R1_M3:Gross Income : Part 2.
net business income is taxable. There are two taxes on net business income.
(1). income tax. (2). federal self-employment [SE] tax.
Uniform capitalization rules apply to the following: (1) real or tangible personal property produced by the taxpayer for use in his or her trade or business;
(2) real or tangible personal property produced by the taxpayer for sale to his or her customers; and (3) real or tangible personal property acquired by the taxpayer for resale, provided the taxpayer's annual average gross receipts for the preceding three years exceeds $10,000,000.
☐ accrual method. (1). the accrual method is required for certain corporate and partnership farmers as well as for all farming tax shelters.
(2). inventories must be used and maintained, and they must be taken at the start and end of the tax year. The following methods of inventory valuation for farming are accepted by the IRS:
☐ cash basis. (1). most farmers use the cash basis. (2). inventories of produce, livestock, etc., are not considered. (3). gross income includes cash and the value of all other items received from the sale of produce, livestock, etc., that has been raised by the farmer.
(4). for livestock or other items a farmer may have bought, profit is computed by subtracting the purchase price [cost] from the sale price. (5). insurance payments from crop damage are treated as income. (6). interest paid on a loan used for the farming business is deductible.
☐ personal portion of: (1). automobile, travel, and vacation expenses. (2). personal meals and entertainment expenses: 100 percent of country club dues are nondeductible. (3). interest expense: this may be reported as an itemized deduction if mortgage interest or investment interest is paid.
(4). state and local tax expense: report as an itemized deduction on schedule A. (5). health insurance of a sole proprietor: although this is not reported on Schedule C as an expense, it is reported as an adjustment to arrive at AGI.
Rule: If foreign travel is primarily personal in nature (e.g., a vacation), none of the travel expenses
(e.g., round-trip airfare) incurred will be allowable business deductions, even if the taxpayer was involved in business activities while in the foreign country.
Warehousing costs incurred by a manufacturing company (making inventory for sale to its customers) are subject to the Uniform Capitalization Rules. Further, they are the only item on the list that is real or tangible personal property. In this case, the inventory is not acquired for resale
(it is produced by the taxpayer for sale to his or her customers), so the fact that the annual sales are $12,000,000 does not matter in this case. The sales could have been less than $10,000,000 annually, and the Uniform Capitalization Rules would still have applied.
Rule: The uniform capitalization rules apply to the following: 1. Real or tangible personal property produced by the taxpayer for use in a trade or business. 2. Real or tangible personal property produced by the taxpayer for sale to customers.
3. Real or personal property acquired by the taxpayer for resale. 4. However, the uniform capitalization rules do not apply to property acquired for resale if the taxpayer's annual gross receipts for the preceding three tax years do not exceed $10,000,000 (not $2 million).
Rental Income or Loss
= passive activity [Schedule E].
Long-Term Contracts. Special tax rules are required of most taxpayers who operate under long-term contracts [exceptions exist].
A long-term contract is generally defined as a contract that is incomplete at the end of a tax year in which it was started [i.e., it does not start and finish within the same tax year] and relates to the manufacture, installation, building, or construction of real or personal property.
Nonresidence [Rental Property]. for rental property, the taxpayer includes income received from the property in gross income and deducts all expenses allocated to the rental property on Schedule E of Form 1040.
As discussed later in this unit, rental losses are considered passive and will be deductible only to the extent of passive income. An exception to this rule allows an active participation in rental activity to deduct up to $25,000 of rental losses against non-passive income.
Vacation Home Rental. Julie rents her vacation home for two months and lives there for one month [during the other 11 months, Julie lives in the city]. Thus , of the three-month period the vacation home is used, one-third is personal and two-thirds is rental.
Assume that Julie's gross rental income is $6,000, her real estate taxes are $2,400, interest is $3,600, utilities are $4,800, and related depreciation is $7,200.
Rental [Schedule E]. Gross rental income $6,000. Less: $1,000 from 2/12 of taxes: $2,400 and interest: $3,600. = $5,000 [reported in schedule A].
