11-Accounting Periods And Methods
A change in accounting methods usually results in
duplications or omissions of items of income or expense
Why? Cost of sale is
higher
In limited instances (explained below), taxpayers may use
the completed contract method.
Thus, a department store might create separate pools for
tools, appliances, clothing, furniture, and other products.
The Adjusted Basis Of The Installment Obligations Can Be Calculated As Follows:
Face Amount X (100% - Gross Profit Percentage)
The Restrictions On The Completed Contract Method are
Increasing Over Time
Most ___________________________________________________________________________use the cash receipts and disbursements method of accounting.
Individuals and small and medium sized businesses
Annual Accounting Periods are used to
Measure Taxable Income
Annualization Starts With
Modified Taxable Income for the Short Period Utilizing Itemized Deductions ONLY
Gift Loans
Money may not be pay back
[ Required Payments and Fiscal Years ] As Calendar Year Tax Years are Required For
More Entities
[ Reporting The Amount Of The Change ] The net amount of the change
Must be taken into account
A change of accounting methods should
NOT be confused with the correction of an error.
[ DEFERRED PAYMENT SALES ] The installment sale rules are
Not applicable to all sales involving future payments.
For the class purposes and tax purposes
Replacement Cost
IRS Approval Is Generally
Required To Change Accounting Methods
The resulting interest income is
Taxable to the lender
[ Accrual Method - Accrual Basis Taxpayers ] Report Income And Deduct Expenses Under
The All-Events Test And Economic Performance Tests
Taxpayers who do not have books (e.g., an individual with wage income) must use
The calendar year.
CASH RECEIPTS AND DISBURSEMENTS METHOD Most individuals and small and medium sized businesses use
The cash receipts and disbursements method of accounting.
A manufacturing contract is long-term only if
The contract involves the manufacture of either a unique item not normally carried in finished goods inventory -OR- The items that normally require more than 12 calendar months to complete.
Taxpayers who value inventory at cost may
Write down goods that are not salable at their normal price (e.g., damaged, obsolete, or shopworn goods) -------> ONLY after the selling price has been reduced.
Taxable income is computed on the basis of
the taxpayer's annual accounting period Which is ordinarily 12 months (either a calendar year or a fiscal year).
These "special rules" permit taxpayers to report income from
this type of transaction when they have the wherewithal to pay the tax (i.e., the year in which payment is received).
In Cases Where IRS Approval MUST Be Obtained, The Taxpayer MUST Establish
A Substantial Business Purpose (Non-Tax) for the proposed Accounting Period Change
Under Certain Conditions Partnerships, S Corporations And Personal Service Corporations May Elect
A Taxable Year that Results In A Deferral Of Three Months Or Less ----> SEC, 144 ELECTION
An installment sale is
Any disposition of property where at least one payment is received after the close of the taxable year in which the disposition occurs.
In such situations, the installment method is of little use because
Any gain on the sale is covered by Sec. 1245.
A manufacturer may use standard costs to value inventory if
Any significant variance is reallocated pro rata to ending inventory and cost of goods sold.
A newly married person may
Change tax years to conform to that of his or her spouse so that a joint return may be filed. The election must be made in either the first or second year after the marriage date.'
The all-events and economic performance tests prevent the use of such
Reserves for tax purposes. Reserves for items such as product warranty expense and uncollectible accounts are commonly encountered in financial accounting. This is because the amount of such expense is not usually determinable with sufficient accuracy.
In These Types Of Loan Situations: The Lender is Treated as
Returning The Imputed Interest To The Borrower
Dividend Treatment
S Cor / C Corp 50% or more General Partnership 50%
Taxpayers using the index method must
Divide their inventories into one or more pools (groups of similar items).
The percentage is determined by
Dividing current year costs by the expected total costs. Current year costs / The expected total costs.
Contracts for services (architectural, accounting, legal, and so on)
Do NOT qualify for long-term contract treatment
If taxpayers on a hyper method (small business, less than 1M)
Do not change to accrued or cash ------> WILL GET AUDIT
[ Amount Of Change ] Generally A Change In Accounting Methods Results In:
Duplications - OR - Omissions of Income -OR- Expense Items
Utilization of 52-53 Week Year
EG, Tax Year Ending on the Last Friday Of December is Also Allowed
This Test Would Normally Be Applied To
Each Item Of Inventory
The lower of cost or market method must ordinarily be applied to
Each separate item in the inventory.
For deductions, the all-events test is not satisfied until
Economic performance has taken place.
A 52-53-week taxable year must end
Either: - The last time a particular day occurs during a calendar month (e.g., the last Friday in October) -OR- - The occurrence of the particular day that is closest to the end of a calendar month (e.g., the Saturday closest to the end of November).
Personal service corporations also may
Elect a fiscal year. However, deductions to shareholder/employees may be limited if distributions: To such shareholder/employees during the deferral period do not exceed a minimum amount. In general, the rules prevent a distribution pattern that creates a tax deferral. This is achieved by requiring that the deductible payments made to owners during the deferral period be at a rate no lower than during the previous fiscal year.
If a particular item does not occur in the first year, the accounting method is
Elected the first year in which the item occurs.
A natural business year
Ends at or soon after the peak income earning period (e.g., the natural business year for a department store that has a seasonal holiday business may be on January 31).
An exception is made for partnerships that can
Establish to the satisfaction of the IRS a business purpose for having a different year.
[ Installment Sales Method ] Many taxpayers deduct the purchase price of equipment
In the year of purchase under Sec. 179.
If a CPA accepts a set of golf clubs as payment from a client for services rendered, the CPA must
Include the fair market value of the golf clubs in his gross income.
A taxpayer's method of accounting determines the year in which
Income is reported and expenses are deducted.
Personal service corporations are
Incorporated medical practices and other businesses owned by individuals who provide their services through the corporation.
A taxpayer who erroneously files tax returns using an accounting period other than that on which his or her books are kept is
Not required to obtain permission to file returns for later years based on the way the books are kept.
Taxpayers who use the LIFO inventory valuation method (discussed later in this chapter) may
Not use the lower of cost or market method.
The Supreme Court has held that the standard of clear reflection of income prevails in a case where the two standards conflict. Regulation Sec. 1.471-4(b) states that
Obsolete or other slow-moving inventory cannot be written down unless the selling price is also reduced. Hence, generally accepted accounting principles are used only when the Regulations do not specify the treatment of an item or, alternatively, when the Regulations provide more than one altenative accounting method.
Best interest for S Corporation and Partnership to filed
On accounting basis Because the shareholders tend to filed on accounting (year) basis
Imputed Interest Can Be Reported On The Cash Method In The Following Situations:
Sales Of Personal Residences Certain Farm Sales For $1,000,000 Or Less Transactions With Total Payments Of $250,000 Or Less Related Party Land Sales For $500,000 Or Less Certain Sales With Principal Of $2,000,000 Or Less If Borrower And Lender Jointly Elect
The accrual method must be used for
Sales and cost of goods sold ----> If inventories are an income-producing factor to the business.
