ACCY 171

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summersgrace3
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144668
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ACCY 171
Updated:
2012-04-10 17:26:28
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Federal Tax Procedures CSUS Course South Western Taxation Business Entities 2012 Edition
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Chapter 4 & 5 of South-Western Federal Taxation: Taxation of Business Entities 2012 Edition
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  1. Tax Formula

    EXCLUSIONS
    - APPLY TO ALL ENTITIES
  2. Tax Formula

    INCOME
    INCLUDES ALL INCOME, BOTH TAXABLE AND NON TAXABLE
  3. COMPONENTS OF THE TAX FORMULA
    • - INCOME (BROADLY CONCEIVED)
    • - EXCLUSIONS
    • - GROSS INCOME
    • - DEDUCTIONS
    • - DETERMINING TAX
  4. Tax Formula

    GROSS INCOME

    Internal Revenue Code:
    - SECTION 61 - "except as otherwise provided in this subtitle, gross income means all income from whatever source determined"
  5. Tax Formula

    GROSS INCOME

    Items included:
    • - COMPENSATION FOR SERVICES
    • - BUSINESS INCOME
    • - GAINS FROM SALES & OTHER DISPOSITION OF PROPERTY
    • - INTEREST
    • - DIVIDENDS
    • - RENTS & ROYALTIES
    • - CERTAIN INCOME ARISING FROM DISCHARGE OF INDEBTEDNESS
    • - INCOME FROM PARTNERSHIPS
  6. Tax Formula

    DEDUCTIONS

    2 Types
    • 1 - DEDUCTIONS FOR AGI
    • 2 - DEDUCTIONS FROM AGI
  7. Tax Formula

    DEDUCTIONS

    General Rule:
    ... ALL ORDINARY AND NECESSARY TRADE OR BUSINESS EXPENSES ARE DEDUCTIBLE BY TAXPAYING ENTITIES.
  8. Tax Formula

    DEDUCTIONS

    General Rule - Types of Expenses Included
    • - COGS
    • - SALARIES
    • - WAGES
    • - OPERATING EXPENSES (I.E. RENT/UTILITIES)
    • - RESEARCH & DEVELOPMENT EXPENDITURES
    • - INTERET
    • - TAXES
    • - DEPRECIATION
    • - AMORTIZATION
    • - DEPLETION
  9. Tax Formula

    DEDUCTIONS

    General Rule - Individuals
    • - PERMITTED TO DEDUCT VARIETY OF PERSONAL EXPENSES (UNRELATED TO BUSINESS OR INVESTMENT)
    • - ALLOWED A STANDARD DEDUCTION IF THIS AMOUNT EXCEEDS THE DEDUCTIBLE PERSONAL EXPENSES
    • - ALLOWED A DEDUCTION FOR PERSONAL & DEPENDENCY EXEMPTIONS
  10. Tax Formula

    DETERMING THE TAX

    Taxable Income:
    SUBTRACTING DEDUCTIONS (after any applicable limitations) FROM GROSS INCOME

    TAXABLE INCOME = GROSS INCOME - DEDUCTIONS (after applicable limitations)
  11. Tax Formula

    DETERMING THE TAX

    Tax
    TAX RATES (found on table) APPLIED TO TAXABLE INCOME

    TOTAL TAX = TAXABLE INCOME * TAX RATE (from tax table)
  12. Tax Formula

    DETERMING THE TAX

    Tax Refund/Tax Owed
    CALCULATED BY SUBTRACTING TAX PREPAYMENTS (such as Federal Income tax withholding on salaries & estimated tax payments) and WIDE VARIETY OF CREDITS

    TAX REFUND/OWED = TOTAL TAX (from Taxable Income * Tax Rate) - TAX PREPAYMENTS - APPLICABLE CREDITS
  13. Gross Income - What is it?

    ECONOMIC & ACCOUNTING CONCEPTS OF INCOME

    Two Competing Models of Income
    • 1 - ECONOMIC INCOME
    • 2 - ACCOUNTING INCOME
  14. Gross Income - What is it?

    ECONOMIC & ACCOUNTING CONCEPTS OF INCOME

    Economic Income
    • - MEASURED BY DETERMING THE CHANGE (INCREASE/DECREASE) IN THE FAIR MARKET VALUE OF THE ENTITY'S ASSETS (net of liabilities) FROM THE BEGINNING TO THE END OF THE YEAR
    • - FOCUS ON CHANGE IN NET WORTH AS A MEASURE OF INCOME/LOSS
    • - REQUIRES NO DISPSITION OF ASSETS
    • INDIVIDUAL TAX PAYERS
    • - ADD THE VALUE OF THE YEAR'S PERSONAL CONSUMPTION OF GOODS/SERVICES (food, the rental value of owner-occupied housing, etc)
  15. Gross Income - What is it?

