### ch07

```Chapter 7
Accounting Periods & Methods
and Depreciation
©2003 South-Western College Publishing, Cincinnati, Ohio
Objective
Have a general understanding
of the different accounting
periods and methods allowed
Transparency 7-2
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
Transparency 7-3
Tax Years for Partnerships
 Partnerships 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 year
May use fiscal year if it results in a deferral period of no
more than three months
Transparency 7-4
Tax Year for S Corporations
 S 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
 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 31
required tax payment also applies to fiscal year-end
partnerships
Transparency 7-5
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.
Calculation
The “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
Transparency 7-6
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
Transparency 7-7
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 _____”
Transparency 7-8
Accounting Methods
There are three acceptable accounting methods
 Cash
must use same method
 Hybrid
for tax & books
 Accrual
 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
Transparency 7-9
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), or
partnership with a corporation as a partner, or
C 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
 Hybrid basis taxpayers
 Cash method but must use accrual for COGS
Transparency 7-10
Objective
Understand the concept of
depreciation and be able to
calculate depreciation expense
using MACRS tables
Transparency 7-11
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
Transparency 7-12
Personal Property
 Each asset is depreciated according to an IRSspecified recovery period
 3 year
 5 year
Race horses, tractors
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
Transparency 7-13
Personal Property (continued)
 Depreciation is determined using IRS tables
(Table 2 in text)
 Percentages from tables are based on the doubledeclining balance method of depreciation
Applied to cost basis without regard for estimated
salvage value
 May elect to use tables based on straight line
 Tables include half year convention
1/2 year depreciation in year of acquisition and 1/2 year
depreciation in year of disposition
Transparency 7-14
Personal Property (continued)
 Always use the half-year convention unless midquarter 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
Transparency 7-15
Personal Property Example
March 15 - purchase furniture for \$180,000. Furniture is
a 7-year asset.
Using tables:
Year 1: \$180,000 x .1429 = \$25,722
Year 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 = \$2,400
Year 2: \$12,000 x .32 = \$3,840
Transparency 7-16
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
Transparency 7-17
Real Property
 Real 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
Transparency 7-18
Objective
Know when an election to expense
the cost of an asset may be used
Transparency 7-19
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
 §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.
Transparency 7-20
Section 179 Example
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.
Calculation
Cost
\$39,000
§179 expense
(24,000)
\$15,000
less 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
Transparency 7-21
Objective
Understand the limitations placed
on depreciation of “listed” property
and luxury automobiles
Transparency 7-22
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
 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
Transparency 7-23
Luxury Autos Limits
 Maximum allowed amount is
 Luxury auto limits x business use %
 Depreciation on automobiles is also limited based on
 Luxury auto limits are quite low:
 Depreciation on autos placed into service in 2001 is:
Year 2001 - \$3,060
Year 2002 - \$4,900
Year 2003 - \$2,950
Year 2004 and subsequent years - \$1,775
 Automobiles may be wholly depreciated, it will just take
much longer than five years
Transparency 7-24
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 limit
 May use 30% Bonus depreciation in addition
to regular depreciation
Transparency 7-25
Luxury Auto Example
In July 2002, purchase a new automobile (5-year
asset) for \$50,000. The automobile was used 60% of
Calculation
30% Bonus depreciation (50,000 X .3)
\$15,000
Regular depreciation (50,000 - 15,000).2
7,000
Total
\$22,000
X .60
Possible depreciation
\$13,200
Luxury limitation 60% of (\$3,060 + \$4,600)
\$ 4,596
Total depreciation: \$4,596
Transparency 7-26
Objective
Know the tax treatment for goodwill
and certain other intangible assets
Transparency 7-27
Intangible Assets
 Section 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
 Must allocate for partial year in year of
acquisition
 Report in separate section of Form 4562
Transparency 7-28
Objective
Be able to determine whether
parties are classified as related for
tax purposes and understand the
tax treatment of related party
transactions
Transparency 7-29
Related Party Transactions
 Related parties are:
 A corporation and > 50% owner
 Brother/sister corporations
 Parent/subsidiary corporations
 Family members
spouses, lineal descendants, siblings
also 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
Transparency 7-30
The End!
Transparency 7-31
```