5 Accounting Methods and Special Entities Flashcards
(142 cards)
1
Q
How should a person account for revenue from an accounting perspective?
A
A person must use the method of accounting regularly used to compute income in keeping books and records. The method must clearly reflect income. The cash method and the accrual method are the most common. Specific provisions of the Internal Revenue Code (IRC) may override and require specific treatment of certain items.
2
Q
Whose consent is required for changes in accounting method?
A
Generally, IRS consent is required, which include, but are not limited to, change in either the overall system of accounting for gross income or deductions or treatment of any material item used in the system.
3
Q
When is income reported?
A
Income is reported when it can be estimated with reasonable accuracy.
4
Q
When are adjustments to income made?
A
Adjustments are made in a later year for any differences between the actual amount and the previously reported amounts.
5
Q
How is the tax year determined?
A
The accounting method determines the tax year, which is the annual accounting period used to keep the person’s books and records, in which an item is includible or deductible in computing taxable income.
6
Q
How are federal income taxes imposed?
A
Federal income tax is imposed on taxable income.
7
Q
When is the taxable period adopted?
A
The taxable period is adopted in a person’s first tax year.
8
Q
What are types of taxable periods?
A
- calendar year - 12-month period ending on December 31
- fiscal year - any 12-month period ending on the last day of the month
- 52 or 53 week tax year
- a short tax year is allowed for a business not in existence for an entire year (365 or 366 days) - ex - the start-up year or the year at dissolution
- a change of tax year generally requires IRS consent, and a short tax year return is then required
9
Q
What is the cash method?
A
A cash-method taxpayer accounts for income when one of the following occurs:
- cash or its equivalent is actually received
- cash or its equivalent is constructively received
10
Q
How are noncash forms of income, such as property or services, valued?
A
They are included in gross income at the fair market value - even if the property or service can be converted into cash at an amount lower than face value.
11
Q
What is a cash equivalent?
A
Property that is readily convertible into cash and typically has a maturity of 3 months or less. Cash equivalents are so near to maturity that the risk of loss due to a change in value is immaterial.
12
Q
What are examples of cash equivalents?
A
- checks (valued at face)
- promissory notes (valued at FMV)
- Property (transferable at current FMV)
13
Q
If the value of property cannot be determined, how is it valued?
A
If the value of property received cannot be determined, the value of what was given in exchange for it is treated as the amount of income received.
14
Q
If the property received and the property given are impossible to value, how is value determined?
A
The transaction is treated as open, and the consideration is not viewed as income until its value can be ascertained.
15
Q
What is the doctrine of constructive receipt?
A
An item is included in gross income when a person has an unqualified right to immediate possession.
16
Q
When does a person constructively receive income?
A
A person constructively receives income in the tax year during which it is credited to their account, set apart for them, or otherwise made available so that they may draw upon it at any time.
- it is more than a billing, offer, or promise to pay
- it includes the ability to use on demand, as with escrowed funds subject to a person’s order
- deferring deposit of a check does not defer income. However, dishonor (bounced or returned checks) retroactively negates the income.
17
Q
How is constructive receipt by an agent treated?
A
It is treated as if imputed to the principal.
18
Q
What is the claim-of-right doctrine?
A
It indicates that a taxpayer receiving payments under a claim of right and without restrictions on its use includes the payment in income in the year received even though the right to retain the payment is not yet fixed or the taxpayer may later be required to return it.
- if the payment is not received, the payment is not included in income.
19
Q
What is the economic benefit theory?
A
The economic benefit theory is that when an economic or financial benefit is conferred on an employee or independent contractor the transfer of property is equivalent to cash. This applies even when the taxpayer cannot choose to take the equivalent value of the income in cash.
20
Q
When are dividends considered to be constructively received for the cash method?
A
When made subject to the unqualified demand of a shareholder - Ex. - If a corporation declares a dividend in December and pays such that the shareholders receive it in January, the dividend is not treated as received in December.
21
Q
When bonds are sold between interest payment dates, how is the interest treated for the cash method?
