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.