Transcript ch07
Chapter 7
Accounting Periods & Methods
and Depreciation
©2003 South-Western College Publishing, Cincinnati, Ohio
Objective
Have a general understanding
of the different accounting
periods and methods allowed
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Tax Year for Individuals
Individuals must use a calendar year as their
tax year
Businesses must use a calendar year as their
tax year unless they can show a different
“natural business year”
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Tax Years for Partnerships
Partnerships don’t pay taxes themselves but
must file an informational tax return (1065)
Tax year must be the same tax year as 50%
of partners
If partner’s tax years are different, use tax year of
principal owners (principal is 5% or more owner)
or least deferral method
Otherwise use calendar year
May use fiscal year if it results in a deferral period of no
more than three months
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Tax Year for S Corporations
S Corporations don’t pay taxes themselves but
must file an informational tax return (1120S)
They must use a calendar year; however,
May elect a fiscal year if the S corporation can
demonstrate a business purpose, or
A fiscal year results in a deferral period of less than
3 months and S corporation agrees to make annual
“required tax payment.”
deferral period = period of time from fiscal year-end to
December 31
required tax payment also applies to fiscal year-end
partnerships
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Deferral Example
S-Corp has taxable income of $360,000 for the year
ended 5/30 and last year’s required tax payment =
$15,000.
Calculation
The “required tax payment” =
(cash flow in deferral period x 39.6%) - prior year’s tax payment
Deferral period is 7 months.
$360,000/12 x 7 months = $210,000 cash flow.
($210,000 x 39.6%) - $15,000 = $68,160 deposit due
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Tax Year for Personal Service
Corporation
A Personal Service Corporation (PSC) is corporation
with shareholder-employee who provides a personal
service (like an architect or dentist)
Generally must adopt calendar year
Can adopt a fiscal year if:
Can prove business purpose, or
Shareholders’ salaries for deferral period are proportionate
to salaries received during rest of the period and corporation
limits its deduction
Purpose is to keep the PSC from deducting one year’s worth of
salary in beginning nine months. If salaries don’t remain
constant, the PSC can only deduct pro rata amount
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Short Tax Periods
Occur when taxpayer changes from fiscal
year-end to calendar year-end or visa versa
Taxpayer must annualize income (see
example in text), calculate tax and then
allocate it to the short period
At top of tax return must complete: “For Short Tax
Year From _____ to _____”
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Accounting Methods
There are three acceptable accounting methods
Cash
must use same method
Hybrid
for tax & books
Accrual
Must use one method consistently
Make an election on your first return by filing using a
particular method
Must file Form 3115 within first 6 months after initial
election to request permission from IRS to change
accounting methods
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Accounting Methods (continued)
Cash basis taxpayers
Can’t deduct prepaid rent or interest
Can’t use cash basis if taxpayer is a:
trust with UBI (unrelated business income), or
partnership with a corporation as a partner, or
C corporation
PSCs and farms may use cash basis, and entities
with gross receipts < $5M
Accrual basis taxpayers
Must report prepaid interest or rent as income when
received (i.e., use cash method)
Hybrid basis taxpayers
Cash method but must use accrual for COGS
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Objective
Understand the concept of
depreciation and be able to
calculate depreciation expense
using MACRS tables
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Depreciation (Form 4562)
Depreciation is a process of allocating the
cost of assets to expense over their useful life
Land is not depreciated
Rules for depreciation have changed over the
years
Pre-1980: depreciated using straight line method
1980-1986: use ACRS tables
Post-1986: use MACRS tables
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Personal Property
Each asset is depreciated according to an IRSspecified recovery period
3 year
5 year
Race horses, tractors
Computer, cars and light trucks, R&D
equipment
7 year Office furniture, machinery, property with
no life
10 year Barges, vessels
15 year Land Improvements
20 year Utility plants, sewers
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Personal Property (continued)
Depreciation is determined using IRS tables
(Table 2 in text)
Percentages from tables are based on the doubledeclining balance method of depreciation
Applied to cost basis without regard for estimated
salvage value
May elect to use tables based on straight line
instead
Tables include half year convention
1/2 year depreciation in year of acquisition and 1/2 year
depreciation in year of disposition
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Personal Property (continued)
Always use the half-year convention unless midquarter convention applies
Assumes asset owned half of year of purchase, regardless
of true purchase date
Assumes asset owned half of year of disposition, regardless
of true disposition date
Mid-quarter convention is required if taxpayer
purchases 40% or more of total assets in last quarter
of tax year
Applies to every asset purchased in the year
Excluding real property and §179 property
Must use special mid-quarter tables
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Personal Property Example
March 15 - purchase furniture for $180,000. Furniture is
a 7-year asset.