Interest must be inventoried if the property is
Real property, long-lived property, or property requiring more than two years (one year in the case of property costing more than $1 million) to produce.
The Effect Of Interest Imputation is to
Reallocate Characterization of Payments FROM Principal TO Interest
Generally, The Entire Gain Or Loss Is
Recognized In The Year of Sale -----> Only when we elect out of the instalment method
All Depreciation Recapture Must Be
Recognized in the Year of Disposition
Under the completed contract method, income from a project is
Recognized upon completion of the contract.
The Resulting Tax is
Reduced by Multiplying It By Months in Short Period Divided By 12
The term market refers to
Replacement cost.
Under the cash receipts and disbursements method of accounting, a taxpayer is required to
Report income for the tax year in which payments are actually or constructively received.
The installment method is often used to
Report real estate sales Because the cost of real estate cannot be deducted in the year of purchase
Under the percentage of completion method, income from a project is
Reported in Installments as the work progresses.
As noted, Sec. 1245 gains must be
Reported in the year of sale Even when the gain is greater than the amount received during the year
Prepaid Expenses Which Have A Life That Extends Substantially Beyond The Tax Year are:
Required to be Capitalized And Amortized Ex: Insurance - Can only take the month we expense
Partnerships, S corporations, and personal service corporations (such as incorporated medical practices) allow to elect a taxable year that results in a tax deferral of three months or less (e.g., a partnership with calendar-year partners may elect a September 30 year-end). This is called
Sec. 444 election.
Loans are divided into
Short-term (not over three years) Mid-term (over three years but not over nine years) Long-term (over nine years).
An important exception permits taxpayers with average annual gross receipts of $5 million or less for the current and two preceding tax years to use the "_________________________".
Simplified LIFO method
In general, a new taxpayer elects an accounting method by
Simply applying the selected method when computing income for the initial tax return.
Partnerships, S Corporations And Personal Service have
Special restrictions on utilization of A Fiscal Year Utilization of 52-53 Week Year
Taxpayers may determine inventory costs by the following methods:
Specific identification method; first-in, first-out method (FIFO); last-in, first-out method (LIFO); or average cost method.
Calender Year to Fiscal Year Closr Tac on Dec 31st -----> Not elecr June 30th Tax Year End = June 30th (6month)
Stump-Return (Partial Year Return) Filed 6 month
The Year End Reporting Crunch for
Tax Professionals Increases
Certain dispositions of installment obligations, such as gifts, are _______
Taxable events.
Individual taxpayers do not have the same opportunity to determine the year in which income is recognized, because the constructive receipt rule requires
Taxpayers to recognize income ------> If a payment is available, Even if actual payment has not been received. (See Chapter I:3 for a discussion of constructive receipt.)
[ Reporting The Amount Of The Change ] The Period Over which the Accounting Method Change is Reported Depends On
The Amount
If Imputed Interest Is Required
The Applicable Federal Rate May Be Substitute ------> By The IRS For The Contractual Rate
All Trusts (Except Tax-Exempt) are Required To report on
The Calendar Year
Most Individuals And Many Service Businesses utilize
The Cash Receipts & Disbursements Method
The Gross Profit Percentage (Gross Profit/Contract Price) is Multiplied By:
The Collections Of Principal In Any Tax Year X Determine Recognized Income
[ Deferred Payment Sales ] If A Taxpayer: Elects Out Of The Installment Method OR A Loss Is Involved
The Deferred Payment Sales Rules Are Applicable
[ Returns for periods of Less Than 12 Months ] A Taxpayer May Be Required to File A Short Period Return for:
The First Or Final Tax Year - OR - When An Accounting Method Changes
The term method of accounting is used to include not only overall methods of accounting (i.e., cash, accrual, and hybrid) but also
The accounting treatment of specific items.
An option allows personal service corporations to compute
The amount of the minimum distribution by using a three-year average of income and distributions.
Payment by credit card is considered to be
The equivalent of borrowing funds to pay the expense.
When Any Disposition Of Property for A Gain Occurs Where: At Least One Payment Is Received "After" The Taxable Year of Disposition occurs.
[ Installment Sales Method ] The Installment Rules Apply
[ Determination Of Inventory Cost ] Generally Taxpayers Value Inventory At:
The Lower of Cost -OR- Market (Replacement Cost)
[ Uniform Capitalization Rules ] The Regulations Require Inventory Costing Under
The Uniform Capitalization Rules ( UNICAP )
Expenses are deducted in
The year paid.
Expenses (1) Revenue (2)
Incurred Receive [Accrual]
Replacement cost is used in
The lower of cost or market determination.
Constructively Received
- Transaction has occurs - We have the availability to use the money
Ex: Accrual Income - All Event
A/R Sell
Disbursements Method
Also know as cash Usually with services, attorney, doctors, lawyers, accounting
A fiscal year is
A 12-month period that ends on the last day of any month other than December.
The Taxable Year May Be
A Calendar Year -OR- A Fiscal Year Under Certain Restrictions
Taxpayers Who Have Elected LIFO MUST Value Inventory
At Cost
The Deferred Payment Sales Rules Are Applicable:
To Determine The Amount AND Timing Of The Recognized Gain Or Loss
Most changes in accounting method require
IRS approval
Taxpayers may use a combination of accounting methods as long as
Income is clearly reflected.
Inflationary Time : FIFO/ Weight Avg. to LIFO
Without Prior IRS Consent
Individual are always file on
accounting year unless otherwise notice - Usually on April 15th
EXAMPLE Troy, a practicing CPA, also owns an appliance store. The fact that Troy uses the accrual method of reporting income from the appliance store, where inventories are an income-producing factor,
"Does not preclude" Troy from using the cash method to report income from his service-based accounting practice. Troy could also use the cash method for reporting nonbusiness income (such as dividends) and nonbusiness expenses (such as itemized deductions).
EXAMPLE: If A Taxpayer Cost In An Item Is $50/Unit And Replacement Cost is $45/Unit The Tax Valuation Of These Inventory Items Would Be
$45/Unit
EXAMPLE 1:11-4 ABC Partnership begins operations on October 1, 2021, and elects a September 30 year-end under Sec. 444. The partnership's net income for the fiscal year ended September 30, 2022, is $100,000. ABC must make a required payment OF
$9,500 ($100,000 × 38% × ¾2) on or before April 15, 2023.
The costs that must be included in inventory are found in (1) The requirement is applicable only to (2)
( 1) Sec. 263A and are referred to as the Uniform Capitalization rules (UNICAP). (2) Taxpayers whose average gross receipts for the three (3) preceding years exceed (>) $26 million (in 2021 and 2020).