Balance: $5,000 Less: $3,200 from 2/3 of utilities: $4,800. Less $1,800 from 2/3 of depreciation $7,200 [limited to $1,800]. = $0 The additional $3,000 from depreciation [$4,800 - $1,800] is not deductible, but is carried over to next year and applied against future income from this property.
Deductions to arrive at net self-employed income include all necessary and ordinary expenses connected with the business. Estimated federal income tax payments are not an expense.
Charitable contributions by an individual are only deductible as an itemized deduction on Schedule A. This assumes the contribution was not made with the "expectation of commensurate financial return."
Cash basis taxpayers deduct interest in the year paid or the year to which the interest relates, whichever is later. Even though all of the interest on this loan was paid on
December 1, of the current year, only the interest relating to December of the current year can be deducted in the current year.
☐ change in accounting method= IRS permission required. the method used by a taxpayer for the income recognition on a contract is deemed a "method of accounting" by the IRS and cannot be changed for the contract without consent of the IRS.
Furthermore, if a taxpayer desires to sever a contract into various contracts or aggregates several contracts into one larger contract, IRS approval is generally required, and a statement explaining the changes must be attached to the original tax return for the year.
Business Income or Loss, Schedule C or C-EZ. Net income from self-employment is computed on Schedule C. The net income from the sole proprietorship is then transferred to Form 1040 as one amount.
Gross business income [Less] Business expenses [self-employed] = Profit or loss.
Rental activity is reported on Schedule E. because rental income is usually regarded as passive. The basic formula for the determination of net rental income or loss is as follows:
Gross rental income Add: prepaid rental income [nonrefundable deposits] Add: rent cancellation payment Add: improvement-in-lieu of rent [At FMV] less: Rental expenses. = net rental income or net rental loss.
☐ acquired for resale: real or tangible personal property acquired by the taxpayer for resale [i.e., retailer's inventory].
However, the uniform capitalization rules do not apply to [inventory] property acquired for resale if the taxpayer's average gross receipts for the preceding three tax years do not exceed $10,000,000 annually.
Rule: The basic formula for determination of net rental income or loss follows: Gross rental income add: Prepaid rental income add: Rent cancellation payments add: Improvements in lieu of rent Less: Rental expenses. = Net rental income (loss)
If security deposits are held separately and not available to be applied to last month's rent (as in a segregated account), they are a liability of the taxpayer and not included in income in the year received.
In order to deduct the net operating loss in the future, the taxpayer must generate taxable income in the future.
If the taxpayer expects net operating losses in the future, the taxpayer will not be able to deduct the existing net operating loss carried forward.
Solution: Option A: $100,000 Income This Year $100,000 Income x 30% Marginal Tax Rate = 30,000 Tax on Income x 1.00 Discount Factor = $30,000 Present Value of Tax Savings.
Income After Tax: $100,000 Before-tax Income Less: 30,000 Present value of tax = $70,000 income after tax.
Compare the after-tax effect of Jill's $100,000 sale: Option A: 100,000 Income This Year: Income: $100,000 x 30% of Marginal tax rate = Tax on income $30,000 x 1.00 discount factor = $30,000 present value of tax.
Income after tax: $100,000 Before-tax income Less: present value of tax $30,000 = $70,000 Income after tax.
Farming Gross Profit Calculation. Facts: Evan has a farming business, and is required to use the accrual method. During Year 3 Evan has net sales of $75,000. Inventory at the beginning of Year 3 was $15,600 including livestock held for resale.
Inventory at the end of the year was $14,200. Inventory purchases during Year , 3 including livestock, amounted to $60,000. Required: Determine Evan's farming gross profit.
Note: It does not appear that the examiners are attempting to trick candidates on the classification of the business expenses as travel or educational.
It appears that the purpose of the question is to test the candidate's ability to recognize when expenses are deductible and when they are not deductible business expenses.
Option A offers
Jill the lowest after-tax cost of equipment.
