Chapter 11

Each of the following cases involves a taxable year of less than 12 months. In which situations is annualization​ required? a. A new corporation formed in September elects a calendar year. Annualization required? Yes/No b. A calendar-year individual dies on June 15. Annualization required? Yes/No c. 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. Annualization required? Yes/No d. A calendar-year corporation liquidates on April 20. Annualization required? Yes/No

a. No b. No c. Yes d. No

Is there any instance in which a change in tax years is​ required? Explain. A. A subsidiary corporation filing a consolidated return with its parent is required to change its accounting period to conform with its parent. B. There are no instances in which a change in tax year is required. C. A newly married person is required to change tax years to conform to that of his or her spouse because a joint return must be filed. The change must be made in the first year after the marriage date. D. An existing partnership is required to change its tax year 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.

A. A subsidiary corporation filing a consolidated return with its parent is required to change its accounting period to conform with its parent.

Does annualizing income increase or decrease the​ taxpayer's tax​ liability? Explain. A. Due to our progressive tax​ rates, annualization generally increases the​ taxpayer's tax liability. B. Due to our progressive tax​ rates, annualization generally decreases the​ taxpayer's tax liability. C. Due to the capital gain​ rates, annualization generally decreases the​ taxpayer's tax liability. D. Due to the capital gain​ rates, annualization generally increases the​ taxpayer's tax liability.

A. Due to our progressive tax​ rates, annualization generally increases the​ taxpayer's tax liability.

Is an accrual method taxpayer permitted to deduct estimated​ expenses? What about prepaid​ expenses? Explain. A. 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. B. Yes. Estimated expenses and prepaid expenses are deductible. C. Estimated expenses are not deductible because they have not been paid. Prepaid expenses are always deductible without exception. D. Estimated expenses are deductible as long as the exception to the economic performance test is met. The all events and economic performance tests prevent the deduction of prepaid expenses.

A. 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.

How does a​ taxpayer's tax accounting method affect the amount of tax​ paid? A. 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. B. The accounting methods used by a taxpayer dictate the​ taxpayer's capital gain tax rate. It is preferable to adopt an accounting method that will result in a lower tax rate. C. The accounting methods used by a taxpayer dictate the​ taxpayer's regular tax rate. It is preferable to adopt an accounting method that will result in a lower tax rate. D. The accounting methods used by a taxpayer affect the amount of tax paid by allowing the taxpayer to pay its taxes by installment on a monthly basis. Interest accrues on the unpaid balance.

A. 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 conditions must be met in order to use the installment​ method? A. The installment sales method is applicable only to transactions involving gains where at least one payment is to be received after the close of the taxable year in which the disposition occurs. It may not be used in connection with the sale of publicly traded property or inventory. B. The installment sales method is applicable only to transactions involving gains where at least two payments are to be received after the close of the taxable year in which the disposition occurs. It may not be used in connection with the sale of publicly traded property or inventory. C. The installment sales method is applicable only to transactions involving gains where at least one payment is to be received after the close of the taxable year in which the disposition occurs. There is no​ exception, all type of property or inventory sold qualify for the installment method. D. The installment sales method is applicable to transactions involving gains or losses where at least one payment is to be received after the close of the taxable year in which the disposition occurs. It may not be used in connection with the sale of publicly traded property or inventory.

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

Most individuals use the calendar year as their tax year. What​ requirement, if​ any, in the tax law causes​ this? A. 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. B. There is no requirement in the tax law that requires individuals to use the calendar year as their tax year. C. The tax law contains incentives for taxpayers that use the calendar year as their tax year. D. The tax law states that all taxpayers must use the calendar year as their tax​ year, no exceptions.

A. 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? A. When a taxpayer files his or her first or final return or when the taxpayer changes accounting periods. B. When a taxpayer changes accounting​ method, a tax return must be filed even if the period is less than 12 months. C. In the case where there is an involuntary conversion of​ property, a tax return must be filed from the beginning of the tax year up to the date of the event that cause the involuntary conversion. D. All of the above.

A. When a taxpayer files his or her first or final return or when the taxpayer changes accounting periods.

What transactions are subject to the​ long-term contract method of​ reporting? A. ​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. B. Contracts for services. C. The manufacture of either a unique item not normally carried in finished inventory or items that normally require less than 12 calendar months to complete. D. All of the above.

A. ​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.

Are the rules that determine when interest is deductible by a cash method taxpayer the same as for other​ expenses? A. Yes. The rules are the same. Prepaid interest can be deducted in the year paid. An exception prohibits a​ cash-method taxpayer from deducting points paid on a home mortgage in all cases. B. 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. C. Yes. The rules are the same without exception. D. No. Prepaid interest is not deductible. There are no exceptions to this.