Transfers to controlled corporations under Sec. 351: (1) In these cases, the recipients of the obligations (2)
(1) Certain corporate reorganizations and liquidations Transfers on the taxpayer's death Transfers incident to divorce Distributions by partnerships Contributions of capital to a partnership are exceptions to this rule (2) Obligations report income when the installments are collected.
EXAM: Cash Method For Purchases And Sales Of Inventory (Small Business on Cash Method) Under Cash Method for Small Manufacture is alright to go back to (1) Retail (2)
(1) 2301 Beg + Purch - End =COGS (2) Beg + Purch - End =Cost of Sale As long as the value of inventory within reasonable amount
Sections 483 and 1274 now impute interest in " __________________"(1) where "_____________________"(2) is provided.
(1) A Deferred payment contract (2) No interest or a low rate of interest
[ Cash Receipts And Disbursements Method ] Cash Basis Taxpayers: Report Income for The Tax Year In Which Payments are ______________ (1) Expenses Are Generally _____________________________ (2)
(1) Actually or Constructively Received (2) Deducted In The Year Paid
A positive adjustment is "_____________"(1), whereas a negative adjustment is "__________________" (2). This adjustment can, of course, be made (3).
(1) Added to income (2)Subtracted from income (3) In the year of the change
In the case of goods manufactured by the taxpayer, cost is determined by using the UNICAP rules, which may be thought of as (1) Thus, direct costing and prime costing are (2)
(1) An expanded version of the full absorption costing method. (2) Not acceptable inventory methods.
Thus, if a corporation distributes an installment obligation as a dividend or if a father gives his daughter (1) In general, the gain or loss recognized is equal to (2) In the case of a gift, the gain recognized is equal to (3)
(1) An installment obligation, gain or loss is recognized. (2) The difference between the FMV of the obligation and its adjusted basis. (3) The difference between the face of the obligation and its adjusted basis.
For cash method taxpayers, the FMV of the installment obligation is treated (1) The amount realized, however, (2)
(1) As part of the amount realized in the year of sale. (2) Cannot be considered to be less than the FMV of the property sold minus any other consideration received (e.g., cash).
Taxpayers "____________" change (1) account period to [ save tax ] The IRS does "_______________"(2) to change accounting period to "save tax"
(1) CANNOT (2) NOT ALLOWED
Its to go from _________________ (1) than __________________(2)
(1) Cash to Accrual (2) Accrual to Cash (2) Because we have to go back and annualized all and take out income and expense so that we don't over reporting expenses and underreporting sale
The inventory method used by a taxpayer must conform to the best accounting practice in the trade or business, and it must (1) However, best accounting practices (synonymous with generally accepted accounting principles) and clear reflection of income |(which is determined by the IRS) "____________________" (2).
(1) Clearly reflect income. (2) Occasionally conflict
Retailers use appropriate categories in the ___________________(1); other taxpayers use categories in the ______________________(2).
(1) Consumer Price Index (2) Producer Price Index
Because the recognition of expense is measured by the flow of cash, a taxpayer can "________________________(1)" in which an expense is deductible by "_______________________________________(2)"
(1) Control the year (2) Choosing when to make the payment
Now ________________ (1) is the only thing we can use for tax purposes Cannot use ______________(2)
(1) Direct Write-Off (2) Allowance Method ( GAAP Purposes for deferred Tax)
[ Modified Percentage of Completion Method ] Under this method, if a contract has just been started as of the end of the year, the taxpayer (1) The next year the taxpayer will (2) Of course, this assumes that (3)
(1) Does not have to estimate the profit on the contract during that year. (2) Report profit on all work that has been completed, including work done during the first year. (3)
An error is normally corrected by (1) In general, there is ________________________(2) on the correction of errors. After three years, the tax year is ______________(3).
(1) Filing an amended return for the tax year or years in which the error occurs. (2) Athree-year statute of limitations (3) Closed and changes cannot be made
Taxpayers wishing to change accounting methods must file "_____________"(1) with the IRS, (2) A duplicate copy of Form 3115 (3)
(1) Form 3115 (2) On or before the due date of the tax return including extensions. (3) Must be filed with the tax return for the year.
Lower rates are specified for two types of transactions: (1) If the stated principal amount for qualified debt obligations that are (2) The interest rate is limited to
(1) Issued in exchange for property under Sec. 1274A does not exceed $2.8 million, the interest rate is limited to 9% compounded semiannually (2) 6% compounded semiannually in the case of sales of land between related individuals (unless the sales price exceeds $500,000).
On the date an inventory is valued, the replacement cost of each item in the inventory is compared with (1) The lower figure is used as (2)
(1) Its cost. (2) The inventory value.
Sec. 446(e) states that a taxpayer changing the method of accounting "on the basis of which he regularly computes his income in keeping his books" This implies that a taxpayer who has been computing taxable income on a method (2)
(1) MUST obtain consent before computing taxable income under the new method. (2) OTHER THAN that used in computing book income. (DOES NOT need approval to conform the computation of taxable income to the method regularly used on the taxpayer's books)
The applicable federal rate is determined (1) The rate varies with (2)
(1) Monthly and is based on the rate paid by the federal government on borrowed funds. (2) he terms of the loan.
Criminal Act (1) Not A Criminal Act (2)
(1) Not filling your tax (2) Not paying your tax - Installment Agree
In addition, if the borrower and lender jointly elect, and if the stated principal does not exceed $2 million, accrual of interest is (1) This election is not available if (2)
(1) Not required. (2) The lender is an accrual method taxpayer - OR - A dealer with respect to the property sold or exchanged.
However, a taxpayer's note is _______________________(1), so if a cash method taxpayer gives a note in payment, he or she ________________________(2), even if the note is secured by collateral.
(1) Not the equivalent of cash (2) Cannot take the deduction until the note is paid
[ Installment Sales Between Related Persons ] Installment sales between related persons are subject to the same rules as (1) The primary purpose of the resale rule is to (2)
(1) Other installment sales except when the property is resold by the related purchaser. (2) Prevent the original owner from deferring gain recognition by selling the property to a related person who, in turn, resells the property.
Example Involuntary Changes (More Than $3,000 Positive Adjustment) Are Reported (1) Voluntary Changes (More Than $3,000 Positive Adjustment) May Be Reported (2)
(1) Over A Three Year Period (2) Under The Reconstruction Of Income Method - OR - Over A 9 Year Period
In the case of voluntary changes, taxpayers must agree to report the adjustment (1) When the amount of the adjustment is $25,000 or less, taxpayers (2) In the case of a change spread over four years (3)
(1) Over a period not to exceed four years (2) May elect to include the full amount in the current year (3) Equal portions of the change are reported in each of the four years beginning with the year of the change.
[ Installment Sales Method ] The Income is Reported (1) Unless (2)
(1) Over the Period Payments are Received (2) The Taxpayer Elects Out Of The Installment Method
[ Installment Sales for More Than $150,000 ] Second, if the installment method is used, interest must be (1) This rule, however, applies only to (2)
(1) Paid to the government on the deferred tax. (2) Deferred principal payments over $5 million.