    ECONOMIC & ACCOUNTING CONCEPTS OF INCOME

    Economic Income - EXAMPLE
    Helen's economic income is calculated by comparing her net worth at the end of the year (12/31) w/her net worth at the beginning of the year (1/1) & adding her personal consumption

    • Fair Mkt Value of assets at 12/31 220,000
    • Less Liabilities at 12/31 (40,000)
    • Net worth at 12/31 180,000
    • Fair Mkt Value of assets at 1/1 200,000
    • Less Liabilities at 1/1 (80,000)
    • Net worth at 1/1 120,000
    • Increase in net worth 60,000
    • Consumption
    • Food, clothing, & other
    • personal expenditures 25,000
    • Imputed rental value of the home
    • owned & occupied 12,000
    • Total Consumption 37,000
    • Economic Income 97,000
  16. Gross Income - What is it?

    ECONOMIC & ACCOUNTING CONCEPTS OF INCOME

    Economic Income - Tax Law
    • - ANYTHING THAT INCREASES NET WORTH IS INCOME
    • - ANYTHING THAT DECREASES NET WORTH IS DEDUCTIBLE (if permitted by statute)
  17. Gross Income - What is it?

    ECONOMIC & ACCOUNTING CONCEPTS OF INCOME

    Economic Income - Tax Law - Windfall Income
    - BURIED TREASURE FOUND IN ONE'S BACKYARD IS TAXABLE UNDER THEORY THAT IS INCREASES NET WORTH HAS BEEN INCREASED
  18. Gross Income - What is it?

    ECONOMIC & ACCOUNTING CONCEPTS OF INCOME

    Problems with Economic Income
    • - WOULD REQUIRE TAXPAYERS TO DETERMINE THE VALUE OF THEIR ASSETS ANNUALLY - compliance would be burdensome
    • - CONTROVERSIES BETWEEN BETWEEN TAXPAYERS AND THE IRS - would enevitably arise because of the subjective nature of valuation in many circumstances
    • - USING MARKET VALUES TO DETERMINE INCOME FOR TAX PURPOSES COULD RESULT IN LIQUIDITY PROBLEMS - taxpayer's assets could increase in value but not be easily converted into the cash needed to pay the resulting tax (increases in the value of commercial real estate)
  19. Gross Income - What is it?

    COMPARISON OF THE ACCOUNTING AND TAX CONCEPTS OF INCOME
    • - UNEARNED (PREPAID) INCOME RECEIVED BY AN ACCRUAL BASIS TAXPAYER OFTEN IS TAXED IN THE YEAR OF RECEIPT
    • - FOR FINANCIAL ACCOUNTING PURPOSES, SUCH PREPAYMENTS ARE NOT TREATED AS INCOME UNTIL EARNED
  20. Gross Income - What is it?

    COMPARISON OF THE ACCOUNTING AND TAX CONCEPTS OF INCOME

    Form of Receipt
    • - CASH & ANY FORM, WHETHER MONEY, PEROPERTY, OR SERVICES, OR MEALS
    • - INCOME MAY BE REALIZED (and recognized), IN ANY FORM OF SERVICES, MEALS, ACOMMODATIONS, STOCK OR OTHER PROPERTY, AS WELL AS IN CASH.
  21. Gross Income - What is it?

    COMPARISON OF THE ACCOUNTING AND TAX CONCEPTS OF INCOME

    Example 3 - Company Car for Vacation Use
    Ostrich Corporatoin allows Cameron, an employee, to use a company car for his vacation. Cameron realizes income equal to the rental value of the car for the time and mileage.
  22. Gross Income - What is it?

    COMPARISON OF THE ACCOUNTING AND TAX CONCEPTS OF INCOME

    Example 4 - Dental Svs for Accounting Svs
    Donn is a CPA specializing in individual tax return prepartion. Her neighbor, Jull, is a dentist. Each year, Donna prepares Jull's tax return in exchange for two detal check-ups. Jull and Donna both have gross income equal to th efair market value of the services they provide.
  23. Year of Inclusion

    TAXABLE YEAR

    General
    • - CALENDAR YEAR (typically used)
    • - FISCAL YEAR - period fo 12 months ending on the last day of any month other than December (can be elected if the tax payer maintans adequate books and records)
  24. Year of Inclusion

    TAXABLE YEAR

    Fiscal Year
    • - FISCAL YEAR - period fo 12 months ending on the last day of any month other than December (can be elected if the tax payer maintans adequate books and records)
    • - OPTION GENERALLY IS NOT AVAILABLE TO PARTNERSHIPS, S CORPORATIONS, & PERSONAL SERVICE CORPORATIONS
  25. Practice Exam 2

    Office Palace, Inc., leased an all-in-one printer to a new customer, Ashly, on December 27, 2011. The printer was to rent for $600 per month for a period f 36 months beginning January 1, 2012. Ashley was required to pay the first and last month's rent at the time the lease was signed. Ashley was also required to pay a $1,500 damage deposit. Office Palace must recognize as income for the lease:

    a- $0 in 2011, if Office Palace is a cash basis taxpayer
    b- $7,800 in 2012, if Office Palace is a cash basis taxpayer
    c- $2,700 in 2011, if Office Palace is a cash basis taxpayer
    d- $1,200 in 2011, if Office Palace is an accural basis taxpayer
    e- None of the above
    D- $1,200 in 2011, if Office Palace is an accrual basis taxpayer
  26. Practice Exam 2

