Depreciation Study Gudide


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  • Changed “provides” to provide in second line
  • Changed “see example in text” to “see example on p. 7-4”
  • Changed “< $5,000,000” to $5,000,000 or less
  • Changed for 3 year property “tractors” to “tractor units”
  • Example 2 is a bit confusing as; 1) if assume only asset placed in service during the year would have to use the mid-quarter convention and students aren’t provided that table in the textbook or, 2) if assume additional information pertaining to example 1 (i.e., had purchased the furniture in March and now a computer – the example would be correct as would use the Table 2 on p. 7-9. If #2 then need additional information to say in addition to the purchase on March 15….
  • Added “such as the” to Toyota Prius/Honda Insight as more than just the two hybrids available
  • Added p. 7-21 to bullet “see complete list in text”
  • Depreciation Study Gudide

    1. 1. Depreciation Accounting Periods & Methods and Depreciation Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved.
    2. 2. Objective Identify different accounting periods and methods allowed
    3. 3. Tax Year for Individuals <ul><li>Individuals must use a calendar year as their tax year </li></ul><ul><li>Businesses must use a calendar year as their tax year </li></ul><ul><ul><li>unless they can show a different “natural business year” </li></ul></ul>
    4. 4. Tax Years for Partnerships <ul><li>Partnerships don’t pay tax as an entity </li></ul><ul><ul><li>must file an informational tax return </li></ul></ul><ul><ul><ul><li>1065 </li></ul></ul></ul><ul><li>Tax year must be the same tax year as 50% of partners </li></ul><ul><ul><li>if partners’ tax years are different, use tax year of principal owners </li></ul></ul><ul><ul><ul><li>principal is 5% or more owner </li></ul></ul></ul><ul><ul><li>otherwise use calendar year </li></ul></ul><ul><ul><ul><li>may use fiscal year if it results in a deferral period of no more than three months </li></ul></ul></ul>
    5. 5. Tax Year for S Corporations <ul><li>S-Corporations don’t pay tax as an entity </li></ul><ul><ul><li>must file an informational tax return </li></ul></ul><ul><ul><ul><li>1120S </li></ul></ul></ul><ul><li>Must use a calendar year </li></ul><ul><ul><li>or may elect a fiscal year </li></ul></ul><ul><ul><ul><li>if the S corporation can demonstrate a business purpose, or </li></ul></ul></ul><ul><ul><ul><li>fiscal year results in a deferral period of less than 3 months and S corporation agrees to make annual “required tax payment” </li></ul></ul></ul><ul><ul><ul><ul><li>deferral period is period of time from fiscal year-end to December 31 </li></ul></ul></ul></ul><ul><ul><ul><ul><li>required tax payment also applies to fiscal year-end partnerships </li></ul></ul></ul></ul>
    6. 6. Deferral Example <ul><li>S-Corp has taxable income of $360,000 for the year ended 5/30 and last year’s required tax payment = $15,000 </li></ul><ul><li>Calculation </li></ul><ul><li>The required tax payment = </li></ul><ul><li>(Cash flow in deferral period x 36%) - prior year’s tax payment </li></ul><ul><li>Deferral period is 7 months </li></ul><ul><li>$360,000/12 x 7 months = $210,000 cash flow </li></ul><ul><li>($210,000 x 36%) - $15,000 = $60,600 deposit </li></ul>
    7. 7. Tax Year for Personal Service Corporation <ul><li>A Personal Service Corporation (PSC) is a corporation with shareholder-employees who provide a personal service </li></ul><ul><ul><li>for example, an architect or dentist </li></ul></ul><ul><li>Generally must adopt calendar year </li></ul><ul><li>Can adopt a fiscal year if </li></ul><ul><ul><li>can prove business purpose, or </li></ul></ul><ul><ul><li>shareholders’ salaries for deferral period are proportionate to salaries received during rest of the period and corporation limits its deduction </li></ul></ul><ul><ul><ul><li>purpose is to keep the PSC from deducting one year’s salary in beginning nine months </li></ul></ul></ul><ul><ul><ul><li>if salaries don’t remain constant, the PSC can only deduct pro rata amount </li></ul></ul></ul>