One notable exception to the one-year rule denies a deduction for _______________ (1) Cash-method taxpayers must ___________________________________________________(2)
(1) Prepaid interest (2) Capitalize such amounts and allocate interest over the prepayment period.
Another impact of the imputed interest rules on sellers is to (1) The result is often an increase in (2) The rules are generally applicable to (3) In certain instances, the buyer may want interest to be imputed in order to (4)
(1) Reallocate payments received between interest (which is fully taxable) and principal (only the gain portion of which is taxable). (2) The income reported in early years and a decrease in later years. (3) Both buyers and sellers. (4) Increase his interest deduction in early years.
If the amount is small, "______________________________________________________________" (1) is both simple and equitable. This is the only option available when the amount of the change is (2)
(1) Recognizing the full amount of the net adjustment in the year of the change (2) $3,000 or less.
Items may be valued at a bona fide selling price (1) The option to write down this type of merchandise is available even if (2)
(1) Reduced by the direct cost of disposal. (2) The taxpayers use the LIFO inventory method.
EXAMPLE (1) ABC Partnership, which has filed its returns on a calendar-year basis, terminates on June 30. ABC's final return is due on? (2) Joy, a single individual who has filed her returns on a calendar-year basis, dies on June 30. Joy's final return is due?
(1) September 15 (2*1/2 month after date) - Stomp return (2) The following April 15
[ Costs Subject to Long-Term Contract Rules ] Direct contract costs are (1) Labor, materials, and overhead costs must be (2) In general, administrative overhead must be (3)
(1) Subject to the long-term contract rules. (2) Allocated to the contract and accounted for accordingly. (3) Allocated to long-term contracts. (See the earlier list of overhead items that must be included in inventory.) This is not required of taxpayers (other than homebuilders) using the completed contract method, but as noted below, the use of the completed contract method is limited.
Taxpayers who use the cash method of accounting' in determining gross income from a trade or business must use (1) Similarly, taxpayers who use the accrual method of accounting for expenses must use (2)
(1) The cash method for deter mining expenses of the same trade or business. (2) The accrual method in computing gross in come from the trade or business.
Taxpayers who use _______________________________________ (1) are required to Capitalize ______________(2) [AND] To recover the cost through depreciation or amortization
(1) The cash receipts and disbursements method (2) fixed assets
The adjusted basis of an installment obligation is equal to (1) In general, this means the adjusted basis of an obligation is equal to (2)
(1) The face amount of the obligation reduced by the gross profit that would be realized if the holder collects the face amount of the obligation. (2) Face amount × (100% - Gross profit percentage)
[ Lower of Cost or Market Method ] Inventory may be valued at (1) This option is available to all taxpayers other than (2)
(1) The lower of cost or market. (2) Those who determine cost using the LIFO method.
As previously noted, the term accounting method indicates not only "________________________________"(1), but also "____________________________________"(2)
(1) The overall accounting method used by the taxpayer (2) The treatment of any item of income or deduction.
The alternative might be to require the taxpayer to conform his or her book accounting method with (1) The answer may well be in (2)
(1) The tax accounting method (2) how one defines "books."
A corporation meeting the following specified conditions may change without IRS approval:
(1) There has been no change in its accounting period within the past ten calendar years (2) the resulting year does not have a net operating loss (NOL) (3) the taxable income for the resulting short tax year when annualized is at least 90% of the taxable income for the preceding full tax year (4) there is no change in status of the corporation (such as an S corporation election)
[ Installment Sales for More Than $150,000 ] First, if the taxpayer borrows funds using the installment obligations as security, the amount borrowed is (1) This prevents the taxpayer from (2)
(1) Treated as a payment received on the installment obligation. (2) Using the installment method to defer tax and yet obtain cash by borrowing against the installment obligation.
For accrual method taxpayers, the total amount receivable from the buyer (exclusive of interest) is (1) Thus, the entire gain or loss is (2)
(1) Treated as part of the amount realized. (2) Reported in the year of sale.
Sec. 7872 applies to transactions involving related parties (1) These situations include:(2)
(1) Whose taxes are lowered as a result of low interest or interest-free loans. (2) Gift loans—loans between friends and family members other than spouses. Compensation-related loans—loans from an employer to an employee or independent contractor. Loans from a corporation to one or more of its shareholders. Any loan made specifically to reduce someone's tax responsibility. Certain loans made to continuing care facilities under a contract.
For example, taxpayers may adopt the LIFO inventory method (1) Once such methods are adopted, however, they (2)
(1) Without prior IRS approval. (2) Cannot be changed without IRS approval.
[ Installment Sales Method ] In general, the gain or loss from the sale of property is reported (1) If the sales proceeds are collected in years after the sale, the taxpayer may (2) To reduce the burden, the tax law permits taxpayers to (3)
(1) in the year the property is sold. (2) Find it difficult to pay the tax on the entire amount of the gain in the year of sale. (3) Spread the gain from installment sales over the collection period.
[ Completed Contract Method ] Under the completed contract method of accounting, income from a contract is (1) This is true without regard to (2) Costs associated with the contract are (3)
(1) reported in the taxable year in which the contract is completed. (2) Whether the contract price is collected in advance, upon completion of the contract, or in installments. (3) Accumulated in a work-in-progress account and deducted upon completion.
The use of the completed contract method may only be used in two limited circumstances. The method can be used by (1) It cannot be used by (2)
(1) smaller companies (those whose average gross receipts for the three preceding tax years is $26 million or less) for construction contracts that are expected to take two years or less to complete and for home construction contracts. (2) Larger companies for manufacturing, or for other long-term contracts other than construction or for construction contracts expected to last longer than two years.
Sec. 453(e) requires (1) Thus, the first seller would be required to (2) This acceleration provision is applicable only if the resale takes place (3)
(1) the first seller to treat amounts received by the related person (second seller) as having been personally received. (2) Report the gain in the year (or years) in which proceeds are received by the second seller. (3) Within two years of the initial sale.
An exception gives taxpayers (other than tax shelters) whose ______________________________________________________________________________________________ (1)the option of using the cash method.
(1)Average gross receipts for the three prior years do not exceed $26 million (in 2020 and 2021) This rule simplifies accounting for millions of small and medium sized businesses. Also, businesses without inventories, such as accounting firms and architects, can use the cash method regardless of size.
The accounting methods used to compute taxable income generally must be __________ (1) as those used in keeping the taxpayer's books and records and determine when income and expenses are reported, not Whether they are________ (2)
(1)The same (2) Reported
The All-Events Test Is Met when:
- All Events Have Occurred To Fix The Taxpayer's Right To Receive The Income [AND] - The Amount Of Income Can Be Determined With Reasonable Accuracy
[ All-Events Test ] Similarly, an expense is deductible when
- All events have occurred that establish the fact of the liability -The amount of the expense can be determined with reasonable accuracy.