A
The interest accrued up to the sale date is added to the selling price of the bond. The seller includes the accrued interest in gross income as interest income. The buyer reduces interest income, as a return of capital, by the same amount.
22
Q
When is prepaid rent included in gross income?
A
Prepaid rent is included in gross income when received, for both cash-method and accrual-method taxpayers.
23
Q
When are lease cancellation payments included in gross income for cash-method taxpayers?
A
Lease cancellations are included when received for cash-method taxpayers
24
Q
When are tenant improvements, in lieu of rent, included in gross income for cash-method taxpayers?
A
Tenant improvements, in lieu of rent, are included when received for cash-method taxpayers
25
When should advance rental payments be deducted by cash-method taxpayers?
The payee must deduct during the tax periods to which the payments apply.
26
When are tips reportable as gross income?
Tips are gross income when reported. An employee who receives $20 or more in tips per month working for any employer must report the tips to the employer by the 10th day of the following month.
27
When are a cash-method taxpayer's deductions included?
Their deductions include expenditures when actually paid, except generally for prepaid expenses.
28
If a taxpayer uses the cash-method to report income, must they use the cash-method to report expenses?
Yes
29
How are prepaid expenses deducted for cash-method taxpayers?
For cash-method taxpayers, prepaid expenses are generally not deductible when paid. Instead, prepaid expenses are prorated over the period of the expense.
30
What is the exception to the prepaid expense rule for cash-basis taxpayers?
The 12-month rule - This allows a cash-basis taxpayer to deduct a prepaid expense in the year of payment if two conditions are met:
1. the contract period of the expense cannot exceed 12 months (the taxpayer cannot prepay for 13 months of a service)
2. the contract period cannot extend beyond the end of the next taxable year (payment in year 1 cannot be for a benefit in year 3)
31
Is prepaid interest an allowed deduction under the 12-month rule?
No, prepaid interest is not allowed a deduction until the year to which the interest relates.
32
When do accrual-method taxpayers account for income?
In the period it is actually earned.
33
When do taxpayers with applicable financial statements (AFSs) include income?
Generally no later than the inclusion for financial accounting purposes. This AFS rule does not apply to special methods of accounting (ex - long-term contracts, installment agreements) or mortgage servicing contracts.
34
When do taxpayers without applicable financial statements (AFSs) include income?
They include income when all the events have occurred that fix the right to receive it and the amount can be determined with reasonable accuracy.
35
Is a right to receive income fixed if it is contingent on a future event?
NO
36
When are goods shipped on consignment considered to have met the all-events test to fix the right to receive income?
When the goods shipped on consignment are sold
37
When do accrual-method taxpayers include prepaid income?
Prepaid income must generally be included when received.
38
When do accrual-method taxpayers include prepayments for merchandise sales in gross income?
When it is reported for accounting purposes, if reported earlier than when earned.
39
When do accrual-method taxpayers include expenses?
Expenses are deductible in the period in which they accrue.
40
What are the requirements for an accrual-method taxpayer to claim an allowable deduction?
The accrual-method taxpayer may claim an allowable deduction when both of the following requirements are met:
1. all events have occurred that establish the fact of the liability, including that economic performance has occurred.
2. the amount can be determined with reasonable accuracy
41
For accrual-method taxpayers, when does economic performance occur?
Economic performance occurs as services are performed or as property is provided or used.
42
How are reserves for contingent liabilities determined for accrual-method taxpayers?
Under current case law, reserves for contingent liabilities (such as product warranties) are not determinable in amount with reasonable accuracy. Therefore, only amounts paid are deductible. Both cash-basis and accrual-method taxpayers must use the direct write-off method.
43
How are tax deductible expenses related to contingent liabilities calculated?
Using the direct write-off method
beginning balance + accrued expense - ending balance = tax deductible expense
44
How is accrued vacation pay deducted for accrual-method taxpayers?
It is generally deductible by the employer when paid or in the year accrued if paid within 2.5 months of year end.
45
How are deductions for amounts payable to related parties treated for accrual-method taxpayers?
Deduction of an amount payable to a related party is allowed only when includible in gross income of the related party.
