Accy 171 Ch 4 Structure of the Federal Income Tax
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is not recognized unit it is realized.
- For realization to occur:
- 1. an exchange of goods or services must take place
- 2. The goods or services received by the entity must be capable of being objectively valued.
- * change in fair value is not sufficient.
- * imputed savings like a farmer creates feed on his own to save is not sufficient
economist determine by the change (increase or decrease) in the fair market value of the entity's assets (net of liabilities) from the beginning to the end of the year.
(unearned) prepaid income
different from accounting. received by an accrual basis taxpayer is taxed in the year of receipt.
Form of receipt
not limited to cash. includes income realized in any form, property, or services. May be realized and recognized.
meals, accommodations, stock or other property as well as cash.
A calendar and fiscal year are sufficient. A period of 12 months
*fiscal yr not used for partnerships, S corps, and personal.
3 Accounting Method
- 1. the cash receipts and disbursements method.(personal)
- 2. the accrual method (large business)
- 3. hybrid method (some use the combo of 1 & 2
To spread the gain from an installment sale of property over the collection period by using the:
installment method of income recognition.
- 1. Percentage of completion method. spread over life of contract
- 2. The completed Contract method. defer all profit until the year in which the project is completed
Cash Receipts Method
- Property, or services received are included in the taxpayer's gross income in the year of actual receipt regardless of whether income was earned that year.
- *with property or services received is measurable by a fair market value.
- *an A/R is not usually considered to have a fair market value with no supporting note. (defer income recognition until the account receivable is collected.
Accrual method must be used by
- 1. corporations (other than S corporations)
- 2. partnerships with a corporate partner
- 3. tax shelters
Business that can use the cash method
- 1. a farming business
- 2. a qualified personal service corp (services in health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting)
- 3. Any entity that is not a tax shelter whose average annual gross receipts for the most recent three year period are 5 million or less.
- Used to determine sales and COGS. an item generally included in gross income for the year in which it is earned, regardless of when the income is collected.
- It is earned when:
- 1. all the events have occurred that fix the right to receive the income
- 2. the amount to be received can be determined with reasonable accuracy. ex title passing
Claim to right doctrine
if the payment is received before the dispute is settled, the claim of right doctrine requires the taxpayer to recognize the income in the year of receipt.
- When the accrual method is used for sales and COGS and the cash method is used for all other income and expense items.
- Used primarily with small business when inventory is a material income producing factor.
Special rules for cash basis taxpayers
- 1. constructive receipt: income that has not been received us taxed as though it has been received. *conditions: amount is made radially available to the taxpayer, the receipt is not subject to limitations or restrictions.
- 2. Original Issue Discount: The amount of payment at maturity is more than the original loan is actually interest but referred to original issue discount. Calculated by the effective interest rate method.
- 3. Amounts received under an obligation to repay: is like borrowing so the income not realized when the borrowed funds are received. ex landlord deposit.
Special Rules for Accrual Basis Taxpayers
- 1. Prepaid income: the prepaid income is taxed in the year of receipt.
- 2. Deferral of Advance Payment for Goods: can defer recognition of income from advance payment for goods if the method of accounting for the sale is the same for tax and financial reporting purposes.
- 3. Deferral of Advance Payment for Services: can defer after the end of the tax year of receipt. The portion of pymnt for future services after the tax year is including in the following tax year. *Advanced payments of prepaid rent and interest are always taxed in the year of receipt.
Income from property
- income earned from property (rent interest, dividends), is included in the gross income of the owner of the property.
- Allocations of income from transfer parties:
- Interest: interest accrues daily
- Dividends: The dividend can take the form of an actual dividend or a constructive dividend (shareholder use of corp assets). Partial double taxation has been provide as the dividends are taxed at the rate of a capital gain. some pay 15% some pay 0 see pg 4-15. Qualified dividends receive preferential treatment. Dividend must be held 60 days during a 120 day period.
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