Situations Where IRS Approval Is NOT Necessary Include:
- Conformity Between Newly Married Spouses - Change To A 52-53 Week Year Ending In The Same Calendar Month As The Prior Tax Year - Conformity Between Financial Reporting Year And - Tax Year - Certain Corporations Which Have NOT Changed Accounting Periods Within 10 Years
Completed Contract Method
- Currently Available Only To Companies Whose Average Gross Receipts For The Three Preceding Tax Years Are $25 Million Or Less -For Construction Contracts That Are : Expected To Take 2 Years or Less To Complete For Certain Other Taxpayers For Home Construction
The following transactions are EXEMPT from the imputed interest rules:
- Debt subject to original issue discount provisions (basically bonds issued for less than face where amortization of the discount is required under Sec. 1274; see Chapter I:5) - Sales of property for $3,000 or less - Any sales where all of the payments are due within six months - Sales of patents to the extent the payment is contingent on the use or disposition of the patent - Certain carrying charges for personal property or educational services covered by Sec. 163(b) when the interest charge cannot be ascertained - Charges for the purchase of personal-use property (purchaser only)"
Resulting In Possible Gift Tax Consequences
- Dividend Treatment - Compensation - Partnership Loans
[ All-Events Test ] An accrual-method taxpayer reports an item of income when "all events" have occurred that
- Fix the taxpayer's right to receive the item of income - The amount can be determined with reasonable accuracy.
There are several important exceptions intended to limit the application of imputed interest in situations where tax avoidance may be immaterial:
- Interest is not imputed on gift loans between two individuals totaling [ $10,000 or less ] , except when the borrowed funds are used to purchase income-producing property. - If the gift loans between two individuals total $100,000 or less, the imputed interest is limited to the borrower's "net investment income" as defined by Sec. 163(d)(4). ----- > If the net investment income is $1,000 or less, it is not necessary to impute interest. - Interest is not imputed on compensation-related and corporate shareholder loans totaling $10,000 or less. These exceptions do not apply when tax avoidance is one of the principal purposes of the loans.
Special rules have been established for two types of transactions that cover long periods of time.
- One rule applies to installment sales (a sale in which final payment is not received until a subsequent tax year) [AND] - One separate set of rules applies to long-term contracts (construction and similar contracts that are not completed in the same year they are started).
[ Installment Sales for More Than $150,000 ] The special rules do not apply to
- Sales of personal use property - Sales of property used or produced in the trade or business of farming - Sales of timeshares or residential lots.
For an accrual basis taxpayer, there are two tests used to determine when an item of income must be reported or an expense deducted:
- The all-events test - The economic performance test.
The requirement that economic performance take place before a deduction is allowed is waived if all of the following five conditions are met:
- The all-events test, without regard to economic performance, is satisfied. - Economic performance occurs within a reasonable period (but in no event more than 8½ months) after the close of the tax year. - The item is recurring in nature, and the taxpayer consistently treats items of the same type as incurred in the tax year in which the all-events test is met. - The taxpayer is not a tax shelter. - Either the amount is not material or the earlier accrual of the item results in a better matching of income and expense.
A partnership generally must use
- The same tax year as the partners who own the majority (greater than 50%) of partnership income and capital. If a majority of partners do not have the same year: -The partnership must use the tax year of its principal partners (those with more than a 5% interest in the partnership). If the principal partners do not have the same tax year: - The partnership must use the taxable year that results in the least aggregate deferral of income to the partners.
Income is annualized as follows:
1. Determine modified taxable income. Individuals must compute their taxable income for the short period by itemizing their deductions (i.e., the standard deduction is not allowed). 2. Multiply modified taxable income by the following fraction: 12 / Number of months in short period 3. Compute the tax on the resulting taxable income using the appropriate tax rate schedule. 4. Multiply the resulting tax by the following fraction: Number of month in short period / 12
Most income tax returns cover an accounting period of
12 months
In general, at least ________________ must occur during the last two months of the year in order to qualify as a natural business year.
25% of revenues
Payments can be made either by
A check that is honored in due course or by the use of a credit card.
A taxpayer with a seasonal business may find
A fiscal year to be advantageous. 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.
The IRS has ruled that a reconciliation of taxable income with accounting income was
A part of the taxpayer's auxiliary records.
Partnerships and S corporations making the Sec. 444 election, however, must make
Annual required payments by May 15 of the following year. The purpose of the required payment is: to offset the tax deferral advantage obtained when fiscal years are used.
Taxpayers Changing From : One Accounting Period TO Another MUST
Annualize Their Taxable Income
Taxpayers who change from one accounting period to another must
Annualize their income for the resulting short period. This prevents income earned during the resulting short period from being taxed at lower rates.
[ Percentage of Completion Method ] Under the percentage of completion method of reporting income, the taxpayer reports
A percentage of the gross income from a long-term contract based on the portion of work that has been completed.
To be deductible, a payment must be more than just
A refundable deposit.
Also, a taxpayer can elect out of the installment method when
A sale results in a gain.
The simplified LIFO method uses
A single LIFO pool, thereby avoiding problems with multiple pools.
For purposes of Sec. 453(e), the term related person includes
A spouse, children, grandchildren, and parents. Controlled corporations, partnerships, estates, and trusts are also covered.
An accounting method
A system of rules and procedures used to determine the year in which income and expenses are reported for tax purposes.
Ex: Accrual Expense - Economic Performance
A/P Cash
For the purpose of EXAM IRS Approval is
ALWAYS REQUIRED
A similar rule generally requires S corporations and personal service corporations to
Adopt a calendar year Unless the corporation has a business purpose for electing a fiscal year.
The accounting method selected by a taxpayer must be used for
All long-term contracts in the same trade or busines
Interest costs directly attributable to a contract and those that could have been avoided if contract costs had not been incurred must be
Allocated to long-term contracts.
Once LIFO has been elected for tax purposes, the taxpayer's "financial reports" must
Also be prepared using LIFO.
While most tax years end on the last day of a month, the tax law allows taxpayers to use a tax year that
Always ends on the same day of the week, such as the last Friday in October. This means that the tax years will vary in length between 52 and 53 weeks.
The Resulting Tax Calculation will ELIMINATE :
Any Potential Bracket Benefit For Including Less Than A Full Year Of Income
[ IMPUTED INTEREST COMPUTATION ] In order to avoid the imputation of interest, the stated interest rate must be
At least equal to 100% of the Applicable Federal Rate (110% of the applicable federal rate in the case of sale-lease back arrangements).
Taxpayers may adopt LIFO by
Attaching a completed Form 970 (or by a statement acceptable to the IRS) to the return for the tax year in which the method is first used.