46
Which taxpayers are required to use the accrual method?
- C corporations
- partnerships with a C corporation as a partner
- charitable trusts with unrelated income
- tax shelters
47
What are considered tax shelters?
Tax shelters include any arrangement for which the principal purpose is avoidance of tax, any syndicates, and any enterprise in which the interests must be registered as a security.
48
What entities are not considered tax shelters?
The following taxpayers are exceptions to the general rule and allow the use of the cash method:
- qualified personal service corporations
- entities that meet the gross receipts test by having $27 million or less average gross receipts in the 3 preceding years
- farming or tree-raising businesses
49
What is the required accounting method for a taxpayer who maintains inventory?
Accrual method, with regard to purchases and sales.
50
Which taxpayers maintaining inventory are exceptions to the inventory rule (required accrual method)?
Qualifying taxpayers who satisfy the gross receipts test for each test year. The average annual gross receipts (consisting of the test year and the preceding 2 years) for each test year must be $27 million or less.
51
How does the gross receipts test apply to S corporations regarding the inventory method?
S corporations are not subject to the $27 million limitation, however if inventory sales are a material part of the S corporation's operations, the accrual method must be used to calculate gross profit.
52
What is the inventory method?
A taxpayer who maintains inventory must use the accrual method, exceptions to the rule include qualifying taxpayers who satisfy the gross receipts test for each year. The inventory method used must clearly reflect income and conform to GAAP of the trade or business. Inventory may be valued at cost or at the lower of cost or market.
53
How may inventory be valued?
At cost or the lower of cost or market
54
What is gross income for the inventory method?
Gross income includes receipts reduced by COGS whether purchased or manufactured
55
How is the cost of purchased merchandise calculated?
Cost = purchase price - trade discounts + handling charges
56
What are the uniform capitalization rules?
The uniform capitalization rules require the costs for acquiring property for sale to customers (retail) to be capitalized. These rules do not apply if property is acquired for resale and the company's annual gross receipts (for the past 3 years) do not exceed $27 million. Both direct and most allocable indirect costs necessary to prepare the inventory for its intended use must be capitalized.
57
How is the cost of produced merchandise calculated?
Cost must be calculated using the full absorption costing method. Direct costs of material and labor are included in inventory. Overhead costs for manufacturing are also included. Nonmanufacturing costs need not be included in inventory, but interest must be included in inventory on property that is real or requires more than 2 years of production (1 year if it costs more than $1 million).
58
What standard methods to determine inventory costs are allowable?
- specific identification
- average cost
- FIFO
- LIFO
59
What is the first in first out (FIFO) inventory costing method?
FIFO assumes that the first items acquired are the first items sold. Ending inventory contains the most recently acquired items.
60
What is the last in first out (LIFO) inventory costing method?
LIFO assumes that the latest items acquired are the first items sold. If LIFO Is used, inventory must be valued at cost.
61
What is the benefit LIFO in a period of rising prices?
LIFO results in a higher cost of goods sold, because COGS is higher, net income is lower, resulting in lower current tax liability.
62
What is the restriction for using LIFO for tax purposes?
LIFO may only be used for tax purposes if it is used for financial reporting.
63
Can taxpayers using the rolling-average method for financial accounting purposes use the same method for tax purposes?
Yes, if the related safe harbor rules are satisfied.
64
What is a long-term contract?
A long-term contract is a contract completed in a tax year subsequent to the one in which it was entered into for building, construction, installation, or manufacturing.
65
What are long-term manufacturing contracts?
Long-term manufacturing contracts are for items that normally require more than 12 months to complete or that are unique and not usually inventory items.
66
How should long-term contracts be accounted for by a trade or business of a taxpayer?
A trade or business of a taxpayer must use the same method for each of its long-term contracts. Long-term contract rules apply to direct costa and allocable portions of labor, material, and overhead costs.
67
What costs do not need to be allocated to a specific contract?
- unaccepted bids
- marketing
- research and development (if not restricted to the specific contract)
68
What is the completed-contract method?