    8. 8. Short Tax Periods <ul><li>Occur when taxpayer changes from fiscal year-end to calendar year-end or visa versa </li></ul><ul><li>Taxpayer must annualize income </li></ul><ul><ul><li>see example on p. 7-4, </li></ul></ul><ul><ul><li>calculate tax, then </li></ul></ul><ul><ul><li>allocate it to the short period </li></ul></ul><ul><li>At top of tax return must complete: “For Short Tax Year from _____ to _____” </li></ul>
    9. 9. Accounting Methods <ul><li>There are three acceptable </li></ul><ul><li>accounting methods </li></ul><ul><li>Cash </li></ul><ul><li>Hybrid </li></ul><ul><li>Accrual </li></ul><ul><ul><li>Must use one method consistently </li></ul></ul><ul><ul><ul><li>make an election on your first return by filing using a particular method </li></ul></ul></ul><ul><ul><ul><li>file Form 3115 within first 6 months after initial election </li></ul></ul></ul><ul><ul><ul><ul><li>this requests permission from IRS to change accounting methods </li></ul></ul></ul></ul>must use same method for tax & books
    10. 10. Accounting Methods (continued) <ul><li>Cash basis taxpayers </li></ul><ul><ul><li>can’t deduct prepaid rent or interest </li></ul></ul><ul><ul><li>can’t use cash basis if taxpayer is a </li></ul></ul><ul><ul><ul><li>trust with UBI (unrelated business income), or </li></ul></ul></ul><ul><ul><ul><li>partnership with a corporation as a partner, or </li></ul></ul></ul><ul><ul><ul><li>C corporation </li></ul></ul></ul><ul><ul><li>PSCs and farms may use cash basis, and entities with gross receipts $5,000,000 or less </li></ul></ul><ul><li>Accrual basis taxpayers </li></ul><ul><ul><li>must report prepaid interest or rent as income when received </li></ul></ul><ul><li>Hybrid basis taxpayers </li></ul><ul><ul><li>cash method but must use accrual for COGS </li></ul></ul>
    11. 11. Objective Describe the concept of depreciation and be able to calculate depreciation expense using MACRS tables
    12. 12. Depreciation (Form 4562) <ul><li>Depreciation is a process of allocating the cost of assets to expense over their useful lives </li></ul><ul><ul><li>land is not depreciated </li></ul></ul><ul><li>Rules for depreciation have changed over the years </li></ul><ul><ul><li>pre-1980: straight line (SL) method </li></ul></ul><ul><ul><li>1980-1986: use ACRS tables </li></ul></ul><ul><ul><li>Post-1986: use MACRS tables </li></ul></ul>
    13. 13. Personal Property <ul><li>Each asset is depreciated according to an IRS-specified recovery period </li></ul><ul><ul><li>3 year Race horses, tractors units </li></ul></ul><ul><ul><li>5 year Computer, cars and light trucks, R&D equipment </li></ul></ul><ul><ul><li>7 year Office furniture, machinery, property with no life </li></ul></ul><ul><ul><li>10 year Barges, vessels </li></ul></ul><ul><ul><li>15 year Land Improvements </li></ul></ul><ul><ul><li>20 year Utility plants, sewers </li></ul></ul>
    14. 14. Personal Property (continued) <ul><li>Depreciation is determined using IRS tables (Table 2 in text) </li></ul><ul><ul><li>percentages from tables are based on double-declining balance </li></ul></ul><ul><ul><li>salvage value not used in MACRS </li></ul></ul><ul><ul><li>tables based on half year convention </li></ul></ul><ul><ul><ul><li>1/2 year depreciation taken in year of acquisition </li></ul></ul></ul><ul><ul><ul><li>1/2 year depreciation taken in final year </li></ul></ul></ul><ul><li>May elect to use tables based on straight line instead </li></ul>
    15. 15. Personal Property (continued) <ul><li>Always use the half-year convention </li></ul><ul><ul><li>unless mid-quarter convention applies </li></ul></ul><ul><li>Mid-quarter convention is required if taxpayer purchases 40% or more of total assets (except real estate) in last quarter of tax year </li></ul><ul><ul><li>applies to every asset purchased in the year </li></ul></ul><ul><ul><li>excluding real property and §179 property </li></ul></ul><ul><ul><li>must use special mid-quarter tables </li></ul></ul>