    Office Palace, Inc., leased an all-in-one printer to a new customer, Ashly, on December 27, 2011. The printer was to rent for $600 per month for a period f 36 months beginning January 1, 2012. Ashley was required to pay the first and last month's rent at the time the lease was signed. Ashley was also required to pay a $1,500 damage deposit. Office Palace must recognize as income for the lease:

    a- $0 in 2011, if Office Palace is a cash basis taxpayer
    b- $7,800 in 2012, if Office Palace is a cash basis taxpayer
    c- $2,700 in 2011, if Office Palace is a cash basis taxpayer
    d- $1,200 in 2011, if Office Palace is an accural basis taxpayer
    e- None of the above
    D- $1,200 in 2011, if Office Palace is an accrual basis taxpayer
  27. Practice Exam 2

    Kathy operates a gym. She sells memberships that entitle the member to use the facilities at any time. A one-year membership costs $360 ($360/12=$30 mo); a two-year membership costs $600 ($600/24=$25 per mo). Cash payment is required at the beginning of the period. On July 1, 2011, Kathy sold a one-year and a two-year membership.

    I - If Kathy is a cash basis taxpayer, her 2011 gross income from the contracts is $960 ($360 + $600)
    II - If Kathy is an accrual basis taxpayer, her 2011 gross income from the contracts is $330 [(6/12 x $360) + (6/24 x $600)]
    III - If Kathy is an accrual basis taxpayer, her 2012 gross income from the contracts is $630 [(6/12 x $360) + $450)] *$450 = $600 - $150 (from 2011)

    a- Only I is true
    b- Only I and II are true
    c- Only II and III are true
    d- I, II and III are true
    e- None of the above
    D- I, II and III are true
  28. Practice Exam 2

    On October 1, 2011, Bob, a cash basis taxpayer, gave Dave common stock that paid a dividend of $1,000 on December 15, 2011. On Novemeber 15, 2011, the corp declared the dividened payable to shareholders of record as of November 22, 2011. The copr has paid the $1,000 dividend once each year for the past ten years, during which Bob owned the stock. When Dave collected the dividend on December 15, 2011:

    a- Bob must include all of teh dividend in his gross income
    b- Dave must include all of the dividend in his gross income
    c- Bob must report $750 of dividend income, and Dave must report $250 of dividend income
    d- Bob must report $250 of dividend income, and Dave must report $750 of dividend income
    e- None of the above is correct
    B- Dave must include all of the dividend in his gross income.
  29. Practice Exam 2

    Our tax laws encourage taxpayers to _____________ assets that have appreciated in value and _________ assets that have declined in value.

    a- sell, keep
    b- sell, sell
    c- keep, sell
    d- keep, keep
    e- None of the above
    C- keep, sell
  30. Turquoise Company purchased a life insurance policy on the company's chief executive officer, Joe. After the company had paid $400,000 in premiums, Joe died and the company collected the $1.5 million face amount of the policy. The company also purchased group term life insurance on all its employees. Joe had included $16,000 in gross income for the group term life insurance premiums. Joe's widow, Rebecca, received the $100,000 proceeds from the group term life insurance policy.

    a- Rebecca can exclude the life insurance proceeds of $100,000, but Turquoise Company must include $1,100,000 ($1,500,000 - $400,000) in gross income.

    b- Turquoise Company and Rebecca can exclude the life insurance proceeds of $1,500,000 and $100,000 respectively from gross income

    c- Turquoise Company can exclude $1,100,000 ($1,500,000 - $400,000) from gross income, but Rebecca must include $84,000 in gross income.

    d- Turquoise Company must include $1,100,000 ($1,500,000 - $400,000) in gross income and Rebecca must include $100,000 in gross income

    e- None of the above
    B- Turquoise Company and Rebecca can exclude the life insurance proceeds of $1,500,000 and $100,000 respectively from gross income
  31. Practice Exam 2

    During the year, Kim sold the following assets: business auto for a $1,000 loss, stock investment for a $1,000 loss, and pleasure yacht for a $1000 loss. Presuming adequate income, how much of these losses may Kim claim?

    a- $0
    b- $1,00
    c- $2000
    d- $3000
    e- None of the above
    c- $2000

    *Business auto loss $1000 + Stock investment loss $1000 = $2000
  32. Practice Exam 2

    Which of the following in incorrect?

    a- all salaries of a business are deductible
    b- to be deductible, a business expense must be both ordinary and necessary
    c- the income and expenses of a sole proprietorship business are reported on Schedule C
    d- the purchase of a building must be capitalized
    e- All of the above
    A- All salaries of a business are deductible
  33. Practice Exam 2