The completed-contract method accounts for (report) receipts and expenditures in the tax year in which the contract is completed.
69
When is the completed-contract method allowed?
This method is allowed only for:
- home construction projects
- small businesses (average annual gross receipts not greater than $27 million for the 3 preceding tax years) whose construction contracts are expected to take not greater than 2 years to complete.
70
What is the percentage-of-completion method?
The percentage-of-completion method reports as income that portion of the total contract price that represents the percentage of total work completed in the year. It may be measured by the ratio of costs for the tax year to total expected costs.
71
How do you calculate the percentage-of-completion gross profit for the current period?
Contract price - total estimated cost of contract = estimated total gross profit
Total gross profit x percent completed = gross profit recognized to date
Gross profit recognized to date - gross profit recognized in prior periods = gross profit recognized in current period
72
How do you calculate total estimated cost of contract?
cost incurred to date + remaining estimated cost to complete = total estimated cost of contract
73
How do you calculate percent completed of a contract?
Total cost to date / total estimated cost of contract = % complete
74
If the percentage-of-completion method is used for calculating gross profit for a contract, what happens when the contract is complete?
The taxpayer must pay interest on any additional tax that would have been incurred if actual total costs had been used instead of expected costs.
A taxpayer may elect not to apply this if the cumulative taxable income or loss using estimated costs is within 10% of the cumulative taxable income or loss using actual costs.
75
What is the installment method required for?
Installment sales by both cash-method and accrual-method taxpayers, unless an election is made not to apply the method.
76
What is the installment method required for?
Installment sales by both cash-method and accrual-method taxpayers, unless an election is made not to apply the method.
77
What is an installment sale?
An installment sale is a disposition of property in which at least one payment is received after the year of sale.
78
Does the installment method apply only to gains?
Yes
79
How are losses on installment sales recognized?
A loss on an installment sale is fully recognized in the year realized (unless recognition would be deferred even if the sale was not an installment sale).
80
What sales is the installment method not generally applied to?
- inventory personal property sales
- revolving credit personal property sales
- dealer dispositions
- securities, generally if publicly traded
- sales by manufacturers of intangible personal property
81
How is installment sale income calculated?
Current-year receipts x gross profit percentage
82
How do you calculate gross profit percentage for the installment method?
Calculate COGs = adjusted basis + selling expense
calculate gross profit = contract (sale) price - COGS
calculate gross profit % = gross profit / contract (sales) price
83
How is depreciation recapture recharacterized as ordinary income treated regarding the installment method?
The fully amount of any depreciation recapture recharacterized as ordinary income must be recognized in the year of sale, regardless of the payments received. This does not apply to unrecaptured Sec. 1250 gains because it is not recharacterized as ordinary income.
84
What are hybrid methods?
Any combination of permissible accounting methods may be employed if the combination clearly reflects income and is consistently used.
85
May a taxpayer use different methods for separate businesses?
Yes
86
When is does an organization have exempt status?
Exempt status generally depends on the nature and purpose of an organization. An organization is tax-exempt only if it is of a class specifically described by the IRC as one on which exemption is conferred.
87
How may organizations that are tax-exempt be organized?
They may be organized as a:
- corporation
- trust
- foundation
- fund
- community chest
- society
- etc.
88
Is an organization operated for the primary purpose of carrying on a trade or business for profit tax-exempt?
Generally, no.
89
What are examples of organization types that my be exempt?
- religious or apostolic organizations
- political organizations
- social clubs
- athletic clubs
- fraternal beneficiary associations
- chambers of commerce
- real estate boards
- labor organizations
- civic welfare associates
- certain domestic and foregin corporations
90
May organizations that foster national or international amateur sports competition be exempt?
Yes, if they do not provide athletic facilities or equipment.
91
When are social clubs considered exempt organizations?
If they are organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes, are an exempt class.
- no part of net earnings may inure to the benefit of any private shareholder
- exempt status is lost if 35% or more of its receipts are from sources other than membership fees, dues, and assessments.
92
What are prohibited transactions?