Schedule E [Reporting of Supplemental Income and Loss]. (2)
K-1S
Farming Gross Profit Calculation. Solution: Evan's gross profit for Year 3 is $13,600, calculated as follows:
Net sales $75,000 + Ending Inventory $14,200 [Less] Beginning Inventory $15,600 [Less] Inventory purchases $60,000 = $13,600
☐ cost allocation rules required for tax on long-term construction contracts: Essentially, the uniform capitalization rules discussed previously apply to long-term contracts.
Note that costs associated with marketing, advertising, selling, and research and development are not subject to such cost allocation [capitalization].
Option B: $100,000 Income Next year: $100,000 income x 30% Marginal Tax Rate = $30,000 tax on income x 0.909 discount factor. =Present value of tax $27,270 Income after tax: $100,000 Before-tax income Less: Present value of tax $27,270 = $72,730 income after tax.
Option B to defer the $100,000 income to next year results in $2,730 in additional income after tax, considering the time value of money since the present value of tax paid one year later is lower than if the tax is paid in the current year.
Option A: Purchase $20,000 Equipment This Year: $20,000 Tax Deduction x 30% of Marginal tax rate = 6,000 Tax Savings x 1.00 discount factor = $6,000 present value of tax savings. After-Tax Cost of Equipment: $20,000 Before-tax cost Less: present value of tax $6,000 = $14,000 after-tax cost.
Option B: Purchase $20,000 Equipment Next Year: $20,000 Tax Deduction x 30% of Marginal tax rate = 6,000 Tax Savings x 0.909 discount factor = $5,454 present value of tax savings. After-Tax Cost of Equipment: $20,000 Before-tax cost Less: present value of tax $5,454. = $14,546 after-tax cost.
Option A: Purchase $20,000 Equipment This Year: $20,000 Tax Deduction x 30% of Marginal tax rate = 6,000 Tax Savings x 1.00 discount factor = $6,000 present value of tax savings. After-Tax Cost of Equipment: $20,000 Before-tax cost Less: present value of tax $6,000 = $14,000 after-tax cost.
Option B: Purchase $20,000 Equipment Next Year: $20,000 Tax Deduction x 35% of Marginal tax rate = 7,000 Tax Savings x 0.909 discount factor = $6,363 present value of tax savings. After-Tax Cost of Equipment: $20,000 Before-tax cost Less: present value of tax $6,363. = $13,637 after-tax cost.
Section B-Long Schedule SE
Part I: self-employment tax. Part II: Optional Methods to Figure Net Earnings.
Timing of Income [With Increasing Tax Rates]. Facts: Using the example above, assume that Jill's marginal tax rate is 30 percent this year but will increase to 31 percent next year under tax law.
Required: Advise Jill on whether it is optimal for the sale to be made in the current year on December 31 or next year on January 1.
Farming Deduction. Facts: Bob is a cash basis sole proprietor farmer. During Year 2, Bob spends $2,100 on feed for the livestock.
Required: Determine how much Bob can deduct in Year 2 related to feed for the livestock. Solution: Bob may deduct the entire $2,100 on his Year 2 income tax return, because he is not required to consider inventory.
Calculation of Self-Employment Tax. Facts: Tyler earns $20,000 from his consulting business, which he runs as a sole proprietorship. this was the only income he had in the current year.
Required: determine Tyler's self-employment tax. Solution: Tyler's self-employment tax is $2,826 calculated as follows: $20,000 x 92.35% = $18,470. $18,470 x 15.3% = $2,826.
Timing of Deductions [With Increasing Tax Rates]. Facts: Use the same facts as above, but now assume that Jill expects that her business income will rise when the use of the new equipment. therefore, her marginal tax rate will increase from 30 percent in the current year to 35 percent next year.
Required: determine which year Jill should purchase the equipment to provide the lowest after-tax cost.
A rule of thumb is that personal expenses are not allowed as deductions on the Schedule C. For instance, personal use of an automobile is considered a personal expense, not a deductible expense on Schedule C.
Schedule C items should be only those related to the operation of the business itself. Health insurance for himself and his family is actually an adjustment to arrive at adjusted gross income.
Schedule E [Reporting of Supplemental Income and Loss].
Schedule E [Form 1040]
Farm Income Averaging. In current year, a farmer had a bountiful crop, and the income from his farming business increased significantly in Year 2 as compared with Year 1.