    16. 16. <ul><li>Example 1 : On March 15 purchased furniture for $180,000; furniture is a 7-year asset (use ½ yr convention) </li></ul><ul><li>Using tables </li></ul><ul><li>Year 1: $180,000 x .1429 = $25,722 </li></ul><ul><li>Year 2: $180,000 x .2449 = $44,082 </li></ul><ul><li>Example 2 : On November 3, purchased computer for $12,000; it is a 5-year asset. </li></ul><ul><li>Using tables </li></ul><ul><li>Year 1: $12,000 x .20 = $2,400 </li></ul><ul><li>Year 2: $12,000 x .32 = $3,840 </li></ul>Personal Property Example
    17. 17. 30% Bonus Depreciation <ul><li>Additional depreciation is available for assets purchased between 9/11/01 and 12/31/04 </li></ul><ul><li>Amount = 30% of adjusted basis </li></ul><ul><ul><li>only for new personal property with recovery period < 20 years </li></ul></ul><ul><li>Take 30% bonus first, then regular MACRS depreciation on remaining basis </li></ul><ul><li>May elect out of bonus if anticipate need for higher depreciation in future years </li></ul>
    18. 18. 50% Bonus Depreciation <ul><li>Additional depreciation is available for assets purchased between 5/5/03 and 12/31/04 </li></ul><ul><li>Amount = 50% of adjusted basis </li></ul><ul><ul><li>only for new personal property with recovery period < 20 years </li></ul></ul><ul><li>Take 50% bonus first, then regular MACRS depreciation on remaining basis </li></ul><ul><li>May elect out of bonus if anticipate need for higher depreciation in future years </li></ul>
    19. 19. Real Property <ul><li>Real assets depreciated based on a recovery period depending on use </li></ul><ul><ul><li>27.5 year: Residential rental </li></ul></ul><ul><ul><li>39 year: Nonresidential </li></ul></ul><ul><li>Real assets are depreciated using the straight-line method with a mid-month convention (Table 4) </li></ul><ul><ul><li>treats all acquisitions/dispositions as occurring mid-month </li></ul></ul><ul><ul><li>no mid-quarter convention for real estate </li></ul></ul>
    20. 20. Objective Identify when an election to expense the cost of an asset may be used and calculate amount
    21. 21. Election to Expense - Section 179 <ul><li>§179 allows immediate expensing of qualifying property </li></ul><ul><ul><li>in 2004, the annual amount allowed is $102,000 </li></ul></ul><ul><ul><li>qualifying property is tangible personal property used in a business </li></ul></ul><ul><li>§179 limited: </li></ul><ul><ul><li>if cost of qualifying property placed in service in a year > $410,000, reduce §179 expense $ for $ </li></ul></ul><ul><ul><li>cannot take §179 expense in excess of taxable income </li></ul></ul><ul><ul><ul><li>may carry forward any unused amount </li></ul></ul></ul><ul><li>If using bonus depreciation, </li></ul><ul><ul><li>take §179 first </li></ul></ul><ul><ul><li>then 30% or 50% bonus depreciation </li></ul></ul><ul><ul><li>then MACRS depreciation </li></ul></ul>
    22. 22. <ul><li>Example: On 7/11/04, purchase a tooling machine (7-year asset) for $139,000. The taxable income from business is $245,500 and total asset acquisitions for year are $182,453. </li></ul><ul><li> Answer: </li></ul><ul><li>Cost $139,000 </li></ul><ul><li>§179 expense (102,000) </li></ul><ul><li>Adjusted depreciable basis 37,000 </li></ul><ul><li>Less 50% bonus ( 18,500) </li></ul><ul><li>Remaining depr. basis 18,500 </li></ul><ul><li> x Table % 0.1429 </li></ul><ul><li>MACRS 2,644 </li></ul><ul><li>Total depreciation: </li></ul><ul><li>102,000 §179 </li></ul><ul><li> 18,500 50% bonus depreciation </li></ul><ul><li> 2,644 MACRS </li></ul><ul><li> $123,144 </li></ul>Section 179 Example
    23. 23. Objective Define listed property and luxury automobiles ; describe the limitations placed on depreciation of these items
