Unit 2 Flashcards
52/53 week tax year
Instead of a calendar tax year or a physical tax year that are both 12 consecutive months
This variation does not have a fixed end date
Ranges from 52 to 53 weeks in length
May not always end on the last day of the month
Some businesses opted for a specific day of the week as their fiscal year end, such as the final Friday and June
When would you see a short tax year?
The first or last year of an entities existence
Or when an entity changes its accounting. (from fiscal to calendar or vice versa.)
How does a business adopt or elect a tax year?
When it files its first income tax return
Determining an estate tax year
The taxpayers death marks the end of an individuals final tax year
The following day is the beginning of the first tax year for the decedents estate
The first tax year is any period of 12 months or less that ends on the last day of the month
Can have a short tax year and use December or choose another month and have a fiscal tax year
What form is used to request a change in the tax year?
Form 1128, application to adopt, change, or retain a tax year
The IRS requires the use of the calendar year in the following instances
If the business keeps no books or records
There is no annual accounting period
The internal revenue code or IRS regulations require the use of a calendar year
What is the tax return due date for an estate, formed 1041
The 15th day of the fourth month, following the end of the entities tax year
With an extension of 5 1/2 months after the original due date (on the last day of the month and not the 15th of the month)
Requirement for partnerships and corpse to use a required tax year
The partnership or S corporation tax year must conform to its partners tax years
If one or Moore partner with the same tax year, owns a majority interest in the partnerships capital and profits, the tax year of those partners is the required tax year for the partnership (if owned by a corporation with a fiscal year)
If no majority interest tax year, the partnership must use the tax year if all the principal partners have the same tax year
If no majority interest, and all the principal partners do not have the same tax, the partnership must use the tax year that would result in the least aggregate deferral of income to its partners
Establishing substantial business purpose for an alternate tax year
A business can establish a business purpose for using a fiscal year, and corporation or partnership must generally use the calendar year
Form 1128, application to adopt, change, or retain tax year is used to establish a bona fide business purpose for a tax year
Sometimes called a natural tax year – follows the natural cycle of the business itself with a fiscal year in which the last two months of the year provide over 25% of gross receipts for the entire year
PSC
Personal service corporation
Section 444 election - what is it, requirements to make election
A partnership, corporation, or personal service corporation can request to use a tax year other than it’s required tax year by filing form 8716, election to have a tax year other than a required tax year
A business can request a section 44 for election if it meets all of the following requirements
- It is not a member of a tiered structure.
- It has not previously had a section 444 election in effect.
- It Alexa that meets the deferral period requirement.
Also must generally make certain required payments based upon the value of the tax deferral, the owners received by using a tax year different from the required tax year
Section 444 – deferral period
Deferral period is the number of months between the beginning of the retained year and the end of the first required tax year
If the election is to retain its tax year, it may only do so if the deferral period is three months or less
If requesting an adoption or a change to a tax year, the deferral period is the number of months from the end of the new tax year to the end of the required tax year
The IRS will allow a section 444 election only if the deferral period is less than the shorter of
- Three months or.
- The deferral period of the tax year being changed.
Section 444 election remains in effect until
It is terminated
If the election is terminated, another section 444 election cannot be made for the same tax year
It also ends automatically when any of the following occurs :
- The entity changes to its required tax year.
- The entity liquidates.
- The entity becomes a member of a tiered structure.
- The IRS determines that the entity willfully failed to comply with the required payments or distributions.
- The entity is an corporation, and the election is terminated.
Tax return due date of partnership and S corporations
Due on the 15th day of the third month, following the end of the year
For a calendar year partnership and corporations are due March 15
C corporation tax return due date
Due on the 15th day of the fourth month, following the end of the tax year
For a calendar year – tax return due on April 15 of the following year
Tax return filing requirement if a business ceases operations before the end of their year
Would be the 15th day of the third or fourth month, following the close of its short tax year
If a sea corporation dissolves on July 22, 2023 - the final return is due by November 15, 2023
Nonprofit entities filing due date
Returns are due on the 15th day of the fifth month following the end of their tax year
If using a calendar year, that would be May 15
Extended due date November 15 or six months
Sole proprietorship filing deadline
April 15 – extended due date, October 15
Partnerships, filing due date
15th day of the third month equals March 15
Extended due date September 15, six months
C corporations, filing due date
15th day of the fourth month equals April 15
Extended due date October 15 or six months
Unless the fiscal year ends June 30 – resulting and only three months, not four months with a due date of September 15, and extended due date of April 15 (7 months)
As corporation filing due date
15th day of the third month following the tax year
If a calendar year equals March 15
Extended due date of September 15 or six months
Form 1041 or trust and fiduciary returns filing due date
15th day of the fourth month equals April 15 on a calendar year
Extended due date September 30, only 5 1/2 months
FBAR filing due date
April 15 with an extended due date of October 15
The extension is automatic without the need to request
Retirement plans, form 5500 – filing requirement
July 31, extended due date of October 15
Estate tax return, form 706 – filing requirement
Nine months after death, with a six month extension allowed
What types of accounting methods are used to report taxable income?
