What are the differences for the bad debt expense deduction for an accrual vs cash-based company for tax purposes?
Accrual: bad debts are expensed using the direct write-off (not allowance) method
Cash: Since the money was never received, no expense may be taken, except in the case of receiving a check that bounces.
True / False: For cash-based small companies, the cash based method of inventory can also be used.
False
The accrual based inventory method must be used
For a small business using Schedule C, what two taxes are paid on income?
Income Tax: at ordinary income rates
Self-Employment Tax: 15.3% total (6.2% x2 for social security tax; 1.45%x2 for MCare thus if this person were employed by a company 7.65% would be the employer’s portion and 7.65% the employee’s portion)
How much of the Self-Employment tax is deductible for a taxpayer who files Schedule C?
It’s not a deduction, it’s an adjustment to determine AGI
Adjusted by reducing taxable income by 7.65% of self-employment income (what would be the employer’s portion)
How would you calculate the NET Self-Employment tax paid?
100% of income – 7.65% adjustment = 92.35% of income subject to the entire Self-Employment tax rate of 15.3%
Your sole proprietorship suffers a loss. How can this loss be used on the tax return? Is there carryover?
The loss can offset other income (such as a paycheck earned by your spouse).
Excess loss not taken can be carried back 2 years or forward 20 years.
What types of property are subject to the uniform capitalization rules?
Items produced for use in your own business to create more property
Items produced for resale
Items purchased for resale
What costs are required to be capitalized under the Uniform Capitalization Rules and added to the basis of the inventory?
Direct materials
Direct labor (compensation, vacation pay, payroll taxes)
True / False: Advertising and research costs must be capitalized under the Uniform Capitalization Rules.
False
These are period expenses and not added to production costs
What accounting method must be used for tax purposes on long-term contracts? What exemptions are allowed?
Percentage-of-completion must be used UNLESS
A small contractor (annual gross receipts <$10M/yr for the preceding 3 years) with a contracted expected to last no more than 2 years AND
Home construction or rehabilitation contractors (not hotels)
True / False: The Uniform Capitalization Rules apply to long-term contract costs.
True
What is the production period for a long-term contract?
START DATE
++ Cash Basis: The date the contractor incurs costs of actual construction
++ Accrual Basis: When 5% of the costs are accrued
END DATE
Either the date the contract is complete OR the taxpayer has incurred at least 95% of the total expected costs
How is the percentage of completion calculated?
Step 1: Total costs incurred / Total estimated cost of project = % completed
Step 2: (Total contract price X % completed) – income previously recognized = income currently recognized
True / False: The contractor uses percentage-of-completion on his regular tax return. This same amount can be used to calculate the Alternative Minimum Tax.
Not necessarily
Percentage of completion must be used for AMT, but
AMT may use different types of depreciation amounts that would affect the costs involved
True / False: A contractor qualifies for an exemption for a contract and uses the contract completion method when filing the Year 1 tax return. The contractor can later switch to the percentage of completion method for Year 2.
False
Any change in accounting method must be approved by the IRS
When is a personal property contract considered a long-term contract?
The contract cannot be completed within the year it was started
The item must be of a “unique” nature (specially made for that customer) and cannot be sold to others
The item requires significant preproduction costs
True / False: Insurance payments to a farmer from crop damage are treated as income.
True
True / False: A farmer purchases livestock. He purchases feed for the livestock during the year. Both the livestock and the feed are considered Cost of Goods Sold and cannot be deducted until the animal is sold or processed.
False
Farmers don’t have inventory. Any amounts paid to purchase or raise livestock, or seed and fertilizer for crops is expensed when incurred.
Fred takes out a short-term loan to purchase seed for farming. How is the interest handled for tax purposes?
The interest is deductible as an expense.
Fred takes out a loan to purchase a tractor. How is the interest handled for tax purposes?
The interest is deductible as an expense
How does farm income averaging work?
A farmer may elect to average the current year’s income by spreading it out over the past 3 years. This is typically used when a farmer has a bumper crop that would jump him to a higher tax bracket.
How many days may a home be rented and have the rental income excluded from personal income?
Fewer than 15 days (14 days or fewer)
What period of time is used to determine if a home is split as a rental / personal purposes?
The home is rented for 15 or more days AND
Is used for personal purposes for the GREATER of
++ more than 14 days OR
++ more than 10% of the rental days
For a nonresidence (true rental) property, how are income and expenses allocated for tax purposes?
Income received is included in gross income
All expenses for the home are deducted using Schedule E
For a nonresidence (true rental) property, how are losses treated for tax purposes?
If the owner is an active participant, up to $25,000 of rental losses may be deducted against nonpassive income
OTHERWISE, passive losses can only be used to reduce passive income.