    Vera is the CEO of Brunettes, a publicly held corporation. For the year, she receives a salary of $900,000, a bonus of $500,000 and contrubutions to her retirement plan of $42,000. The bonus was awarded at the December board meeting based on Vera's threat to accept a better paying job with a competitor. What amount may Brunettes deduct?

    a- $942,000
    b- $1,042,000
    c- $1,400,000
    d- $1,442,000
    e- None of the above
    B- $1,042,000
  34. Practice Exam 2

    Last year, Green Corporation incurred the following expenditures in the development of a new plant process:

    Salaries $200,000
    Materials 80,000
    Utilities 10,000
    Quality Control Testing Costs 30,000
    Management Studey Costs 5,000
    Depreciation of equipment 15,000

    During the current year, benefits from the project began being realized in March. If Green Corporation elects a 60-month deferral and amortization period, determine the amount of the deduction for the current year.

    a- $50,833
    b- $55,833
    c- $56,667
    d- $61,000
    e- None of the above
    • A- $50,833
    • ($200000+80000+10000+15000=$50833)

    *Quality control testing for $30,000, Management Study Costs for $5000 NOT included
  35. Practice Exam 2

    On June 1 of the current year, Tab converted a machine from personal use to rental property. At the time of the conversion, the machine was worth $90,000. Five years ago Tab purchased the machine for $70,000. The machine is still encumbered by a $50,000 mortgage. What is the bais of the machine for cost recovery?

    a- $70,000
    b- $90,000
    c- $120,000
    d- $140,000
    e- None of the above
    A- $70,000

    *basis = lower of cost or fair market value
  36. Practice Exam 2

    Tan Co. acquires a new machine (10 yr property) on January 15, 2011, at a cost of $200,00. Tan also acquires another new machine (7 yr property) on Nov 5, 2011, at a cost of $40,000. No election is made to use the straight-line method. The company does not make the section 179 election. Tan elects not to take additional first-year depreciation. Determine the total deductions in calculating taxable income related to the machines for 2011.

    a- $24000
    b- $25716
    c- $10200
    d- $132858
    e- None of the above
    B- $25716

    • 10 yr: $200000 x 10% (From Table) = $20000
    • 7 yr: $40000 x 14.29% (From Table) = $5716

    $20000+5716=$25716
  37. Practice Exam 2

    Augie purchased one used asset during theyear (5 yr property) on Nov. 10, 2011, at a cost of $650000. She made the section 179 election. The income from the business before the cost recovery deduction and the section 179 deduction was $400000. Determine the total cost deduction with respoect to the asset for 2011.

    a- $7500
    b- $92500
    c- $392500
    d- $500000
    e- None of the above
    C- $392500

    $400,000 (IBD) - $7,500 (MACRS) = $392,500 (Section 179 Deduction)

    **item doesn't have to be new, but it has to be new to you
  38. Practice Exam 2

    Problem:
    In order to protect against rent increases on the building in which she operates a dance studio, Mella signs an 18-month lease for $18,000. The lease commences on Nov. 1, 2011. how much of the $18,000 payment can she deduct in 2011 and 2012?

    a- If Mella is an accrual basis taxpayer

    b- If Mella is a cash basis taxpayer
    • A- 2011--$2,000; 2012--$12,000
    • *2011: 18000(total lease)/18(total months)=$1,000(per month) x 2(# of months in 2011) = $2,000
    • *
  39. Chapter 4 - Companion Site Quiz

    Sierra is a cash basis attorney. In 2011, she performed services in connection with the formation of a corporation and received stock with a value of $20,000 for her services. By the end of the year, the value of the stock had decreased to $16,000. She continued to hold the stock. Sierra must recognize $20,000 of gross income from the stock for 2011.

    -True
    -False
    True

    Sierra must recognize the income that relates to the services she rendered in 2011. Therefore, Sierra must recognize gross income of $20,000 in 2011. pp. 4-5 to 4-7
  40. Chapter 4 - Companion Site Quiz

    In the case of an employer to employee loan of less than $100,000, the imputed interest rules do not apply if net investment income is less than $1,000.

    -True
    -False
    False

    The imputed interest rules apply to employer to employee loans. However, for gift loans, if the amount of the loan is for $100,000 or less, the imputed interest cannot exceed the borrower's net investment income for the tax year. If net investment income is $1,000 or less, it is considered to be $0. pp. 4-20 and 4-21
  41. Chapter 4 - Companion Site Quiz

    Jacob loaned $30,000 to his mom. When it became apparent his mom would not be able to repay the loan in the near future, Jacob cancelled the debt. His mom must include the cancellation of indebtedness in income.

    -True
    -False
    -False

    When a creditor reduces a debt as an act of love, affection, or generosity, the debtor is not required to recognize income. The debtor has simply received a nontaxable gift. p. 4-27
  42. Chapter 4 - Companion Site Quiz

    Gain on the sale of collectibles may be subject to tax at a rate higher than 28%.