Using tables:
Year 1: $180,000 x .1429 = $25,722
Year 2: $180,000 x .2449 = $44,082
November 3 - purchase computer for $12,000. This is a
5-year asset.
Using tables:
Year 1: $12,000 x .20 = $2,400
Year 2: $12,000 x .32 = $3,840
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Bonus Depreciation Property
Additional depreciation is available for assets
purchased between 9/11/01 and 9/11/04
Amount = 30% of adjusted basis
Only for new personal property with recovery
period < 20 years
Take 30% bonus first, then regular MACRS
depreciation on remaining basis
May elect out of bonus if anticipate need for
higher depreciation in future years
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Real Property
Real assets are placed in a recovery period
depending on use
27.5 year: Residential rental
39 year: Nonresidential
31.5 year if placed in service before 5/13/93
Real assets are depreciated using the
straight-line method with a mid-month
convention (Table 4)
Treats all acquisitions/dispositions as occurring in
the middle of the month
There is no mid-quarter convention for real estate
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Objective
Know when an election to expense
the cost of an asset may be used
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Election to Expense - Section 179
§179 allows immediate expensing of qualifying
property
In 2002, the annual amount allowed is $24,000
Qualifying property is tangible personal property used in a
business
§179 limited:
If cost of qualifying property placed in service in a year
exceeds $200,000, reduce §179 expense dollar for dollar
Cannot take §179 expense in excess of taxable income, but
may carry forward any unused amount
If using 30% bonus take §179 first, then 30%, then
regular depreciation.
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Section 179 Example
In July 2002, purchase a tooling machine (7-year asset)
for $39,000. The taxable income from business is
$45,500 and total asset acquisitions for year are
$82,453.
Calculation
Cost
$39,000
§179 expense
(24,000)
Adjusted depreciable basis
$15,000
less 30% bonus
( 4,500)
Remaining depreciable basis
$10,500
x Table %
0.1429
$ 1,500
Total depreciation: $20,000 + $4,500 + $1,500 = $30,000
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Objective
Understand the limitations placed
on depreciation of “listed” property
and luxury automobiles
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Listed Property
Special rules exist to limit deductions on assets used
both in a business and personally
Cars, cell phones, computers (unless used exclusively at
business), entertainment equipment
Limitation depends on amount of business use
If asset used > 50% for business, can use MACRS
If asset used < 50% for business, must use straight line
If business usage drops from > 50% to < 50%, must claim
excess depreciation as income on Form 4797
Separate section on page 2 of Form 4562 for listed
property
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Luxury Autos Limits
Maximum allowed amount is
Luxury auto limits x business use %
Depreciation on automobiles is also limited based on
business use (5-year MACRS amount x business use %)
Luxury auto limits are quite low:
Depreciation on autos placed into service in 2001 is:
Year 2001 - $3,060
Year 2002 - $4,900
Year 2003 - $2,950
Year 2004 and subsequent years - $1,775
Automobiles may be wholly depreciated, it will just take
much longer than five years
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Special First-Year Depreciation for
Automobiles
Extra depreciation of $4,600 is allowed
New autos placed in service between 9/11/01 and
9/11/04 and
Used > 50% for business
The $4,600 increases the luxury auto limit
May use 30% Bonus depreciation in addition
to regular depreciation
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Luxury Auto Example
In July 2002, purchase a new automobile (5-year
asset) for $50,000. The automobile was used 60% of
the time for business.
Calculation
30% Bonus depreciation (50,000 X .3)
$15,000
Regular depreciation (50,000 - 15,000).2
7,000
Total
$22,000
Times business use percentage 60%
X .60
Possible depreciation
$13,200
Luxury limitation 60% of ($3,060 + $4,600)
$ 4,596
Total depreciation: $4,596
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Objective
Know the tax treatment for goodwill
and certain other intangible assets
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Intangible Assets
Section 197 intangible assets (see list in text)
acquired by purchase may be amortized
based on a 15-year period
Many intangible assets are excluded from Section
197 provisions, for example, may not depreciate
internally generated assets like patent and
copyright
Must allocate for partial year in year of
acquisition
Report in separate section of Form 4562
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Objective
Be able to determine whether
parties are classified as related for
tax purposes and understand the
tax treatment of related party
transactions
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Related Party Transactions
Related parties are:
A corporation and > 50% owner
Brother/sister corporations
Parent/subsidiary corporations
Family members
spouses, lineal descendants, siblings
also used for purposes of calculating ownership in corporations
§267 disallows losses on sales between related
parties
When property is later sold to an unrelated party, all
previously disallowed losses may be taken against gain
§267 also applies to unpaid interest and expenses
between related parties
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The End!
My head hurts!
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