    24. 24. Listed Property <ul><li>Special rules exist to limit deductions on assets used both in a business and personally </li></ul><ul><ul><li>cars </li></ul></ul><ul><ul><li>cell phones </li></ul></ul><ul><ul><li>computers (unless used exclusively at business) </li></ul></ul><ul><ul><li>entertainment equipment </li></ul></ul><ul><li>Limitation depends on amount of business use </li></ul><ul><ul><li>if asset used > 50% for business , can use MACRS </li></ul></ul><ul><ul><li>if asset used < 50% for business , must use straight line </li></ul></ul><ul><li>Separate section on page 2 of Form 4562 </li></ul>
    25. 25. Luxury Autos Limits <ul><li>Maximum allowed amount is </li></ul><ul><ul><li>luxury auto limits x business use % </li></ul></ul><ul><ul><li>depreciation on automobiles is also limited based on business use (5-year MACRS amount x business use %) </li></ul></ul><ul><li>Luxury auto limits are quite low: </li></ul><ul><ul><li>depreciation on autos placed into service in 2004 is: </li></ul></ul><ul><ul><ul><li>2004 - $2,960 </li></ul></ul></ul><ul><ul><ul><li>2005 - $4,800 </li></ul></ul></ul><ul><ul><ul><li>2006 - $2,850 </li></ul></ul></ul><ul><ul><ul><li>2007 and subsequent years - $1,675 </li></ul></ul></ul>
    26. 26. Special First-Year Depreciation for Automobiles <ul><li>Extra depreciation is allowed on autos used more than 50% business </li></ul><ul><ul><li>maximum of 50% up to $7,650 </li></ul></ul><ul><ul><ul><li>then multiply by business use % </li></ul></ul></ul><ul><ul><li>new autos purchased before 12/31/04 </li></ul></ul><ul><ul><li>may elect ‘out of’ special first year depreciation </li></ul></ul>
    27. 27. Luxury Auto Example <ul><li> Example: On 3/15/04, Jim purchased a new automobile for $50,000. The automobile was used 60% for business and Jim wants to maximize the special first-year depreciation. </li></ul><ul><li>Answer: </li></ul><ul><li>50% Bonus depreciation (50,000 X .5) $25,000 </li></ul><ul><li>Regular depreciation (50,000 - 25,000) x .2* 5,000 </li></ul><ul><li>Total 30,000 </li></ul><ul><li>Times business use percentage 60% X .60 </li></ul><ul><li>Possible depreciation 18,000 </li></ul><ul><li>Luxury limitation {60% of ($2960 + $7650)} $ 6,366 </li></ul><ul><li>Total allowable depreciation: $6,366 </li></ul><ul><li>*From MACRS tables – cars are 5-year assets </li></ul>
    28. 28. Hybrid/Electric Cars <ul><li>May qualify for up to $2000 deduction for AGI if purchase hybrid vehicle </li></ul><ul><ul><li>Such as the Toyota Prius/Honda Insight </li></ul></ul><ul><ul><li>vehicle may be used 100% personal </li></ul></ul>
    29. 29. Objective Describe the tax treatment for goodwill and certain other intangible assets
    30. 30. Intangible Assets <ul><li>§197 intangible assets are acquired by purchase </li></ul><ul><ul><li>amortized over 15-years beginning in month acquired </li></ul></ul><ul><ul><ul><li>goodwill </li></ul></ul></ul><ul><ul><ul><li>going-concern </li></ul></ul></ul><ul><ul><ul><li>covenant not to compete </li></ul></ul></ul><ul><ul><ul><li>see complete list in text, p. 7-21 </li></ul></ul></ul><ul><li>Many intangible assets are excluded from Section 197 provisions </li></ul><ul><ul><li>may not amortize internally-generated assets like patents and copyrights </li></ul></ul><ul><li>Report in separate section of Form 4562 </li></ul>
    31. 31. Objective Determine whether parties are classified as ‘related’ for tax purposes and identify tax treatment of related party transactions
    32. 32. Related Party Transactions <ul><li>Related parties are: </li></ul><ul><ul><li>a corporation and > 50% owner </li></ul></ul><ul><ul><li>brother/sister corporations </li></ul></ul><ul><ul><li>parent/subsidiary corporations </li></ul></ul><ul><ul><li>family members </li></ul></ul><ul><ul><ul><li>spouses, lineal descendants, siblings </li></ul></ul></ul><ul><ul><ul><li>also used for purposes of calculating ownership in corporations </li></ul></ul></ul><ul><li>§267 disallows losses on sales between related parties </li></ul><ul><ul><li>when property sold later to an unrelated party, all previously disallowed losses may be taken against gain </li></ul></ul>
    33. 33. The End! My head hurts!