The increased farming income resulted in the farmer being taxed at a higher rate than in the past three years. The farmer can elect to average some or all of the current year's income over the past three years.
Guaranteed payments are reasonable compensation paid to a partner for services rendered (or use of capital) without regard to his ratio of income. Earned compensation is subject to self-employment tax. Payments not guaranteed are merely another way to distribute partnership profits.
The ordinary income reported from an S corporation is taxable income to the individual or their own individual tax return but is not subject to self-employment tax. The ordinary income reported from a partnership may be subject to self-employment tax (if to a general partner).
However, if tax rates in the future will be higher than they were in the carryback years, the benefit from deducting the loss in the future will be larger than the refund obtained by carrying the loss back to the past.
Thus, in that situation, the taxpayer should elect to forgo the carryback and instead carry the net operating loss forward.
Tax Planning. Understanding the implications of the timing of income and deductions is an effective tool for maximizing the after-tax wealth of a taxpayer.
Using the time value of money principles, a taxpayer can evaluate the effect of the timing of a tax decision. The two basis tax strategies, assuming that the taxpayer's tax rate remains constant, are to: (1). defer taxable income. (2). accelerated tax deductions.
Absent any special election, a net operating loss is carried back two years and then forward 20 years. However, taxpayers can elect to forgo the two-year carryback period and just carry the loss forward for 20 years.
Usually, taxpayers do not make this election because taxpayers would rather get the cash refund resulting from carrying back the loss than wait for the benefit of a lower tax in the future resulting from carrying the loss forward.
☐ percentage-of-completion method required for tax for nonexempt long-term contracts. Unless an exemption exists for a taxpayer or a contract, long-term contracts must be accounted for using the percentage-of-completion method to determine taxable income for a particular contract.
[Note that a taxpayer may use other methods for other contracts if an exemption exists; thus, contracts are evaluated on a contract-by-contract basis].
☐ exemptions. Certain contracts are exempt from the requirements of long-term contract income recognition for tax purposes and may use other methods
[e.g., completed contract method] to calculate their taxable income under the contract for regular income tax purposes. These include: ☐ small Contractors: ☐ Home Construction contractors:
☐ small Contracts:
[projects that are expected to last no more than two years and are performed by a taxpayer who has average annual gross receipts not exceeding $10 million for the three years that precede the tax year in question].
☐ Home Construction contractors:
[where at least 80 percent of the total contract costs are related to the construction or rehabilitation of certain dwelling units, which do not include hotels, etc., where the majority of the use is on a transient basis].
Farming Income: Schedule F. a person [or entity] who engages in the management or operation of a farm with the intent of earning a profit will report income and expenses [either cash or accrual basis] using a Schedule F
[which carries to the face of Form 1040, like 18, in the same way that net income reported on a Schedule C carries to Form 1040 on line 12]. essentially, income from farming activities is treated the same as income from other business activities.
Solution: Option B: $100,000 Income Next Year $100,000 Income x 31% Marginal Tax Rate = 31,000 Tax on Income x 0.909 Discount Factor = $28,179 Present Value of Tax Savings. Income After Tax: $100,000 Before-tax Income Less: 28,179 Present value of tax = $71,821 income after tax.
although Option B is still more attractive, the increase in taxable income is only $1,821. A taxpayer must evaluate the specific facts and circumstances in his or her tax situation to effectively understanding the timing effects of taxable income.
Timing of Income [with constant tax rates]. Facts: Jill Jones owns a small retail business. Jill is a cash-based, calendar-year taxpayer. she reports her income and expenses related to the business on Schedule C. Jill has the opportunity to make an unusually large sale in the amount of $100,000
and is trying to determine the best tax strategy regarding the timing of the sale. She can finalize the sale and receiving payment on either December 31 of the current year or January 1 of the next year. Jill's marginal tax rate is 30 percent in both tax years.