Certain employee trusts lose exempt status if they engage in prohibited transactions, ex - lending without adequate security or reasonable interest, or paying unreasonable compensation for personal services.
93
How are religious, charitable, scientific, educational, and literary organizations considered exempt organizations?
A broad class of exempt organizations, no part of net earnings may inure to the benefit of any private shareholder or individual. No substantial part of its activities may attempt to influence legislation or a political candidacy (ex - political action committee).
94
What happens if a religious, charitable, scientific, educational, or literary organization, with exempt status, attempt to influence legislation?
The organization will lose its exempt status. However, most organizations can elect to replace the substantial part of activities test with a lobbying expenditure limit.
95
What happens if an organization with a lobbying expenditure limit exceeds their limit?
If an election for a tax year is in effect for an organization and that organization exceeds the lobbying expenditure limits, an excise tax of 25% will be imposed on the excess amount.
96
What happens if an organization with exempt status participates directly in a political campaign?
The exempt status will be lost.
97
What are private foundations?
Each domestic or foreign exempt organization is a private foundation unless, generally, it receives more than a third of its support (annually) from its members and the general public. In this case, the private foundation status terminates, and the organization becomes a public charity.
98
How does exempt status affect private foundations?
The exempt status of a private foundation is subject to statutory restrictions, notification requirements, and excise taxes.
99
When are charitable, religious, or scientific organizations presumed to be a private foundation?
They are presumed to be a private foundation unless it either is a church, or has annual gross receipts under $5,000, or notifies the IRS that it is not a private foundation (on form 1023) within 27 months from the end of the month in which it was organized.
100
What is a feeder organization?
An organization that pays all of its profits to exempt organizations. An organization must independently qualify for exempt status, it is not enough that all of its profits are paid to exempt organizations.
101
What are homeowners' associations?
A homeowners' association is one organized for acquisition, construction, management, maintenance etc., of residential real estate or condominiums. A cooperative housing corporation is excluded.
102
Are homeowners' associations tax exempt?
Yes
103
How can a condominium management association be treated as a tax-exempt housing association?
They must file a separate election for each tax year by the return due date of the applicable year.
104
What are considered 501(c)(3) organizations?
Charitable, educational, religious, scientific, and literary organizations
105
What are considered 501(c)(4) organizations?
civic organizations
106
What are considered 501(c)(5) organizations?
Labor agricultural organizations
107
What are considered 501(c)(6) organizations?
Professional business organizations
108
What are considered 501(c)(7) organizations?
social and recreation clubs
109
What are considered 501(c)(8) organizations?
fraternal beneficiary societies
110
What are considered 501(c)(9) organizations?
employee beneficiary organizations
111
What are considered 501(c)(29) organizations?
qualified nonprofit health insurance issuers
112
What is an unrelated business?
A trade or business activity regularly carried on for the production of income (even if a loss results) that is not substantially related to performance of the exempt purpose or function, i.e., that does not contribute more than insubstantial benefits to the exempt purposes.
113
What is unrelated business income?
The gross receipts from unrelated business less related deductions?
114
Are tax-exempt organizations subject to tax on income from unrelated business income (UBI)?
Yes
115
What are exclusions from unrelated business taxable income (UBTI)?
- investment income - dividends, interest, annuities
- research
- royalties
- rents - real property only
- gain or loss from disposition of property other than inventory
116
Do related deductions for UBI include charitable donations?
Yes, however donations for carrying out a business's own programs are not included.
117
What is a qualified sponsorship payment?
A qualified sponsorship payment is one from which the payor does not expect any substantial return or benefit other than the use or acknowledgement of the payor's name or logo. The payor may not receive a substantial return.
118
What code provisions are exempt organizations subject to tax on UBI required to comply with?
Code provisions regarding installment payment of estimated income tax by corporations.
119
How are losses from an unrelated trade or business treated?
They are not permitted to be offset against income from another unrelated trade or business (except for NOL from tax periods before January 1, 2018).
120
When is an income tax return required of an exempt organization?
Form 990-T is required of an exempt organization with at least $1,000 of gross income used in computing the UBI tax for the tax year.