B. 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.

Why would a taxpayer elect not to use the installment​ method? A. One reason to elect out of the installment method could relate to the application of higher tax rates in the current year where lower 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. B. 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. C. 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 following year. D. None of the above. There are no advantages for not electing to use the installment method.

B. 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.

Can the IRS require a taxpayer to change accounting​ methods? A. The IRS can require a taxpayer to change accounting methods if they determine that the accounting method will result in greater taxable income over the life of the organization. B. The IRS can require a taxpayer to change accounting methods if the method that has been used does not clearly reflect income. C. The IRS cannot require a taxpayer to change accounting methods. D. If the accounting method used by a taxpayer clearly reflects​ income, the IRS can require a change to another​ method, as long as that method would also clearly reflect income.

B. The IRS can require a taxpayer to change accounting methods if the method that has been used does not clearly reflect income.

Under what conditions is a taxpayer required to annualize​ income? A. Annualization is required when a change in the accounting method occurs. B. Annualization is required when a taxpayer files a final return. C. Annualization is required when a change in the accounting period occurs. D. Annualization is required when a taxpayer files an initial tax return.

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

When are expenses deductible by a cash method​ taxpayer? A. A​ cash-method taxpayer deducts expenses when they are paid. A​ cash-method taxpayer​ is, however, required to capitalize prepaid expenses and deduct the cost over the term of the prepayment if that term extends substantially beyond the end of the tax year. A​ cash-method taxpayer is not required to capitalize fixed assets and recover the cost through depreciation or amortization. B. A​ cash-method taxpayer deducts expenses when they are paid. A​ cash-method taxpayer​ is, however, required to capitalize only fixed assets and recover the cost through depreciation or amortization. C. 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. D. A​ cash-method taxpayer deducts all expenses when they are paid. There are no exceptions to this.

C. 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.

Is a cash method taxpayer subject to the same rules for depreciable assets as accrual method​ taxpayers? A. Yes.​ Cash-method taxpayers are subject to the same rules as other taxpayers except for the fact that they are restricted to the use of the​ straight-line method of depreciation. B. Yes.​ Cash-method taxpayers are subject to the same rules as other taxpayers except that the recovery periods are different. C. Yes.​ Cash-method taxpayers are subject to the same rules as other taxpayers. D. No.​ Cash-method taxpayers are not required to capitalize fixed assets and recover the cost through depreciation or amortization.

C. Yes.​ Cash-method taxpayers are subject to the same rules as other taxpayers.

What constitutes a payment in determining when a​ cash-basis taxpayer is entitled to deduct an​ expense? A. 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. B. Payment can be by check that is honored in due course. C. A​ taxpayer's note is considered to be the equivalent of cash and so a payment made by issuing a note constitutes a payment. D. Both A and B are correct.

D. Both A and B are correct.

What is the primary impact of the imputed interest rules on installment​ sales? A. 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. B. The imputed interest rules may convert a favorably taxed capital gain into​ interest, which is taxed at ordinary rates. C. The imputed interest rules provide a deduction to the seller for interest if the stated interest rate is above the applicable federal rate. The result is to increase the amount of interest expense deducted under an installment sale. As a result greater tax savings results from offering a higher interest rate. D. Both A and B are correct.

D. Both A and B are correct.

Who may use the completed contract method of reporting income from​ long-term contracts? A. Companies whose average gross receipts for the three preceding years were​ $5 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 only commercial construction contracts. B. Companies whose average gross receipts for the five preceding years were​ $5 million or less may use the completed contract method for construction contracts that are expected to take five years or less to complete. In​ addition, the completed contract method may be used for home construction contracts. C. Companies whose average gross receipts for the five preceding years were​ $10 million or less may use the completed contract method for construction contracts that are expected to take five years or less to complete. In​ addition, the completed contract method may be used for only commercial construction contracts. D. 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.

D. 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.

Do accounting rules determine the amount of income to be reported by a​ taxpayer? A. The accounting methods used by a taxpayer determine the exact amount of income to be reported by a taxpayer in any given year and over the life of the taxpayer. B. In the long​ run, the amount of income reported by a taxpayer will vary significantly depending on the accounting methods used by the taxpayer. In a given year the amount of income reported by a taxpayer generally be the same regardless of the accounting method used by the taxpayer. C. The accounting methods used by a taxpayer have no bearing on the amount of income to be reported by a taxpayer in any given year or over the life of the taxpayer. D. 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.

D. 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.