    -True
    -False
    True

    The 28% maximum rate applies if the collectible gain is long term (the asset was held for more than 12 months). p. 4-31
  43. Chapter 4 - Companion Site Quiz

    Cleaning Solution, Inc.., an accrual basis taxpayer, leased a steam cleaning machine to a new customer on December 27, 2011. The machine was to rent for $300 per month for a period of 12 months beginning January 1, 2012. The customer was required to pay the first and last month's rent at the time the lease was signed. The customer also was required to pay a $300 damage deposit. Cleaning Solution must recognize as income from the lease in 2011:

    a-$600
    b- None of the above
    c- $0
    d- $300
    e- $900
    A- $600

    The company is required to recognize the $600 (January and December rent) because prepaid income from rents is ineligible for deferral. The damage deposit is not income. pp. 4-11 and 4-12
  44. Chapter 4 - Companion Site Quiz

    Jerome, a cash basis taxpayer, sold 200 shares of Chestnut Company common stock on October 2, 2011. Chestnut Company is a publicly held company that has declared a $1.00 per share dividend on September 30th every year for the last 20 years. Just as Jerome had expected, Chestnut Company declared a $1.00 per share dividend on September 30th, payable on October 15th, to stockholders of record as of October 10th. The buyer received the $200 dividend on October 18, 2011.

    a.Jerome must recognize $150 of the dividend because he owned the stock for three-fourths of the year.

    b.Jerome must recognize the income of $200 because he constructively received the $200.

    c.The buyer must recognize the income because she owned the stock on the record date.

    d.None of the above.e.Jerome must recognize the $200 dividend as his income because he owned the stock on the declaration date.
    C-.The buyer must recognize the income because she owned the stock on the record date.

    The sale of the stock is made prior to the record date. p. 4-16
  45. Chapter 4 - Companion Site Quiz

    As a general rule:

    a.None of the above.

    b.Income from rental property is always taxed to the person who receives the income.

    c.Income from bonds is taxed to the person who collects the income.

    d.The recipient of income from services must pay the tax on the income.

    e.Income from services is taxed to the person who provides the services.
    D- The recipient of income from services must pay the tax on the income.e.Income from services is taxed to the person who provides the services.

    Generally, the owner of the property must pay the tax on the income. Income from services is taxed to the person who provides the services. Thus, answers a., b., and c. are incorrect. pp. 4-14 and 4-15
  46. Chapter 4 - Companion Site Quiz

    Alice operates a women-only gym. She sells memberships that entitle the member to use the facilities at any time. A one-year membership costs $240 ($240/12 = $20 per month); a two-year membership costs $360($360/24 = $15 per month). Cash payment is required at the beginning of the membership. On July 1, 2011, Alice sold a one-year membership and a two-year membership.

    a.None of the above.

    b.If Alice is an accrual basis taxpayer, her gross income from the contracts for 2011 is $480 ($120 + $360).

    c.If Alice is an accrual basis taxpayer, her gross income from the contracts for 2011 is $210 ($120 + $90).

    d.If Alice is an accrual basis taxpayer, her gross income from the contracts for 2011 is $504 ($240 + $90).

    e.If Alice is an accrual basis taxpayer, her gross income from the contracts for 2011 is $600 ($360 + $240).
    C-.If Alice is an accrual basis taxpayer, her gross income from the contracts for 2011 is $210 ($120 + $90).

    The cash basis taxpayer is required to recognize the income in the year it is received. The accrual basis taxpayer can defer the unearned income at the end of the first tax year to the second tax year. So the income is reported as follows:One-year contractTwo-year contractYear 1$120$ 90Year 2120270$240$360The limited deferral is provided under Notice 2004-34.pp. 4-12 and 4-13
  47. Chapter 4 - Companion Site Quiz

    Acorn Company purchased a $2 million life insurance policy on the company's chief executive officer, Joshua. After the company had paid $200,000 in premiums, Joshua died and the company collected the $2 million face amount of the policy. The company also purchased group-term life insurance on all its employees. Joshua's widow, Nancy, received the $250,000 proceeds from the group-term life insurance policy

    a.Acorn Company and Nancy can exclude the life insurance proceeds of $2,000,000 and $250,000 respectively from gross income.

    b.Acorn Company can exclude $1,800,000 ($2,000,000 – $200,000) from gross income, but Nancy must include $250,000 in gross income.

    c.None of the above.

    d.Acorn Company must include $1,800,000 ($2,000,000 – $200,000) in gross income and Nancy must include $250,000 in gross income.

    e.Nancy can exclude the life insurance proceeds of $250,000, but Acorn Company must include $1,800,000 ($2,000,000 – $200,000) in gross income.
    B-.Acorn Company can exclude $1,800,000 ($2,000,000 – $200,000) from gross income, but Nancy must include $250,000 in gross income.