121
What donations are tax-deductible?
Donations to the following organizations:
- corporations organized under an Act of Congress
- all 501(c)(3) organizations except those testing for public safety
- cemetery companies
- cooperative hospital service organizations
- cooperative service organizations of operating educational organizations
- child-care organizations
122
When a tax-exempt organization solicits for contributions or other payments, what is required?
A statement if payments to that organization are not deductible as charitable contributions for federal income tax purposes.
123
How is executive compensation taxed for exempt organizations?
Exempt organizations generally will incur an excise tax of 21% on the sum of compensation in excess of $1 million paid to a covered employee and any excess parachute payment paid to a covered employee.
124
What is a covered employee?
A covered employee includes an employee who is one of the five highest-compensated employees for the current year or who is designated as a covered employee for tax years beginning January 1, 2017.
125
What is a simple trust?
A simple trust is formed under an instrument having the following characteristics:
- requires current distribution of all its income
- requires no distribution of the res (principal, corpus)
- provides for no charitable contributions by the trust
126
What is a complex trust?
A complex trust is any trust other than a simple trust. A complex trust can:
- accumulate income
- provide for charitable contributions
- distribute amounts other than income
127
What is a grantor trust?
A grantor trust is any trust to the extent the grantor is the effective beneficiary.
128
How is the income treated regarding a grantor trust?
The income attributable to a trust principal that is treated as owned by the grantor is taxed to the grantor. The grantor is also taxed on income from a trust in which the income may be applied for the benefit of the grantor. Use of income for the support of a dependent is considered the application of income for the benefit of the grantor. The income that may be supplied for the support of a dependent is not taxable to the grantor if it is not actually used.
129
When is a trust considered a grantor trust?
A trust is considered a grantor trust when the grantor has greater than 5% reversionary interest. All revocable trusts are grantor trusts.
130
What is a grantor?
A grantor is treated as the owner of a trust in which the income may be distributed or accumulated for the grantor's spouse.
131
How are the rules applied for classifying trusts?
The rules for classifying trusts are applied on a year-to-year basis.
132
How is tax imposed for trusts?
Tax is imposed on taxable income (TI) of trusts, not on items treated as fiduciary principal.
133
How is principal and income defined for federal income tax purposes?
State law defines principal and income of a trust for federal income tax purposes.
134
What is the Revised Uniform Principal and Income Act?
Many states have adopted this act, some with modifications. The act and state laws provide that trust instrument designations of fiduciary principal and interest components control. The act and state law also provide default designations.
135
What is trust principal?
Generally, principal is property held eventually to be delivered to the remainderman (the person who inherits or is entitled to inherit the property). It is held for or distributed to the income beneficiary.
Principal is also referred to as the corpus or res.
136
Is change in form of principal taxable income?
NO
137
What is trust income?
Income is return on, or for use of, the principal.
138
What are examples of principal fiduciary receipts?
- consideration for property - gain on sale
- replacement property
- nontaxable stock dividends
- stock splits
- stock rights
- liquidating dividends
- depletion allowance (natural resource property) - royalties (90%)
139
What are examples of income fiduciary receipts?
- business income
- insurance proceeds for lost profits
- interest
- rents
- dividends (taxable)
- extraordinary dividends
- taxable stock dividends
- depletion allowance (natural resource property) - royalties (10%)
140
What are examples of principal fiduciary disbursements?
- principal payments on debt
- capital expenditures - major repairs, modifications
- fiduciary fees - ex. management of principal
- tax on principal items - ex capital gains
141
What are examples of income fiduciary disbursements?
- business expenses (ordinary and necessary) - ex. interest expense
- production of income expenses - ex. maintenance/repair, insurance, rent collection fee, tax on fiduciary income
- depreciation
- fiduciary fees - ex. probate court fees and costs
142
What are the taxable income brackets for 2022?
- 0-$2,750 = 10%
- 2,751 - $9,850 = 24% + $275
- 9,851 - $13,450 = 35% + $1,979
- > $13,450 = 37% + $3,239
