©2003 south-western college publishing, cincinnati, ohio chapter 7 accounting periods & methods...

©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio©2003 South-Western College Publishing, Cincinnati, Ohio

Chapter 7

Accounting Periods & Methods and DepreciationAccounting Periods & Methods and Depreciation

© 2003 South-Western College Publishing Transparency 7-2

Objective

Have a general understanding of the different accounting

periods and methods allowed


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”


Tax Years for PartnershipsPartnerships 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 yearMay use fiscal year if it results in a deferral period of no

more than three months


Tax Year for S CorporationsS 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

31required tax payment also applies to fiscal year-end partnerships


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.

CalculationThe “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


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


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 _____”


must use same method for tax & books

Accounting MethodsThere are three acceptable accounting methodsCashHybridAccrual 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


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), orpartnership with a corporation as a partner, orC 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


Objective

Understand the concept of depreciation and be able to

calculate depreciation expense using MACRS tables


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


Personal PropertyEach asset is depreciated according to an IRS-

specified recovery period 3 year Race horses, tractors 5 year 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


Personal Property (continued)

Depreciation is determined using IRS tables (Table 2 in text) Percentages from tables are based on the double-

declining balance method of depreciationApplied to cost basis without regard for estimated salvage

value

May elect to use tables based on straight line instead

Tables include half year convention1/2 year depreciation in year of acquisition and 1/2 year

depreciation in year of disposition


Personal Property (continued) Always use the half-year convention unless mid-quarter

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


March 15 - purchase furniture for $180,000. Furniture is a 7-year asset.

Using tables: Year 1: $180,000 x .1429 = $25,722Year 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 = $2,400Year 2: $12,000 x .32 = $3,840

Personal Property Example


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


Real PropertyReal 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


Objective

Know when an election to expense the cost of an asset may be used


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.


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.

CalculationCost $39,000§179 expense (24,000)Adjusted depreciable basis $15,000less 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

Section 179 Example


Objective

Understand the limitations placed on depreciation of “listed” property

and luxury automobiles


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


Luxury Autos LimitsMaximum 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 - $4,900Year 2003 - $2,950Year 2004 and subsequent years - $1,775

Automobiles may be wholly depreciated, it will just take much longer than five years


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 limitMay use 30% Bonus depreciation in addition

to regular depreciation


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.

Calculation30% Bonus depreciation (50,000 X .3) $15,000Regular depreciation (50,000 - 15,000).2 7,000Total $22,000Times business use percentage 60% X .60Possible depreciation $13,200

Luxury limitation 60% of ($3,060 + $4,600) $ 4,596

Total depreciation: $4,596


Objective

Know the tax treatment for goodwill and certain other intangible assets


Intangible AssetsSection 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


Objective

Be able to determine whether parties are classified as related for tax purposes and understand the

tax treatment of related party transactions


Related Party TransactionsRelated parties are:

A corporation and > 50% owner Brother/sister corporations Parent/subsidiary corporations Family members

spouses, lineal descendants, siblingsalso 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


The End!My head hurts!

©2003 south-western college publishing, cincinnati, ohio chapter 7 accounting periods & methods...

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