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Accounting Periods. Bus 223F. What is the purpose of an accounting period?. Allow for reporting of taxable income on a regular basis Allow for a consistent treatment for calculating taxable income and tax. How long should the period be?.

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what is the purpose of an accounting period
What is the purpose of an accounting period?
  • Allow for reporting of taxable income on a regular basis
  • Allow for a consistent treatment for calculating taxable income and tax
how long should the period be
How long should the period be?
  • A consecutive period of 12 months unless it is a short period (such as first or last tax year or one that results from a change in period)
slide4
What possible abuses might occur if taxpayers had full control over selecting their accounting period?
  • Might select one that does not tie to books
  • Might end in middle of a month
  • Might not be 12 months long
  • Might end on 2/29
should a natural business year be used
Should a natural business year be used?
  • How to define and identify?
    • Look for time when sales peak (end of natural year)
    • Should at least be a calendar year or fiscal year
should period be same as for books
Advantages:

No special journal entries or add’l set of books needed to computer taxable income

Less chance of taxpayer abuse

Disadvantages:

No extra tax planning opportunities

May create too much work for preparer

Should period be same as for books?
what if business uses a 52 53 week year for books
What if business uses a 52/53 week year for books?
  • Ok to use for tax (441(f))
  • Is a fiscal year
what is appropriate period for a passthrough entity
What is appropriate period for a passthrough entity?
  • One that doesn’t result in too much opportunity for owners to defer reporting of the passthrough entity income
  • Fiscal or calendar year
  • Note – partnerships and S corporations have required tax years
what is appropriate period for individuals without a business
What is appropriate period for individuals without a business?
  • Calendar year
  • Same that records are based on – usually calendar year
how should t p notify irs of its accounting period
How should t/p notify IRS of its accounting period?
  • On initial return
  • Problem – what if file it late, even if after the extended due date? How will you prove the year?
possible problems with use of annual accounting period
Possible problems with use of annual accounting period
  • Later event relates to a prior year event
  • Later event is fundamentally inconsistent with earlier treatment
  • Relief if have to later repay income reported in earlier year under claim of right and tax rate higher in earlier year
  • Error in NOL carryforward
  • Later inconsistent positions – mitigation of statute
arrowsmith and relation back
Arrowsmith and Relation Back
  • Q - In current tax year, Partnership P recovered $3,000 from a shareholder derivative suit brought against a corporation for mismanagement that affected the stock price. P sold the stock two years earlier at a loss. How should P report the $3,000?
tax benefit rule
Tax Benefit Rule
  • §111 + Hillsboro National Bank/Bliss Dairy case (USSC 1983)
    • Hillsboro – “fundamentally inconsistent” approach
    • EX – Sole proprietor, cash method, signs contract 12/1/09 to rent a storage site starting 1/1/10 and deducts in 2009. In January 2010, one of 2 events occurs:
      • A) site burns to ground
      • B) SP decides to use personally instead

Q – how to treat these events in 2009 and 2010 in light of tax benefit rule?

claim of right 1341
Claim of right - §1341

Requirements:

  • (1) an item included in gross income in prior tax year because it appeared that taxpayer had unrestricted right to such item;
  • (2) a deduction is allowed in current tax year because it turns taxpayer did not have an unrestricted right to such item or to a portion of such item; and
  • (3) amount of such deduction exceeds $3,000

See section for details on how to calculate tax for current year.

rationale for 1341
Rationale for §1341

“The legislative history of section 1341 indicates that it was enacted to adequately compensate a taxpayer for the tax he paid for a prior year when he subsequently has been obliged to restore amounts he had included in gross income in the prior year because it appeared that he had an unrestricted right to such amount. Senate Report No. 1622, Eighty-third Congress, at pages 118 and 451. See also 108 Congressional Record 22531 (daily edition, October 5, 1962) (Senator Kerr). Thus, the purpose of section 1341 was to place such a taxpayer at least in no worse a tax position than he would have been had he never received the income originally.” [Rev. Rul. 77-344]