Cash method
Accrual method
Special methods of accounting for certain items of income and expenses
Hybrid method – using elements of the methods above
The accrual method is required for
Publicly traded corporations
Large nonprofit entities also often required to use a cruel method – because of receiving federal grants and having required audited financial statements
What businesses are required to use accrual method for accounting?
Any tax shelter, regardless of its size
A C corporation, or a partnership with a C corporation partner, with average annual gross receipts over the three prior tax years exceeding $30 million
What businesses can use the cash method for accounting?
30 million or less in annual gross receipts and 2024, regardless of the taxpayers industry or whether or not the business produces inventory
This qualifies a business as a small business
However, corporations and partnerships can use the cash method, regardless of their annual gross receipts
Form 3115
Application for change in accounting method
Used to switch from a cruel method to the cash method or vice versa
12 month rule for certain prepaid expenses
Special rule which the cash basis taxpayer is not required to capitalize amounts paid for periods that do not extend beyond the earlier of the following
12 months after the benefit begins
Or
The end of the tax year after the tax year in which payment is made
Constructive receipt and cash method accounting
For tax purposes, constructive receipt is the same as actual receipt of income
Restrictions for the hybrid accounting method
- If an entity uses the cash method for reporting income, it must use the cash method for reporting expenses.
- If an entity uses the accrual method for reporting expenses, it must use the accrual method for reporting income.
- If inventory is necessary to account for income, and the business does not qualify as a small business for the rules for the cash method, the business must use the accrual method for purchases and sales.. but the cash method can be used for other income and expense items
Changing accounting methods – prior approval from the IRS is required for
- Changes from cash to accrual or vice versa, unless required by law.
- Changes in the method used to value inventory.
- Changes in the method of depreciation or amortization.
Must file form 3115, application for change in accounting method, to request a change
Changing accounting methods – prior IRS consent is not required for the following changes
- Making an adjustment in the useful life of a depreciable or amortize asset.
- Correcting a math error or an error in figuring tax liability.
- A change in accounting method when the changes required by tax law – example when a businesses average gross receipts exceeds $30 million – becomes an automatic change.
Depreciation errors – how are they corrected?
Corrected by either filing an amended tax return or filing a change in accounting method form 3115
And amended return is permitted to correct an error that occurred on only one tax return not multiple years
When an accounting method change is mandated by law and does not require prior sent from the IRS… filing requirement
The form 3115 is still filed in the first affected that contains the change
Changing accounting methods – unclaimed depreciation
For closed as well as open years, unclaimed depreciation is allowed through a section 481 a adjustment that reduces income in the year of change
If the entire adjustment is less than $25,000, a minimus rule permits, taxpayers to take 100% of the amount into account in the year of change
Inventories – taxpayers that meet the $30 million gross receipts test in 2024
Not required to account for inventories, but may use a method of accounting for inventories that either
Treat inventories as non-incidental, materials and supplies, or
Conform to the taxpayers financial accounting, treatment of inventories
Cash basis, taxpayer may still not deduct items for sale to customers from inventory until the later of
When they are sold
Or
When they are paid for
UNICAP
The uniform capitalization rules
UNICAP - Businesses that meet the $30 million gross receipts test
No longer required to apply the uniform capitalization rules
But does not apply to businesses that are engaged in the production of real property, for example, a real estate developer that builds houses for resale
Business is subject to the UNICAP rules – inventory should include all of the following
Merchandise or stock in trade
Raw materials, work in process, finished products
Supplies that physically become a part of items for sale – labels, stickers, boxes, exterior, packaging, etc.