    All of the proceeds qualify for the life insurance exclusion because the payments were received as a result of the death of the insured. pp. 4-24 and 4-25
  48. Chapter 4 - Companion Site Quiz

    In December 2011, Chad died. His wife was the beneficiary of his $500,000 life insurance policy. Chad had paid $25,000 in premiums. His wife elected to collect the proceeds in ten equal installments of $55,000 ($50,000 on the face amount of the policy and $5,000 interest). Of the $55,000 she collected in 2011, the taxable amount is:

    a.$50,000.
    b.$55,000.
    c.$0.
    d.$5,000.
    e.None of the above
    D-.$5,000.

    The interest element is included in her gross income. pp. 4-24 to 4-26
  49. Accounting Income
    Accountants use a definition of income that relies on the realization principle. Accounting income is not recognized until it is realized.
  50. Accounting Method
    The year an item of income is subject to tax often depends upon which acceptable accounting method the taxpayer regularly employs. The three primary methods of accounting are (1) the cash receipts and disbursements method, (2) the accrual method, and (3) the hybrid method. Most individuals use the cash receipts and disbursements method of accounting, whereas most larger corporations use the accrual method. The Regulations require the accrual method for determining purchases and sales when inventory is an income-producing factor. Some businesses employ a hybrid method that is a combination of the cash and accrual methods of accounting.
  51. Accrual Method
    Under the accrual method, an item is generally included in the gross income for the year in which it is earned, regardless of when the income is collected. The income is earned when (1) all the events have occurred that fix the right to receive such income and (2) the amount to be received can be determined with reasonable accuracy.
  52. Assignment of income
    It is a well-established principle of taxation that income from personal services must be included in the gross income of the person who performs the services. This principle was first established in a Supreme Court decision, Lucas v. Earl.’ Mr. Earl entered into a binding agreement with his wife under which Mrs. Earl was to receive one-half of Mr. Earl’s salary. Justice Holmes used the celebrated fruit and tree metaphor to explain that the fruit (income) must be attributed to the tree from which it came (Mr. Earl’s services). A mere assignment of income to another party does not shift the liability for the tax.
  53. Buy-sell agreements
    The first three exceptions facilitate the use of insurance contracts to fund buy-sell agreements.
  54. Cash Receipts Method
    Under the cash receipts method, property or services received are included in the taxpayer’s gross income in the year of actual or constructive receipt by the taxpayer or agent, regardless of whether the income was earned in that year. The income received need not be reduced to cash in the same year. All that is necessary for income recognition is that property or services received be measurable by a fair market value. Thus, a cash basis taxpayer that receives a note in payment for services has income in the year of receipt equal to the fair market value of the note. However, a creditor’s mere promise to pay (e.g., an account receivable), with no supporting note, usually is not considered to have a fair market value. Thus, the cash basis taxpayer defers income recognition until the account receivable is collected.
  55. Claim of right doctrin
    Where the taxpayer’s rights to the income are being contested (e.g., when a contractor fails to meet specifications), gross income is recognized only when payment has been received. If the payment is received before the dispute is settled, however, the court-made claim of right doctrine requires the taxpayer to recognize the income in the year of receipt.
  56. Constructive Receipt
    The rationale for the constructive receipt doctrine is that if the income is available, the taxpayer should not be allowed to postpone income recognition. For instance, a taxpayer is not permitted to defer income for December services by refusing to accept payment until January.
  57. Fruit & Tree Metaphor
    It is a well-established principle of taxation that income from personal services must be included in the gross income of the person who performs the services. This principle was first established in a Supreme Court decision, Lucas v. Earl.’ Mr. Earl entered into a binding agreement with his wife under which Mrs. Earl was to receive one-half of Mr. Earl’s salary. Justice Holmes used the celebrated fruit and tree metaphor to explain that the fruit (income) must be attributed to the tree from which it came (Mr. Earl’s services). A mere assignment of income to another party does not shift the liability for the tax.
  58. Gross Income
    Section 61 of the Internal Revenue Code provides the definition of gross income:

    Except as otherwise provided in this subtitle, gross income means all income from whatever sources derived.
  59. Hybrid Method
    The accrual method is used to determine sales and cost of goods sold. To simplify record keeping, some taxpayers account for inventory using the accrual method and use the cash method for all other income and expense items. This approach, called the hybrid method, is used primarily by small businesses when inventory is a material income-producing factor.
  60. Income
    The term income is used in the Code but is defined very broadly. Early in the history of our tax laws, the courts were required to interpret “the commonly understood meaning of the term which must have been in the minds of the people when they adopted the Sixteenth Amendment.”
  61. Life Insurance Proceeds
    Life insurance proceeds paid to the beneficiary because of the death of te insured are exempt from income tax.