An improper election to use a fiscal year
Automatically places the taxpayer on the calendar year. Thus, if the first return is filed late because of oversight, the option to choose a fiscal year is lost.
For Taxpayers with "_____________________________________________________________" that MUST be included • Direct Labor And Materials • Manufacturing Overhead Including Factory Repairs And Maintenance • Utilities • Rent • Insurance • Small Tools • Tax Depreciation • Factory Administration • Taxes • Rework, Scrap, Spoilage
Average Gross Receipts for the Three (3) Preceding Years exceed (>) $25 million and specifically Delineate The Expenses
There is one instance, however, when a change in tax years is required: A subsidiary corporation filing a consolidated return with its parent corporation must
Change its accounting period to conform with its parent's tax year.
[ LONG-TERM CONTRACTS ] Long-term contracts include
Building, installation, construction, or manufacturing contracts that are ---> Not completed in the same tax year in which they began.
The 52-53-week year is especially useful to
Businesses with inventories. For example, a manufacturer might choose a 52-53-week year that ends on the last Friday in December to permit inventory to be taken over the weekend without interfering with the company's manufacturing activity. Similarly, wage accruals would be eliminated for a company with a weekly payroll if the payroll period always ends on Friday.
Once adopted, an accounting period
CANNOT normally be changed without IRS approval.
Capitalization Requirements for Cash-Method Taxpayers Taxpayers who use the cash receipts and disbursements method are required to
Capitalize fixed assets [AND] To recover the cost through depreciation or amortization.
As previously mentioned, interest must be
Capitalized ------> IF the property being produced is real property, long-lived property, or property requiring more than two years (one year in the case of property costing more than $1 million) to produce.
Thus, under the completed contract method, such costs are
Capitalized and deducted from revenue in the year the contract is completed.
The Regulations state that prepaid expenses must be
Capitalized and deducted over the life of the asset ------> If the life of the asset extends substantially beyond the end of the tax year.
Personal Property (for example purposes) included
Cars and Appliances
Ex: Accrual Income - Economic Performance
Cash A/R
Permissible overall accounting methods are:
Cash receipts and disbursements method (often called the cash method of accounting) Accrual method A combination of the first two methods, often called the hybrid method
The Regulations clearly provide that gross income under the cash method includes
Cash, property, or services.
To ensure that income is clearly reflected,
Certain restrictions have been placed on combining accounting methods.
Example It Is Unclear Whether A Taxpayer Must Obtain Prior IRS Approval to:
Change ONLY Financial Reporting (In Light Of Book And Tax Conformity Requirements) - AND - Change FROM An Incorrect Accounting Method (EG, Cash Method For Purchases And Sales Of Inventory) TO A Different Method (EG, Accrual)
Taxpayers willing to make required payments or distributions may
Choose a fiscal year. (See the Required Payments and Fiscal Years section in this chapter.)
How Hybrid Method Work
Constructive Receipt on Sale Sale as Cash Method Beg + Purch. - End Inventory for Cost of Sale = Accrual Method -------> Fool around with Inventory
Inventories may be valued at either
Cost -OR- At the lower of cost -OR- Market value.
EXAMPLE I:11-34 Gordon opened a beauty shop several years ago. Because he had no inventory, no inventory method was selected. In the current year, Gordon expanded his business to offer beauty supplies to his customers. Gordon can?
Delay electing an inventory method until the year in which he first has an inventory
Recordkeeping under LIFO can be cumbersome. For this reason, taxpayers are permitted to
Determine inventories using "dollar-value" pools [AND] Government price indexes rather than by maintaining a record of actual costs.
[ Disposition of Installment Obligations ] A taxpayer who sells property on the installment basis may decide not to hold the obligation until maturity. For example, the holder may sell the obligation to a financial institution for the purpose of raising cash. Alternatively, the holder may not be able to collect the full amount of the installments because of the inability of the buyer to make payments. In these situations, the holder must _____________________________
Determine the adjusted basis of the obligation in order to compute the resulting gain or loss.
Dividing inventory into pools can be critical because of the
Different inflation rates associated with various goods and because, if a particular pool is depleted The taxpayer loses the right to use the lower prices associated with past layers.
The Gain To Be Recognized On The Disposition of Installment Obligations is the
Excess Of The Amount Realized Over The Adjusted Basis Of The Obligations
In general, taxpayers initiate a change in accounting methods from an incorrect to a correct method are
Exempt from penalty and from retroactive application of the new reporting method.
Zero-Based Return
Filed return even though the business have not receive income
As a result, a taxpayer who changes the method of accounting used for financial reporting MAY NOT be required to change the method of accounting used for tax reporting as long as
Financial income and book income are reconciled.
The tax year is elected on the
First tax return That is filed by a taxpayer and CANNOT be changed WITHOUT consent from the IRS.
Although the accounting methods used by a taxpayer do not necessarily affect the amount of income reported over the life of a business, they do affect the tax burden in two ways:
First, selecting the appropriate accounting method can: Accelerate deductions - or- Defer income recognition in order to postpone tax payments Second, because of the progressive tax rate structure, taxpayers "can save taxes" by: Spreading income over several accounting periods rather than having income bunched into one period.
Virtually all C corporations (other than personal service corporations) have
Flexibility in choosing an accounting period.
Application for permission to change accounting periods is made on
Form 1128, Application for Change in Accounting Period, on or before the due date of the return including extensions. The application must be sent to the Commissioner of the IRS, Washington, D.C.
The installment method is applicable only to
GAINS Used to "report income" from an installment transaction UNLESS the taxpayer elects not to use the installment method.
[ Gift, Shareholder, And Other Loans ] Imputed Interest May Also Be Applicable To
Gift Loans - Corporation - Shareholder Related Loans - Compensation - Related Loans - Other Tax Avoidance Loans
LIFO to FIFO
Go back and established base index and revalue
EXAMPLE 1:11-10 Pat, a single taxpayer, obtains permission to change from a calendar year to a fiscal year ending on April 30, 2021. During the four months ending April 30, 2021, Pat earns $25,000 and has $5,000 in itemized deductions.
Gross Income $25,000 Minus: Itemized deductions ($5,000) Modified taxable income = $20,000 Annualized income [(12 ÷ 4) × $20,000] $60,000 Tax on annualized income $ 8,949 Gross tax [(4 + 12) x $8,949] $ 2,983
Any payments on the cash basis that has been constructively receipts
Has to be recorded in the particular year Ex: Received payment on Dec. 31st - Not cash out until Jan. 4th = Constructively receipts on 31st
Do not change from calendar year to 52-53 week year because
Have to go back and allocated those tax and annualized based on the month and week that are outstanding
Imputed Interest is provided by the
IRS IRS public imputed interest annually
If more than 10% of the costs are incurred during the first year, the modified percentage of completion method is
Identical to the regular percentage of completion method.