☐ rented 15 or more days. if the residence is rented for 15 days or more days, and is used for personal purposes for the greater of (i) more than 14 days or (ii) more than 10 percent of the rental days, it is treated as a personal / rental residence. expenses must be prorated between personal
and rental use. However, a different proration method is used for mortgage interest and property taxes than is used for other property-related expenses [e.g., utilities, insurance, depreciation, etc.] rental use expenses are deductible only to the extent of rental income. No rental loss allowed.
☐ exemptions: Small contractor and home construction contractors are not required to employ the costs allocation rules identified above. However, (i) they are required to allocate production period interest related to the contract to the costs of the project; and (ii) home construction projects that
are not also small constructions projects must use the uniform capitalization rules. also, interest for the production period need not be capitalized if the total cost of the project is $1 million or less and the project is estimated to take less than 12 months to complete.
☐ "unique" rules for personal property contracts. in order for the manufacture of personal property ot qualify as a long-term contract, not only must the contract not be completed within the year it was started,
but it also must be for the manufacture of a "unique" item [i.e., an item that is made specifically for a customer and could not be sold to others, is not generally part of a taxpayer's normal inventory, and requires significant preproduction costs].
If the taxpayer expects low tax rates in the future, carrying the net operating loss to the carryback years will result in a larger refund than the tax savings obtained
by carrying the net operating loss forward (assuming that the tax rates in the carryback years are higher than the tax rates expected in the future).
Costs Required to Be Capitalized. Costs required to be capitalized include direct materials, direct labor [e.g., compensation, vacation pay, and payroll taxes], and applicable indirect costs [i.e., those to which an allocation must be applied, such as factory overhead].e.g., of applicable indirect
costs [capitalizable expenses] include utilities, warehousing costs, repairs, maintenance, indirect labor [e.g., supervisory], rents, storage, depreciation and amortization, insurance, pension contributions, engineering and design, repackaging, spoilage and scrap, and administrative supplies.
Costs Not Required to be Capitalized = Period expense.
costs not required to be capitalized include selling, advertising, and marketing expenses, certain general and administrative expenses, research, and officer compensation not attributed to production services.
Farm Income Averaging. Taxpayers with a qualifying farming business may be able to average some or all of the current year's farm income by spreading it out over the past three years. Farm income averaging provides farmers the opportunity to lower their tax liability
during a year in which they earn a significantly higher income than in the previous three years. An individual is not required to have been engaged in a farming business in any of the base years in order to make a farm income averaging election. Schedule J is used for averaging farming income.
☐ start date. for cash basis taxpayers, the starting date of production is generally the date on which the contractor incurs costs [other than the start-up engineering, design, etc., costs that are excluded from cost allocation, as discussed above] under the contract.
for accrual basis taxpayers, the starting date is the later of the date for cash basis taxpayers or the date the taxpayer has incurred at least 5 percent of the total costs initially estimated under the contract.
The uniform capitalization rules do not apply to inventory acquired for resale
if the taxpayer's average gross receipts for the preceding three tax years do not exceed $10,000,000.
with a rising tax rate next year, Option B now offers the lowest after-tax cost of the equipment. Many factors must be considered in determining the timing of income and deductions for a taxpayer.
in a changing tax environment, the facts and circumstances unique to the taxpayer must be evaluated. the examples above illustrate the effect of properly timing income and deductions to increase the after-tax wealth of a taxpayer.
☐ cost allocation rules required for tax on long-term construction contracts: Unless an exemption exists for a taxpayer or a contract, those involved in long-term contracts must use cost allocation rules to account for their long-term projects.
in addition to all the direct costs associated with a project, other costs that relate to the activities of the long-term contract [e.g., storage costs, production period interest, pension plan contributions, etc.]must be allocated to the cost of the long-term project.
The uniform capitalization rules [inventory]: apply to all business enterprises that meet the criteria for implementation [including sole proprietorships, partnerships, and corporations] and provide guidelines with respect to capitalizing or expensing certain costs [i.e.,taxes paid
in connection with the acquisition of property are capitalized as part of the property's cost]. in the first year of implementation, they generally cause an increase in the carrying cost of ending inventory and a decrease in operating expense. This results in an increase to taxable income.