nol adjustments
NOL adjustments
  • Realize mistake made in prior year in which NOL arose and that NOL is being carried forward.
    • Should the NOL be corrected?
    • YES – Rev. Rul. 56-285
inconsistent positions and mitigation of statute of limitations
Inconsistent positions and mitigation of statute of limitations
  • §§1311-1314
  • §1311(a) – “(a) General rule. If a determination (as defined in section 1313) is described in one or more of the paragraphs of section 1312 and, on the date of the determination, correction of the effect of the error referred to in the applicable paragraph of section 1312 is prevented by the operation of any law or rule of law, other than this part and other than section 7122 (relating to compromises), then the effect of the error shall be corrected by an adjustment made in the amount and in the manner specified in section 1314.
  • §1312 – inconsistency generally is double reporting or omission of income or expense
accounting periods irc provisions
Accounting periods – IRC provisions
  • §441 – Period for computation of taxable income
  • §442 – Change of annual accounting period
  • §443 – Returns for a period of less than 12 months
  • §444 - Election of taxable year other than required taxable year
    • §7519 - Required payments for entities electing not to have required taxable year
    • §280H - Limitation on certain amounts paid to employee-owners by personal service corporations electing alternative taxable years
definitions in irc 441 and 1 441 1
Definitions in IRC §441 and 1.441-1
  • Taxable year
  • Annual accounting period
    • Calendar year
    • Fiscal year
      • 12 months ending on last day of any month other than December
      • 52/53 week year
  • Required tax year
when change period
When change period …
  • Will have a short period
  • EX – change from 12/31 to 6/30
    • File for 12/31/09
    • Next return is for 1/1/10 to 6/30/10
    • Subsequent return is back to full year (7/1/10 to 6/30/11)
issues to be addressed when have a short ty caused by period change
Issues to be addressed when have a short TY caused by period change
  • Annualize TI and regular tax and AMT calculations
  • Does it count as a full year in counting loss and credit carryover periods?
    • Generally yes
    • Recall special rule in RP 2004-34
x corp changes ty from calendar year to saturday closest to 12 31 1 2 2010
X Corp changes TY from calendar year to Saturday closest to 12/31 (1/2/2010)
  • X may add the 2 days to its 12/31/10 return
  • Guidance in 441 regs
partnership required ty
Partnership required TY
  • Must use first one of following which exists:
    • Majority interest TY
    • TY of all principal partners (ptr with interest in p/s profits or capital > 5%)
    • TY resulting in least aggregate deferral (see regs)
  • Unless p/s establishes business purpose for a different TY or makes a 444 election
majority interest tax year 706 b 4
Majority interest tax year – 706(b)(4)
  • (A) Majority interest taxable year defined. For purposes of paragraph (1)(B)(i) —
    • (i) In general. The term “majority interest taxable year” means the taxable year (if any) which, on each testing day, constituted the taxable year of 1 or more partners having (on such day) an aggregate interest in partnership profits and capital of more than 50 percent.
    • (ii) Testing days. The testing days shall be—
      • (I) the 1st day of the partnership taxable year (determined without regard to clause (i) ), or
      • (II) the days during such representative period as the Secretary may prescribe.
  • (B) Further change not required for 3 years. Except as provided in regulations necessary to prevent the avoidance of this section , if, by reason of paragraph (1)(B)(i) , the taxable year of a partnership is changed, such partnership shall not be required to change to another taxable year for either of the 2 taxable years following the year of change.
ptr a owns 60 uses 6 30 ty ptr b owns 40 uses calendar year
Ptr A owns 60% uses 6/30 TYPtr B owns 40% uses calendar year
  • Partnership AB must use 6/30
  • See §706; P/s has a majority interest tax year
required year for abc partnership
Required year for ABC Partnership?

No majority interest TY or principal partners TY, so must apply least aggregate deferral determination from 706 regs.

basics of 444
Basics of §444
  • Enacted in 1987 to address “workload compression”
  • Only for S corp, PSC and P/s
  • Allows for no more than 3 months deferral from required TY
    • EX – p/s required TY = 9/30
      • §444 options are 8/31, 7/31 or 6/30
  • If already using required TY, too late typically to make 444 election
  • P/S and S corp – must make required payments under §7519
    • At highest individual rate + 1 percentage point
    • Basically keeping a non-interest bearing deposit at IRS
  • PSC must make required distributions under §280H
changing accounting period
Changing Accounting Period
  • Check 442 and regs and the applicable revenue procedures, as modified
  • Automatic change procedures exist
    • Generally cannot have changed in prior 48 month period
    • Special rules if taxpayer owns interest in passthrough entity
    • If generate NOL in short tax year, generally, may not carry it back
      • To help ensure that taxpayers don’t change periods to purposefully create an NOL to carryback.
  • Form 1128
    • If non-automatic, owe user fee
    • Watch due date