relating to the manufacturing​ process) must be included in inventory. Other overhead costs​ (such as employee benefits and factory​ administration) must also be included in inventory unless they relate to the nonmanufacturing areas such as selling or advertising.

Why are most taxpayers not subject to the alternative minimum tax​ (AMT)?

Most taxpayers do not have substantial tax preferences and AMT adjustments. there is a generous exemption amount to reduce the tax base on which the AMT is calculated.

Does the AMT apply if an​ individual's tax liability as computed under the AMT rules is less than his or her regular tax​ amount?

No

Are these rules the same as for financial​ accounting? If​ not, explain.

No. Financial accounting does not require retailers to include​ purchasing, warehousing,​ packaging, and related administrative costs in inventory. Financial accounting rules have not required manufacturers to inventory employee benefits and certain administration costs that must now be included in inventory for tax purposes.​ Similarly, financial accounting rules do not require that interest be added to the cost of inventory with​ long-term production periods.

Why is it desirable for a new taxpayer to select an appropriate tax​ year?

Once a tax year is​ elected, it normally cannot be changed without IRS approval. The appropriate tax year can make record keeping easier. If the year ends during the slow​ season, inventories may be lower and employees are available to take inventory and perform other accounting duties associated with the year end.

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 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. Payment can be by check that is honored in due course.

If an employer fails to withhold federal income taxes and FICA taxes on wages or fails to make payment to the​ IRS, what adverse tax consequences may​ result? May corporate officers or other corporate officials be held responsible for the​ underpayment?

Penalties are imposed if an employer fails to withhold federal payroll tax and income tax and pay them to the IRS. Corporate​ officers, directors, and other officials may also be held personally liable for payment of the tax.

Do retailers have a similar​ rule?

Retailers whose average gross receipts for the three preceding years exceeds $26 million must include in inventory a portion of​ purchasing, warehousing,​ packaging, and related administrative costs.

What changes in accounting method can be made without IRS​ approval?

Taxpayers may elect to change to the LIFO inventory method without IRS approval.

Is it correct to say that businesses with inventories must use the accrual​ method?

Taxpayers may use the cash method as long as average gross receipts do not exceed $26 million for the prior three years. If receipts exceed the​ threshold, taxpayers with inventories are required to use the accrual method for sales and cost of sales. This is not a requirement that they use the accrual method for other items on their returns.

What is the primary impact of the imputed interest rules on installment​ sales?

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. The imputed interest rules may convert a favorably taxed capital gain into​ interest, which is taxed at ordinary rates.

What conditions must be met in order to use the installment​ method?

The installment sales method is applicable only to transactions involving gains where at least one payment is to be received after the close of the taxable year in which the disposition occurs. It may not be used in connection with the sale of publicly traded property or inventory.

Explain the purpose of the​ four-year method used in computing the tax resulting from a net adjustment due to a change in accounting methods.

The purpose is to spread the amount of the change over four years in order to reduce the immediate impact on taxes. The additional tax​ (or tax​ reduction) is spread over the current year and the subsequent three years.

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.

​Tony, who is single and 58 years​ old, is considering early retirement from his salaried job. He currently has $90,000 salary and also earns $60,000 profit from a consulting business. What advice would you give Tony relative to the need to make Social Security tax payments if he retires and continues to be actively engaged as a consultant during his​ retirement?

Tony will be required to pay FICA taxes on wages and net​ self-employment (SE) earnings ​(92.35​%×SE​ earnings). The Social Security portion of FICA taxes ​(6.2​% on wages and 12.4​% on net SE​earnings) applies up to the $132,900 ceiling. The Medicare portion of FICA taxes (1.45​% on wages and 2.9​% on net SE​ earnings) applies to all earnings without a ceiling.​ Tony's net SE earnings equal $55,410 (92.35​%×$60,000​). If Tony continues as an​ employee, the Social Security portion of FICA will be imposed on his salary of $90,000 and on $42,900 ($132,900-$90,000)bof his net SE earnings. The Medicare portion will be imposed on all earnings. If Tony retires from his​ job, the Social Security portion of FICA will be imposed on his net SE earnings and the Medicare portion will be imposed on his net SE earnings.

Is it possible for Virginia to claim more than five withholding​ allowances?

Virginia can claim more than five withholding allowances in a tax year if she has larger than average deductible expenses​ (for example, mortgage interest expenses on a​ newly-financed house) relative to the average for a family of​ Virginia's income amount.

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.