Direct material, direct labor, and factory overhead (applicable indirect costs) are capitalized with respect to inventory under the uniform capitalization rules for property acquired for resale. Applicable indirect costs include depreciation and amortization,
insurance, supervisory wages, utilities, spoilage and scrap, design expenses, repair and maintenance and rental of equipment and facilities (including offsite storage), some administrative costs, costs of bonus and other incentive plans, and indirect supplies and other materials (including repackaging costs).
☐ gross income recognition calculation. To calculate the amount of income that will be recognized under the contract for a given tax year,
multiply the ratio determined using the cost-to-cost method [above] by the total contract price and subtract the amount of income that was recognized in prior years for the contract.
☐ related parties. A taxpayer who performs an activity that would normally not be considered a long-term contract activity [such as engineering or design services]
must report income using the percentage-of-completion method if it is incidental to or necessary to a related party's long-term contract that must be reported using the percentage-of-completion method.
[for all examples that follow, assume an after-tax rate of return on investments of 10% for present value analysis.the present value factor for one year at 10 percent is .909.] Required: advise Jill on whether it is optimal for the sale to be made in the current year on December 31 or next year
on January 1. Solution: if Jill finalizes the sale and receives payment on December 31 of this year, she will have to report the $100,000 of income on this year's tax return. However, if she waits to finalize the sale on January 1, then she will have income one year later on next year's tax return.
☐ produced for sale:
real or tangible personal property produced by the taxpayer for sale to his or her customers [i.e., manufacturer's inventory].
☐ produced for use:
real or tangible personal property produced by the taxpayer for use in his or her trade or business [e.g., machine tools for use in the production line of a machine tool manufacturer].
Impact on alternative minimum tax [AMT]. ☐ even if the percentage-of-completion method is used for differences in the calculation of taxable income
regular tax purposes, there are likely to be because the calculation of alternative minimum taxable income must take into account not only the method of income recognition, but also other alternative minimum tax rules [e.g., depreciation methods].
Business expenses include work uniforms for the taxpayer and taxpayer's employees,
subscriptions for periodicals for patient use, and continuing education expenses.
(2). inventories must be used and maintained, and they must be taken at the start and end of the tax year. The following methods of inventory valuation for farming are accepted by the IRS: (a). cost. (b). lower of cost or market. (c). farm-price method [inventory is valued at the market price less
the disposition costs and generally must be used for all items inventoried by the farming business, except for any livestock valued using the unit-livestock-price method]. (d). unit-livestock-price method [uses a value for each livestock class at a standard unit price for animals within the class].
☐ end date.
the end date of the production period is generally the date on which the work under the contract is complete [per contract provisions] or on the date the taxpayer has incurred at least 95 percent of the total costs expected under the contract.
☐ rented fewer than 15 days. if the residence is rented for fewer than 15 days per year, it is treated as a personal residence.
the rental income is excluded from income, and mortgage interest [first or second home] and real estate taxes are allowed as itemized deductions. Depreciation, utilities, and repairs are not deductible.
However, important tax factors may change from year to year in a dynamic tax environment. these changes may be a result of a change in tax law or a change in the taxpayer's personal situation, such as retirement or opening a new business.
therefore, many other factors must be considered for tax planning. These include: ☐ type of income. ☐ changing tax rates. ☐ type of entity. ☐ taxpayer's filing status.
☐ cost-to-cost method [to determine percentage]. the percentage is calculated under the cost-to-cost method, which is a ratio of the total cumulative costs incurred to date at the end of the tax year divided by the total expected costs to be incurred under the contract.
this ratio provides a total "percent-complete" amount for the contract as of the end of the tax year.
Timing of Deductions [With Constant Tax Rates]. Accelerate Tax Deduction. Facts: Jill is planning to purchase new equipment for her retail business that costs $20,000. Jill is considering whether to purchase the equipment this year and therefore deduct the cost of the equipment on
this year's tax return or purchase the equipment next year and deduct the cost of the equipment on next year's tax return. Jill's marginal tax rate is 30 percent. Required: Determine which year Jill should purchase the equipment to provide the lowest after-tax cost.