    • Congress chose to exempt life ins proceeds for the following:
    • -For family members, life insurance proceeds serve much the same purpose as a nontaxable inheritance.
    • -In a business context (as well as in a family situation), life ins proceeds replace an economic loss siffered by the beneficiary
  62. Original Issue Discount
    Lenders frequently make loans that require a payment at maturity of more than the amount of the original loan. The difference between the amount due at maturity and the amount of the original loan is actually interest but is referred to as original issue discount. Under the general rules of tax accounting, a cash basis lender would not report the original issue discount as interest income until the year the amount is collected, although an accrual basis borrower would deduct the interest as it is earned. However, the Code puts the lender and borrower on parity by requiring that the original issue discount be reported when it is earned, regardless of the taxpayer’s accounting method. The interest earned is calculated by the effective interest rate method.
  63. Qualified real property business indebtedness

    Income from discharge of indebtedness
    Discharge of qualified real property business indebtedness
  64. Tax Benefit Rule
    However, the tax benefit rule limits income recognition when a deduction does not yield a tax benefit in the year it is taken. If the taxpayer in Example 30 has no tax liability in the year of the deduction, the $800 receipt is excluded from gross income in the year of the recovery. However, the tax benefit rule limits income recognition when a deduction does not yield a tax benefit in the year it is taken. If the taxpayer in Example 30 has no tax liability in the year of the deduction, the $800 receipt is excluded from gross income in the year of the recovery.
  65. Single

    NO ESTIMATES ALLOWED OF EXPENSE FOR TAX EXPENSES (bad debts, warranty on product, repairs & maintenance)
    Single

    DISSALLOWED LISTED BASIS IN THE HAND OF THE THIRD PARTY

    • Ex: 17
    • Return to the facts of The Big Picture on 5-2. Assume Sid Stevens, the 80% shareholder in his small engine service and repair business, sells a stock linvestment in his personal portfolio with a basis of $10,000 to his corporation for its fair market value of $8000. Sid's business sells teh stock several years later for $11000.
    • Sid Steven's $2000 loss from the sale of the stock is disallowed because the sale is to a related party. However, only $1000 of gain ($11000 selling price - $8000 basis - $2000 previously disallowed loss) is taxable to the business upon the subsequent sale.

    • Ex 18:
    • George sells common stock with a basis of $10500 to his wholly owned corporatio for its fairm market value of $8000. George's $2500 loss is disallowed under the related party rules. The corporation sells the stock eight months later to an unrelated party for $9000. The corporation's gain of $1000 ($9000 selling price - $8000 basis) is not recognized because of the offset from George's previously disallowed loss of $2500.
    • The offset may result in only a partial tax benefit upon the subsequent sale (as in this case). if George had not sold teh property to teh corporation, he could have recognied a $1500 loss upon the sale to the unrelated party ($9000 selling price - $10500 basis)
  66. Single

    ________ List are Deductible
    1- Real Estate
    2- Property, Personal Property Taxes
    3-
    4- Payroll Taxes
    5- Sales Tax* ________ paid by bus - sales tax is ______ by _________ only if ______

    __________________ not deductible
    6-
    7-

    Federal Income Tax not Deductible
    8- other misc taxes (_______) ___________________
    • Single
    • Taxes

    • Ex 30
    • A county's real property tax yr runs from jan1 to dec 31. Nuthatch Corp, the owner on Jan 1 of real property located in the county, sells the real property to Crane Inc on June 30. Crane owns the realy property from June 30 - Dec 31. The tax for the real property tax year Jan 1 - Dec 31, is $3650. Assuming this is not a leap year, the portion of the real property tax treated as imposed upon Nuthatch, the seller is $1800 [(180/365) x $3650, Jan 1 - June 29], and $1850 [(185/365) x $3650 June 30 - Dec 31] of the tax is treated as imposed upon Crane, the purchaser.
  67. Single
    Taxes

    Ex 31
    Seth sells real estate on Oct 3 for $400000. The buyer, Winslow, pays te real estate taxes of $3650 for the calendar year, which is the real estate property tax year. Assuming this is not a leap year, $2750 (for 275 days) is apportioned t and is deductible by the seller, Seth, and $900 (for 90 days) of the taxes is deductible by Winslow. The buyer has paid Seth's real estate taxes of $2750 and has therefore paid $402750 for the property. Winslow's basis is increased to $402750, and the amount realized by Seth from the sale is increased to $402750.
    • Single
    • Taxes

    • Ex32
    • Silver Corp sells real estate to Butch for $400000 on Oct 3. While Silver held the property, it paid the real estate taxes of $3650 for the cal yr, which is the real estate property tax year. Although Silver paid the entire $3650 of real estate taxes, $900 of that amount is apportioned to Butch, base on the number of days he owned the property, and is therefore deductible by him. The effect is that the buyer, Butch, has paid only $399,100 ($400000-$900) for the proerty. The amount realized by Silver, the seller, is reduced by $900, and Butch reduces his basis in the property to $399,100
  68. Cost Recovery for Personal Property
    6 MACRS Classes of Peroperty
    • 3 year
    • 5 year
    • 7 year
    • 10 year
    • 15 year
    • 20 year
  69. Cost Recovery of Personal Property

    Straight-line Elections

    -Taxpayers may elect the straight-line method to comput cost recovery allowances for each of the MACRS classes of property.

