Ch 16 Flashcards
Chapter definitions for South-Western Federal Taxation 2015: Comprehensive, 38th Edition
Accounting method
The method under which income and expenses are determined for tax purposes. Important accounting methods include the cash basis and the accrual basis. Special methods are available for the reporting of gain on installment sales, recognition of income on construction projects (the completed contract and percentage of completion methods), and the valuation of inventories (last-in, first-out and first-in, first-out). ?? 446474.
Accounting period
The period of time, usually a year, used by a taxpayer for the determination of tax liability. Unless a fiscal year is chosen, taxpayers must determine and pay their income tax liability by using the calendar year (January 1 through December 31) as the period of measurement. An example of a fiscal year is July 1 through June 30. A change in accounting period (e.g., from a calendar year to a fiscal year) generally requires the consent of the IRS. Usually, taxpayers are free to select either an initial calendar or a fiscal year without the consent of the IRS. ?? 441444.
Accrual method
A method of accounting that reflects expenses incurred and income earned for any one tax year. In contrast to the cash basis of accounting, expenses need not be paid to be deductible, nor need income be received to be taxable. Unearned income (e.g., prepaid interest and rent) generally is taxed in the year of receipt regardless of the method of accounting used by the taxpayer. ? 446(c)(2).
All events test
For accrual method taxpayers, income is earned when (1) all of the events have occurred that fix the right to receive the income and (2) the amount can be determined with reasonable accuracy. Accrual of income cannot be postponed simply because a portion of the income may have to be returned in a subsequent period. The all events test also is utilized to determine when expenses can be deducted by an accrual basis taxpayer. The application of the test could cause a variation between the treatment of an item for accounting and for tax purposes. For example, a reserve for warranty expense may be properly accruable under generally accepted accounting principles but not be deductible under the Federal income tax law. Because of the application of the all events test, the deduction becomes available in the year the warranty obligation becomes fixed and the amount is determinable with reasonable certainty. Reg. ?? 1.4461(c)(1)(ii) and 1.4611(a)(2).
Cash method
A method of accounting that reflects deductions as paid and income as received in any one tax year. However, deductions for prepaid expenses that benefit more than one tax year (e.g., prepaid rent and prepaid interest) usually are spread over the period benefited rather than deducted in the year paid. ? 446(c)(1).
Claim of right doctrine
A judicially imposed doctrine applicable to both cash and accrual basis taxpayers that holds that an amount is includible in income upon actual or constructive receipt if the taxpayer has an unrestricted claim to the payment. For the tax treatment of amounts repaid when previously included in income under the claim of right doctrine, see ? 1341.
Completed contract method
A method of reporting gain or loss on certain long-term contracts. Under this method of accounting, all gross income and expenses are recognized in the tax year in which the contract is completed. Reg. ? 1.4513.
Crop insurance proceeds
The proceeds received when an insured crop is destroyed. Section 451(d) permits the farmer to defer reporting the income from the insurance proceeds until the tax year following the taxable year of the destruction.
Crop method
A method of accounting for agricultural crops that are planted in one year but harvested in a subsequent year. Under this method, the costs of raising the crop are accumulated as inventory and are deducted when the income from the crop is realized.
Economic performance test
One of the requirements that must be satisfied for an accrual basis taxpayer to deduct an expense. The accrual basis taxpayer first must satisfy the all events test. That test is not deemed satisfied until economic performance occurs. This occurs when property or services are provided to the taxpayer, or in the case in which the taxpayer is required to provide property or services, whenever the property or services are actually provided by the taxpayer.
Fiscal year
A 12-month period ending on the last day of a month other than December. In certain circumstances, a taxpayer is permitted to elect a fiscal year instead of being required to use a calendar year.
Hybrid method
A combination of the accrual and cash methods of accounting. That is, the taxpayer may account for some items of income on the accrual method (e.g., sales and cost of goods sold) and other items (e.g., interest income) on the cash method.
Imputed interest
For certain long-term sales of property, the IRS can convert some of the gain from the sale into interest income if the contract does not provide for a minimum rate of interest to be paid by the purchaser. The seller recognizes less long-term capital gain and more ordinary income (interest income). ? 483 and the related Regulations.
Installment method
A method of accounting enabling certain taxpayers to spread the recognition of gain on the sale of property over the collection period. Under this procedure, the seller arrives at the gain to be recognized by computing the gross profit percentage from the sale (the gain divided by the contract price) and applying it to each payment received. ? 453.
Least aggregate deferral method
An algorithm set forth in the Regulations to determine the tax year for a partnership or an S corporation with owners whose tax years differ. The tax year selected is the one that produces the least aggregate deferral of income for the owners.