EXAMPLE I:11-33 Linda made interest-free gift loans to each of her four children: Andy, Bob, Cathy, and Donna. Andy borrowed $9,000 to purchase an automobile. Bob borrowed $25,000 to buy stock. Bob's net investment income is $800. Cathy also borrowed $25,000 to buy stock, but her net investment income is $1,100. Donna borrowed $120,000 to purchase a residence, and her net investment income is $500. Tax avoidance is not a motive for any of the loans.
Imputation of interest is not required for the loans to Andy or Bob. The loan to Andy is exempt because the amount is less than $10,000, and the loan to Bob is exempt because his net investment income is under $1,000. ' Imputation of interest is required for the loans to Cathy and Donna. In the case of Cathy, the amount of imputed interest is limited to her net investment income of $1,100. The imputed interest for Donna, however, is not limited to her net investment income because the amount of the loan is over $100,000.
Example Involuntary Changes Involving A Positive Adjustment Of $3,000 Or Less Are Reported
In The Year Of Change
GIFT, SHAREHOLDER, AND OTHER LOANS Imputed interest rules are not limited to
Installment transactions
Ex: Accrual Expense - All Event
Inventory A/P
[ Accrual Of Interest ] In Most Situations Imputed Interest Is Reported as
It Accrues
[ LIFO Method ] LIFO Is Preferable for Tax Purposes In Inflationary Periods as
It Matches The Highest Costs Against Revenues
In general, once an accounting method is chosen:
It cannot be changed without IRS approval. There are a few exceptions.
Retail usually uses
January 31st as their tax year
EXAMPLE I:11-31 Kasi sells land for $100,000 to Bill, an unrelated person. The sales price is to be paid to Kasi at the end of five years in a single installment with no stated interest. Kasi paid $60,000 for the land. Assume the current federal rate is 10%. Because the amount of the stated principal is less than $2,800,000, interest is imputed at a rate not to exceed 9% compounded semiannually. As a result, the effective rate is 9.2025% (9% compounded semiannually), and the present value factor is .64393 (1 1.092025). Thus, the present value of the final payment is $64,393 (0.64393 x $100,000).
Kasi reports a $4,393 ($64,393 - $60,000) gain on the sale of the land and $35,607 ($100,000 - $64,393) interest income instead of a $40,000 gain and no interest income. The buyer is treated as incurring $35,607 in interest and has a $64,393 basis in the land. Whether the interest is deductible depends on a variety of other factors (see Chapter 1:8).
The Hybrid Method Is The "________________________" By Taxpayers Of The Three Major Overall Accounting Methods
Least Used Method
This requirement to conform financial reporting often discourages companies from electing LIFO because
Lower earnings must be reported to shareholders. However, taxpayers may make footnote disclosure of the amount of net income that would have been reported under FIFO or other inventory methods.
From LIFO to FIFO/ Weight Avg.
MUST have Prior IRS Consent
UNICAP requires that costs associated with these depart- ments be allocated between
Manufacturing and nonmanufacturing functions (e.g., sales, advertising, research and experimentation).
Errors include
Mathematical mistakes Posting errors Deductions of the wrong amount for an expense Omission of an item of taxable income Incorrect computation of a credit.
Generally Dealers In Personal Property:
May NOT Use The Installment Method Of Installment Sales
A business without a peak income period
May not be able to establish a natural business year and may, therefore, be precluded from changing its tax year.
Special Rules Apply To Installment Sales For
More Than $150,000 [AND] Installment Sales Between Related Persons
Modified Taxable Income Is Grossed-Up by
Multiplying It By 12, Divided By Months In Short Period The Tax is then calculated on this Grossed-Up Number
The amount of the required payment under Sec. 444 is determined by
Multiplying the maximum tax rate for individuals plus 1% (38%) times the previous year's taxable income times a deferral ratio. Maximum tax rate + 1%(38%) * The previous year's taxable income * Deferral ratio
[ Percentage of Completion Method ] The portion of the total contract price reported in a given year is determined by
Multiplying the total contract price by the percentage of work completed in the year. The total contract price * The percentage of work completed in the year
[ Imputed Interest ] The Tax Law Imputes Interest in a Deferred Payment Contract Where:
NO Interest -OR- A Low Rate Interest Provided
[ Obtaining IRS Consent ] The Necessity Of Obtaining IRS Approval is
NOT Always Clear
However, an accounts receivable or other UNSUPPORTED promise to pay is considered to have no value and, as a result,
No income is recognized until the receivable is collected.
[ Installment Sales for More Than $150,000 ] Special rules apply to:
Nondealers who sell property for more than $150,000.
A taxpayer who has an option of cancelling delivery and receiving a refund of amounts prepaid is
Not normally entitled to deduct the amount of the deposit.
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. These 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.
Nonmanufacturing costs (e.g., advertising, selling, and research and experimentation costs) are
Not required to be included in inventory.
[ Long-Term Contracts ] Long-Term Contracts May Be Accounted for under the:
Percentage Of Completion Method Completed Contract Method Modified Percentage-Of-Completion Method
A special rule allows homeowners to deduct
Points paid on a mortgage used to buy or improve a personal residence. The payment must be an established business practice in the area and not exceed amounts generally charged for such home loans. (See Chapter I:8 for a discussion of the deductibility of points.)
[ Disposition of Installment Obligations ] The main objective of this rule is to
Prevent income from being shifted from one taxpayer to another.
Although changes in accounting methods require IRS approval, the IRS states that approval will AUTOMATICALLY BE GRANTED for a wide variety of changes if the taxpayer meets specific requirements that include
Proper filing of both Form 3115 and the current year's tax return, agreeing to take into account the Sec. 481(a) adjustment (as described below) Not being under examination Not having changed the same method of accounting within the last four years.
Economic Performance occurs when the
Property Or Services Are Actually Rendered (Provided) By The Other Party
Imputed Interest is NOT
Provided but the Federal or Rate Preferred by Loan Holders
On the other hand, reporting a large positive adjustment in one year could
Push the taxpayer into a higher marginal tax bracket and result in a significant tax increase.
It Is Increasingly More Difficult To
Qualify To Use The Completed Contract Method
C Corporation tax file is different from S Corp. and Partnership because
The income not transferring to shareholders
In the case of merchandise purchased: COST is
The invoice price less (-) trade discounts, plus (+) freight and other handling charges.
The imputation process involves a second step:
The lender is treated as returning the imputed interest to the borrower. This is necessary because the interest was not actually paid. (Extra Info) For example, in the case of a gift loan, the lender is treated as giving the imputed interest back to the borrower. In the case of the corporation-shareholder loan, the corporation is treated as paying the imputed interest back to the shareholder as a dividend. Typically, this does not increase the corporation's tax, but it results in the recognition of dividend income to the shareholder. For compensation-related loans, the second step is to impute compensation paid by the employer and received by the employee. The compensation is taxable to the employee and, if reasonable in amount, is deductible by the employer.