Purchased merchandise if the title has passed to the taxpayer – even if still in transit
Goods under contract for sale that have not yet been applied to the contract
Goods out on consignment
Goods held for sale in display rooms
Intangible cost – examples include film or video production
The following items are never included in inventory
Good the business has sold if the legal title or ownership has passed to the buyer
Goods consigned to the business, but not owned by the business
Ordered for future delivery, if the business does not have the legal title
Land, buildings, and depreciable equipment that are used in the business are never included in the calculation of inventory
Certain types of businesses are not subject to UNICAP regardless of their gross receipts, including
Sellers of personal use or non-business property – such as a hobby activity
Research in experimental, expenditures and marketing or advertising cost
Intangible, drilling, and development cost of oil and gas or geothermal Wells
Timber raised, harvested or grown, and the underlying land
Qualified, creative expenses, incurred as self-employed writers, musicians, or artist
Loan originations
Warranty cost, and product liability cost
Property provided to customers in connection with providing services – property must be minimus and not be included in inventory in the hands of the service provider (example is a vet selling pet food)
Gross profit equals
Gross receipts minus cost of goods sold
Cost of good sold equals
Beginning inventory plus purchases in the current period minus ending inventory
Cost of goods available minus any ending inventory
What is included in the calculation of cost of good sold
Material used for production
Direct labor cost
Manufacturing overhead – think electricity, equipment, depreciation, and rent for a factory or storage facility
Cost of merchandise
Shipping terms and transfer of ownership
Shipping terms dictate when taxpayer must take an item out of inventory and recognize income from a sale
Terms indicate the point which the title or ownership of goods transfers from seller to buyer
FOB destination
Title passes to the buyer at the point of destination – when goods arrive at the buyers location
FOB shipping point
Title passes to the buyer at the point of shipment – when the goods leave the sellers premises
Also called FOB origin
Common inventory methods
Methods used to assign costs to the items in inventory include
Specific identification method
Average cost method
FIFO
LIFO
LIFO and FIFO are the two most common
IRS requirements for inventory methods
The IRS does not require a specific inventory method
But does require permission if the business leader decides to switch from one inventory method to another
To change an inventory method – filing form 3115 to get permission
Average cost method
Used by businesses that carry a large number of inexpensive items – difficult to track individually
Formula for figuring average inventory cost
First – calculate average unit cost = cost of units purchased or manufactured / total quantity of units
Second – calculate aggregate inventory cost = average unit cost x units in current inventory
FIFO - results in what type of ending inventory?
What types of businesses use this method?
In an economy with rising prices or inflation, the use of FIFO will assign a higher value to ending inventory than other methods
Results ANA lower cost of sales and higher taxable income
Used commonly by businesses that sell perishable items like grocery stores
Inventory requirement for stock sales - IRS
When the buyer cannot identify which shares they sold
And the shares acquired were at different times or at different prices
The IRS requires the use of the FIFO method - the sale is allocated to the shares that were purchased earliest
What is the result of using the LIFO method?
Since the price of goods, labor, and materials generally rise over time
This method results in a lower value to inventory on hand
And higher amounts recorded as the cost of sales with a lower taxable income
This method is preferred by most businesses to get the lower taxable income
What are the differences between FIFO and LIFO
Inflation - rising prices
* FIFO has higher value of inventory
* FIFO HAS LOWER COST OF GOOD SOLD
DEFLATION – FALLING PRICES
* FIFO has a lower value of inventory
* FIFO has higher cost of good sold
Inventory methods commonly used in industries where inventory loses value quickly
The cost method
Lower of cost or market
The retail method
Commonly used for retailers of fashion goods, seasonal goods, or technological goods
Which inventory method results in reduced taxes – with inflation
LIFO
The cost method
* merch on hand at beginning of year
* merch purchased during the year
* merch produced during the year
All direct and indirect cost of producing and purchasing the inventory are included in the valuation of the inventory
Merchandise on hand at the beginning of the year – cost means the ending inventory cost of the goods at the end of the proceeding near
Merchandise purchased during the year – cost means the invoice price minus discounts, transportation, or other charges incurred in acquiring the goods. May also include cost that must be capitalized.
Merchandise produced during the year – cost means all direct and indirect cost, including those that have to be capitalized under UNICAP
The lower of cost or market method
Commonly used for inventory that will lose value quickly, such as seasonal clothing, or pharmaceuticals, which lose value the longer they are held in the business
Potentially because they cannot be sold to customers once they are expired
The lower of cost or market method cannot be used in conjunction with what other method
LIFO
Retail inventory method
Only provides an estimate – it is not wholly accurate. Business would still need to perform a physical inventory at reasonable intervals.
Used for certain business types, like multi store retailers across multiple locations
First – need to determine average markup rate = cost / retail price
Ending inventory = starting inventory + purchases - (sales x markup %)
Inventory shrinkage
Term for lost, stolen, or damaged inventory
Shrinkage reduces a businesses ending inventory and thus increases COGS
Sales do not affect the shrinkage calculation
Casualty or theft loss of inventory – two options to record the loss
Adjust its cost of good sold
Or record the loss separately as a casualty or theft loss
If deducted separately – must eliminate the affected inventory items from the CO GS by making a downward adjustment to opening inventory or purchases. Must avoid counting the last twice.
Need to be deducted in the year of discovery
If expecting insurance reimbursement – should not claim a loss to the extent it has a reasonable prospective recovery
