Partnership tax year is based on...?
1. The tax year of partners owning greater than 50% of income and capital.
2. If a majority of the partners do not use the same tax year, then the tax year of the principal partners owning 5% or more
3. If the principal partners do not use the same tax year, use the year that results in the least aggregate deferral of income
52-53 Week Tax Year
The tax year may end on the same day of the week, such as the last Friday in October. This means tax years will vary in length between 52 & 53 weeks.
1. The year must end either on the last time a particular day occurs during a calendar month (e.g. last Friday in Oct)
2. Or the occurance of the particular day closest to the end of the month (e.g. Saturday closest to the end of Oct.)
Partnerships, S Corporations, and Personal Service Corporations may elect a taxable year that results in a tax defferal of 3 months or less.
Annual payments must be made by April 15 of the following year.
Required Payment = Net Income x 36% x Deferral Ratio
36% is the maximum individual tax rate + 1%
Deferral Ratio = # of months in the deferral period / 12
When IRS permission is not required for a change in a tax year.
1. When newly married to conform to the spouse for a joint return.
2. A change to a 52-53 year that ends in the same month as the former tax year.
3. To correct an erroneous filing in the previous year.
4. An existing partnership changing to conform to the partner's year.
5. 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, and (4) there is no change in status of the corporation (such as an S corporation election). A statement should be attached to the return indicating that each condition is met.
When can a tax year be shorter than 12 months?
1. When the taxpayer files a first or final return.
2. When there is a change in accounting periods.
What is Form 1128?
Appication for permission to change accounting periods.
What is the formula for annualizing income?
1. Determine the modified taxable income. Deductions must be itemized. Personal and dependency exemtions are prorated.
2. Modified taxable income x 12 / # of short period months
3. Compute tax using appropriate schedule.
4. Tax x #months in short period / 12
How is the Natural Business Year determined?
At least 25% of revenues must occur during the last two months of the tax year.
Define "Constructive Receipt."
Constructive receipt means that the income is made available to the taxpayer so that he may draw upon it at any time. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. This rule prevents taxpayers from deferring income that is otherwise available by merely "turning their backs" on it. A taxpayer cannot defer income recognition by refusing to accept payment until a later taxable year.
1. A check received after banking hours
2. Savings account interest
3. Bond coupons that have matured but not redeemed.
4. A paycheck received but not cashed.
What are the exceptions to Constructive Receipt?
1. Series E and EE Savings Bonds
2. Farmers and ranchers
3. Small taxpayer exception for inventory
Accrual Method of Accounting
1. Income is reported in the year it is earned
2. Income is earned when all the events that fix the right to receive the income have occurred and the amount of income can be easily determined.
3. The accrual method must be used for sales and costs of goods sold if inventories are an income-producing factor to the business and average gross receipts (over the last three years) exceed $1 million.
Exceptions to Accrual of income.
1. Qualified personal service corporations, certain types of farms, and entities with average gross receipts under $5 million are exempt from the requirement.
2. If the taxpayer's principal business does not involve the sale of inventory, up to $10 million in gross receipts are allowed before the IRS requires that the accrual method be used.
What is the "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 and the amount can be determined with reasonable accuracy. Similarly, an expense is deductible when all events have occurred that establish the fact of the liability and the amount of the expense can be determined with reasonable accuracy.
Define Reasonable Accuracy.
Approximate amounts are ascertainable.
Define the Economic Performance Test
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 requirement that economic performance take place before a deduction is allowed is waived if all of the following five conditions are met:
1. The all-events test, without regard to economic performance, is satisfied.
2. Economic performance occurs within a reasonable period (but in no event more than 8 1/2 months) after the close of the tax year.
3. 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.
4. The taxpayer is not a tax shelter.
5. Either the amount is not material or the earlier accrual of the item results in a better matching of income and expense.
Long Term Contract
Long-term contracts include building, installation, construction, or manufacturing contracts that are not completed in the same tax year in which they began. 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 items that normally require more than 12 calendar months to complete. Contracts for services (architectural, accounting, legal, and so on) do not qualify for long-term contract treatment.
Completed Contract Method
Income from a contract is reported in the taxable year the contract is complete.
Percentage of Completion Method
Taxpayer reports a percentage of gross income based on a percentage of the work completed.
Current Year Cost / Expected Total Cost = Percentage of Completion
Modified Percentage Completion Method
If no more than 10% of the work is done at the end of the year, profits may be defered to the next year.
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. The installment method is not applicable to sales of inventory, or marketable securities.
Calculating Installment Sales
1. Calculate Gross Profit Percentage (GPP) = (Sale Amount - Cost) / Sale Amount
2. Downpayment x GPP = Capital Gain of down payment
3. Calculate loan payment = Sale Amount - Down payment = CHS PV N i Solve for PMT.#months in current year f AMORT = ordinary income (interest) received.
4. X><Y = Principal Received from loan payments
5. Principal x GPP = Capital Gain of loan
6. Capital Gain of Loan + Capital Gain of Down Payment = Total Capital Gains.