Typically, capitalization is required only if
The life of the asset extends beyond the close of the tax year following the year of payment.
[ LIFO Method ] Many taxpayers use the LIFO cost flow assumption because, during inflationary periods, LIFO normally results in
The lowest inventory value and hence the lowest taxable income.
The deferral ratio is equal to
The number of months in the deferral period / the number of months in the taxable year.
An existing partnership can change its tax year without prior approval if
The partners with a majority interest have the same tax year to which the partnership changes -OR- If all principal partners who do not have such a tax year concurrently change to such a tax year.
EXAMPLE 1:11-2 City Corporation receives its charter but does not begin operations for three years. Tax returns are required for all years. Timely returns are not filed because City's officers are unaware that returns must be filed for inactive corporations.
Thus, City Corporation must use "the calendar year" City Corporation may petition the IRS for approval to use a fiscal year.
Sec. 179 does permit taxpayers to deduct annually up
To $1,050,000 in 2021 ($1,040,000 in 2020) of equipment purchases (see Chapter I:10 for a detailed discussion).
In general, the income and expenses associated with long-term contracts may be accounted for by
The percentage of completion method -OR- The modified percentage of completion method.
Economic performance (of services or property to be provided to a taxpayer) occurs when
The property or services are actually provided by the other party.
The installment method cannot be used when
The sale of property produces a loss.
A change to a 52-53-week year that ends with reference to
The same calendar month in which the former tax year ended.
This conclusion is supported by Sec. 441(a), which requires that
The same method of accounting be used in computing taxable income --- > as is used in keeping the books.
Taxpayers who regularly keep their books over a period that varies from 52 to 53 weeks may elect
The same period for tax purposes.
The IRS will usually approve a change only if
The taxpayer can establish a substantial business purpose for the change (e.g., changing to a natural business year).
Market value is the price at which
The taxpayer can replace the goods in question.
Taxable income must be computed using the method of accounting regularly used by
The taxpayer in keeping his or her books -----> If that method clearly reflects income.
The last time a particular day occurs during a calendar month (e.g., the last Friday in October)
The year may end as many as six days before the end of the month, but must end within the month.
The occurrence of the particular day that is closest to the end of a calendar month (e.g., the Saturday closest to the end of November).
The year may end as many as three days before or after the end of the month.
Similarly, if a taxpayer is obligated to provide property or services, economic performance occurs in
The year the taxpayer provides the property or service.
The tax year must coincide with
The year used to keep the taxpayer's books and records.
Other taxpayers, such as partnerships and S corporations, may use a fiscal year if
They have an acceptable business purpose. However, most of these businesses are UNABLE to meet the rather rigid business purpose requirements outlined by the IRS. As a result, these businesses report using the calendar year concentrating most tax work during the early months of the year.
Expenses Are Generally Deducted In The Year Paid which mean that
They have been constructively expense Ex: Pay for Equipment on Dec 31st - Not clear and pick up till Jan. 4th = Constructively Expenses
Any Specific Statutory Mandates Example: When The Tax Reform Act Of 1986 Disallowed Reserves For Bad Debts The Income From The Reversal Of The Reserves Was Mandated _________________________
To Be Taken Into Income Over Four Years
Concern over this problem led Congress to enact Sec. 444 which allows Partnerships S corporations Personal service corporations (such as incorporated medical practices)
To elect a taxable year that results in a tax deferral of three months or less (e.g., a partnership with calendar-year partners may elect a September 30 year-end).
The purpose of the strict rules for selecting accounting periods for partnerships is
To prevent partners from deferring partnership income by choosing a different tax year for the partnership.
The main difference between: - Full absorption costing traditionally used for financial reporting purposes [AND] - UNICAP costing required for tax purposes is that
UNICAP expands the list of overhead costs to include certain indirect costs that have not always been included in overhead for financial reporting purposes.
EXAMPLE: USA Corporation, an accrual method taxpayer, sells land for $100,000. USA receives $50,000 down and a $50,000 note payable in 12 months plus 14% interest. Assume the basis of the land is $80,000 and that it is a capital asset. Because of the buyer's poor credit, the value of the note is only $45,000. USA affirmatively elects not to report the installment sale on the installment method.
USA reports a capital gain of $20,000 ($100,000 - $80,000). If USA collects the face of the note at maturity, no additional gain or loss is recognized. If USA sells the note for $45,000, a $5,000 capital loss is recognized.
[ Hybrid Method ] Taxpayers Who Use Either "The Cash Method -OR- Accrual Method Of Accounting For : Determining Gross Income MUST
Use The Same Method for Determining Expenses
[ Changes In Accounting Methods ] Generally, An Accounting Period is Chosen By:
Using It On The Tax Return For The First Year in which The Method Is Applicable
The methods that are available depend on whether the change is
Voluntary (a change that is initiated by the taxpayer) -OR- Involuntary (a change from an unacceptable to an acceptable method that is required by the IRS).
Whether The Change Was :
Voluntary Or Involuntary
On two occasions, however, a taxpayer's accounting period may be less (>) than 12 months:
When the taxpayer's first -OR- Final return is filed and when the taxpayer changes accounting periods.
However, Taxpayers May Change To LIFO Inventory
Without Prior IRS Consent
[ Changes In The Accounting Period ] In Some Instances, the Taxpayer CAN change Accounting Periods
Without The IRS Approval BUT Generally IRS Approval Is "Required"
Obsolete or other slow-moving inventory can be
Written down below replacement cost ------> ONLY IF the selling price has been reduced.
At the beginning of a contract, it is difficult to estimate total costs. For this reason, taxpayers may elect to defer reporting any income from a contract until they have incurred at least 10% of the estimated total cost. This is called:
[ Modified Percentage of Completion Method ] The Modified percentage of completion method.
In the case of an involuntary change, several alternative methods are
available to the IRS.
If we deferred based on taken the note, with valuable consideration toward sell price then
we got capital gain
If we sell the note
we got capital loss
For Taxpayers with Average Gross Receipts for the Three (3) Preceding Years exceed (>) $25 million and specifically Delineate The Expenses that MUST be included
• Direct Labor And Materials • Manufacturing Overhead Including Factory Repairs And Maintenance • Utilities • Rent • Insurance • Small Tools • Tax Depreciation • Factory Administration • Taxes • Rework, Scrap, Spoilage
Under UNICAP, the following overhead items are included in inventory:
• Direct labor and materials along with manufacturing overhead must be included in inventory. • Factory repairs and maintenance, utilities, rent, insurance, small tools, and depreciation (including the excess of tax depreciation over accounting depreciation) • Factory administration and officers' salaries related to production • Taxes (other than the income tax) • Quality control and inspection • Rework, scrap, and spoilage • Current and past service costs of pension and profit-sharing plans Service support such as purchasing, payroll, and warehousing costs
The installment method is NOT applicable to sales of:
• inventory, or • marketable securities
