Tax USA Assignment 3

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Week14_pope_phft2014_ind_pp_11.pptx

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Accounting Periods and Methods

Chapter 11

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ACCOUNTING PERIODS AND METHODS (1 of 2)

Accounting periods

Overall accounting methods

Inventories

Special accounting methods

Imputed interest

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ACCOUNTING PERIODS AND METHODS (2 of 2)

Change in accounting methods

Tax planning considerations

Compliance & procedural considerations

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Accounting Periods

Fiscal year is any 12-month period other than calendar year

Partnerships, S corps, and PSCs

Generally must have same tax year as majority owners (> 50% ownership)

Required payments and fiscal years

Changes in the accounting period

Returns for periods of < 12 months

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Required Payments and Fiscal Years

C corporations, other than PSCs, can choose any fiscal year

Partnerships, S corps, and PSCs can choose a fiscal year if deferral is 3 months or less (§444 election)

Required payments must be made by April 15 to offset advantage of deferral from §444 election

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Changes in the Accounting Period (1 of 2)

Generally need IRS approval to change accounting period

Must establish substantial business purpose to change accounting period

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Changes in the Accounting Period (2 of 2)

IRS approval not necessary

Conformity of newly married spouses

Change to 52/53 week year ending in same calendar month as prior tax year

Certain corporations that have not changed accounting periods within 10 years

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Returns for Periods of Less than 12 Months (1 of 2)

Taxpayer’s first or final return

No annualization of income required

Change from one accounting period to another

Annualization required

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Returns for Periods of Less than 12 Months (2 of 2)

Annualization procedure

Compute modified TI (MDTI)

Must use itemized deductions

No personal and dependency exemptions

MDTI x [12 ÷ (short period # of mo)]

Compute tax on Step 2

Step 3 x [(short period # of mo) ÷ 12]

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Overall Accounting Methods

Overall accounting method for one trade or business not needed to be used in a second trade or business

Cash receipts and disbursements method

Accrual method

Hybrid method

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Cash Receipts and Disbursements Method (1 of 2)

Report income for the tax year in which payments are received

Generally deduct exp. in year paid

Prepaid exp. capitalized and amortized if benefits extend beyond tax year

Must capitalize fixed assets and recover through depr. or amort.

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Cash Receipts and Disbursements Method (2 of 2)

Most individuals and many service businesses use the cash method

Cannot use cash method in a business where inventory is material income-producing factor

Small business exception – see hybrid method

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Accrual Method (1 of 2)

Report income under all-events test and economic performance test

All events test

Taxpayer’s right to receive inc. & amount determined w/reasonable accuracy

Economic performance test

Property or services actually rendered by other party

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Accrual Method (2 of 2)

Deduction is met when liability established and amount of expense can be determined with reasonable accuracy

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Hybrid Method

Use accrual method for sales and purchases, but may use cash method for other income and expenses

Small business exception

Businesses with inventory whose annual gross receipts for 3 prior years ≤ $1M may use cash method for sales and accrual method for cost of goods sold

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Inventories (1 of 2)

Uniform capitalization rules (UNICAP)

Required for taxpayers whose average gross receipts for 3 prior years >$10M

Must capitalize some period costs

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Inventories (2 of 2)

If using LIFO for tax

Must also use LIFO for financial acctg.

May use lower of cost or market with any inventory method

Cycle inventory valuation

Congress specifically permits method

Inventory counted following a schedule

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Special Accounting Methods

Long-term contracts

Installment sales method

Deferred payment sales

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Long-Term Contracts In General

For items that are not completed in same tax year in which they begin

For manufacture of unique item not normally carried in finished goods inventory

Services not eligible for long-term contract methods

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Long-Term Contracts Completed Contract Method

Income and expenses reported in year contract completed

Only available for

Construction contracts < 2 years OR

Home construction contracts

Qualifying taxpayers

Small companies w/avg gross receipts for prior 3 years ≤ $10M in contracts

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Long-Term Contracts Percentage of Completion Method (1 of 2)

Income and expenses reported in each year of contract based on estimated percentage of completed work

Modified percentage of completion

Income deferred until 10% of estimated cost accumulated

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Long-Term Contracts Percentage of Completion Method (2 of 2)

Look-back interest

May apply if actual expenses paid are much different than calculated

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Installment Sales Method (1 of 3)

Any disposition of property where at least one payment received after close of tax year of disposition

Elective provision

Not applicable for sale of

Inventory

Marketable securities

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Installment Sales Method (2 of 3)

Computation under §453

Compute gross profit from sale

Determine contract price

Compute gross profit percentage

[Gross Profit] / [Contract Price]

Compute gain to be reported

[Proceeds] X [Gross Profit %]

Depr. recap. recognized in year of sale

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Installment Sales Method (3 of 3)

Disposition of installment obligations

Selling price

– Adjusted basis of installment note

Gain recognized

Face amount

x [100% - gross profit percentage]

Adjusted basis in installment note

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Deferred Payment Sales

Installment method cannot be used when property sold at a loss

Obligations with indeterminate market value

E.g., mineral interest sold for 10% of value of future production

Value no lower than value of property sold less value of other prop. received

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Imputed Interest

Imputed interest computation

Generally must be at least 100% of applicable federal rate

Accrual of interest

Generally reported as it accrues

Several major exceptions

Special rules for gift, shareholder, and other tax avoidance loans

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Change in Accounting Methods (1 of 3)

Accounting period chosen by using for first year in which it is applicable

IRS approval required to change methods

May change to LIFO method without IRS approval

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Change in Accounting Methods (2 of 3)

Amount of change

Due to timing of income and deduction recognition due to changes between cash and accrual methods

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Change in Accounting Methods (3 of 3)

Reporting the amount of the change

The amount

Change voluntary or involuntary

Any specific statutory mandates

Must obtain IRS consent

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Tax Planning Considerations

Accounting periods

Consider year-end and marginal tax rate in initial year

Accounting methods

Installment sales

Consider marginal tax rate & amount of gain to decide whether or not to elect out of installment method

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Installment Sales reported on Form 6252

Procedures for changing to LIFO

Advanced IRS permission required except for first year inventory carried

Form 970 in 1st year using LIFO

Compliance & Procedural Considerations

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END Chapter 11

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