    *Certain proerty is not eligible for accelaerated cost recovery and must be depreciated under an alternative depreciation system (ADS)
  70. Deductions are allowed unless specific provisions in the tax law disallow such deductions.

    -True
    -False
    False

    Deductions are a matter of legislative grace. The only deductions allowed are those specifically provided for by statute, rulings, etc. In addition, certain otherwise allowable deductions are specifically disallowed. p. 5-2
  71. Generally, a closely-held family corporation can always take a deduction for a salary paid to a family member

    -True
    -False
    False

    Unreasonable salaries are not deductible. Example 3 and related discussion
  72. If 40% or more of the value of all property other than eligible real estate placed in service during the year is placed in service during the last quarter, the mid-quarter convention applies under MACRS

    -True
    -False
    False

    If more than 40% of property other than real estate is placed in service during the last quarter, the mid-quarter convention applies. p. 5-27
  73. Trademarks generally are § 197 intangibles.

    -True
    -False
    • -True
    • pg5-37
  74. Bradley operates an illegal gambling operation and incurred the following expenses:
    Salaries $100,000
    Illegal kickbacks 32,000
    Bribes to border guards 24,000
    Cost of goods sold 200,000
    Rent 12,000
    Interest 18,000
    Which of the above amounts reduces his taxable income?

    a.$330,000.
    b.$386,000.
    c.None of the above.
    d.$200,000.
    e.$362,000.
    A - $330,000

    All of the usual business expenses are deductible; the illegal kickbacks and bribes are not. pp. 5-7 and 5-8
  75. In January, Sandra sold stock with a cost basis of $40,000 to her brother, Keith, for $30,000, the fair market value of the stock on the date of sale. Five months later, Keith sold the same stock through his broker for $45,000.
    What is the tax effect of these transactions?

    a.Disallowed loss to Keith of $10,000; recognized gain to Sandra of $5,000.

    b.Disallowed loss to Sandra of $10,000; recognized gain to Keith of $15,000.

    c.None of the above.

    d.Deductible loss to Sandra of $10,000; recognized gain to Keith of $15,000.

    e.Disallowed loss to Sandra of $10,000; recognized gain to Keith of $5,000.
    E-.Disallowed loss to Sandra of $10,000; recognized gain to Keith of $5,000.

    The $10,000 loss on the sale from Sandra to Keith is disallowed. When Keith sells this property to someone outside the family he is entitled to offset the gain realized of $15,000 with the $10,000 loss disallowed on Sandra's sale. Example 17
  76. Charlize, a calendar year cash basis taxpayer, owns and operates several fast food restaurants in Tennessee, and wants to expand to other states. During 2011, she spends $25,000 to investigate several restaurants in North Carolina and $10,000 to investigate fresh food markets in Tennessee. She acquires the North Carolina operations, but not the fresh food markets in Tennessee.
    As to these expenses, Charlize should:

    a.None of the above.
    b.Expense $25,000 and not deduct $10,000 related to the fresh food markets.
    c.Expense $2,333 for 2011 and capitalize $32,667.
    d.Expense $10,000 for 2011.
    e.Expense $35,000
    B-.Expense $25,000 and not deduct $10,000 related to the fresh food markets

    Since Charlize owns and operates restaurants, all of the North Carolina investigation expenses can be deducted. Since she is not in the fresh food market business and did not acquire the Tennessee stores, the $9,000 is not deductible. p. 6-10 and Examples 14 and 15
  77. On June 1 of the current year, Harry converted his personal residence into a rental property. At the time of the conversion, the house was worth $310,000. Five years ago Harry purchased the building for $420,000. The building is still encumbered by a $100,000 mortgage.
    What is the basis of the building for cost recovery?

    a.$210,000.
    b.$420,000.
    c.$320,000.
    d.$310,000.
    e.None of the above.
    D-.$310,000.

    The basis is $310,000, the lower of the adjusted basis ($420,000) or fair market value ($310,000) at the date of conversion. p. 5-24 and Example 39
  78. Winona purchased a used business asset (five-year property) on March 10, 2011, at a cost of $200,000. She did not elect to expense any of the asset under § 179, nor did she elect straight-line cost recovery. Winona sold the asset on January 20, 2014.
    Determine the cost recovery deduction for 2014.

    a.$23,040.
    b.None of the above.
    c.$11,520.
    d.$4,800.
    e.$6,452
    C-.$11,520.

    $200,000 X .1152 X 1/2 = $11,520. pp. 5-25 to 5-28 and Table 5.1
  79. Carolina purchased a warehouse on July 15, 2005, for $1,000,000. She sells the factory building on February 2, 2011.
    Determine the cost recovery deduction for the year of the sale.

    a.$5,292.
    b.None of the above.
    c.$25,640.
    d.$3,205.
    e.$1,068.
    D-.$3,205

    0.02564 X $1,000,000 X 1.5/12 = $3,205. p. 5-28 and Table 5.3

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