Net Taxable Loss. A business with a loss may deduct the loss against other sources of income. When the loss exceeds these amounts, the excess net operating loss is permitted as a carryover [at taxpayer's election, it may be used as a carryforward only]:
☐ 2-year carryback. ☐ 20-year carryforward.
Expenses include items that one would expect to find in business, such as: ☐ interest expense on business loans [interest expense paid in advance by a cash basis taxpayer cannot be deducted until the tax year/ period to which the interest relates]. ☐ state and local business taxes paid.
☐ Business meal and entertainment expenses at 50 percent [when all proceeds go to benefit a charity; 100 percent may be deductible as an itemized deduction for charitable contributions]. ☐ office expenses [e.g., supplies, equipment, and rent]. ☐ depreciation of business assets.
Gross Income. Items that normally would be revenue in a trade or business or other self-employed activity [such as director or consulting fees] are included as part of gross income on Schedule C.
☐ Cash = amount received [cash basis]. ☐ property = fair market value. ☐ cancellation of debt.
Expenses include items that one would expect to find in business, such as: ☐ salaries and commissions paid to others. ☐ bad debts actually written off for an accrual basis taxpayer only [the direct write-off method, not the allowance method, is used for tax purposes.]
☐ actual automobile expenses [depreciation expense is limited to only that portion used for business] or a standard mileage rate [53.5 cents per mile for 2017]. ☐ employee benefits. ☐ legal and professional services. ☐ cost of goods [inventory is expensed when sold].
Miscellaneous Effects:
☐ change in accounting method. ☐ "unique" rules for personal property contracts. ☐ related parties.
Cost Allocation Rules:
☐ cost allocation rules required for tax on long-term construction contracts. ☐ exemptions.
Calculation for percentage-of-completion method income recognition. in simple terms, the amount of gross income under the contract that is recognized on the tax return is the portion of income that relates to the percentage of the contract that has been completed during the year.
☐ cost-to-cost method [to determine percentage]. ☐ gross income recognition calculation.
Nondeductible Expenses [on schedule C]. ☐ salaries paid to the sole proprietor [they are considered a "draw"].
☐ federal income tax. ☐ personal portion of: ☐ bad debt expense of a cash basis taxpayer [who never reported the income]. ☐ charitable contributions: report as an itemized deduction on schedule A.
Cash basis and accrual method: ☐ cash basis. ☐ accrual method.
☐ gross profit equals the value of inventories at year-end plus the proceeds received from the sales during the year, less the value of inventories at the beginning of the year, less the cost of inventory purchased during the year.
Income Recognition:
☐ percentage-of-completion method required for tax for nonexempt long-term contracts. ☐ exemptions.
Types of Property. Uniform capitalization rules apply to the following:
☐ produced for use: ☐ produced for sale: ☐ acquired for resale:
Rental of Residence = Home
☐ rented fewer than 15 days. ☐ rented 15 or more days.
Production Period Defined:
☐ start date. ☐ end date.
(2). federal self-employment [SE] tax. ☐ up to $127,200 in 2017 is subject to the 12.4 percent Social security tax [i.e., a total of 15.3 percent on self-employment earnings up to $127,200 in 2017].
☐ the actual SE tax is calculated on 92.35 percent of self-employment income.
Impact on alternative minimum tax [AMT]. The details of alternative minimum tax are presented when the calculation of tax liability is discussed in more detail. Certain items should be noted with regard to the effects from long-term contracts.
☐ the percentage-of-completion method is required to be used for alternative minimum taxation, regardless of the method used for regular tax [except for home construction contracts].
(2). federal self-employment [SE] tax. ☐ an adjustment to income is allowed for one-half [which is 7.65 of up to $127,200 of self-employment income in 2017 plus 1.45 percent of self-employment income thereafter, if applicable] of SE tax [Medicare plus Social Security] paid.
☐ this allows the sole proprietor the ability to "deduct" the employer portion of the SE tax as an adjustment to gross taxable income [of which the net schedule C amount is a part]. ☐ all self-employment income is subject to the 2.9 percent Medicare tax.
