Chapter 7

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  • Section 7.1 Accounting Periods Almost all individual taxpayers file their returns based on a calendar year accounting period. However, there are no restrictions on an individual taking a tax year other than a calendar year. The choice to file on a fiscal year basis must be made with an initial tax return and books and records must be kept on that basis. Many individual tax returns include the passthrough of income from partnerships, S corporations and personal service corporations. In the past, partnerships and corporations had a great deal of freedom in establishing their year, but Congress has limited the choices by establishing provisions. The first provision applies to partnerships. Partnerships must establish a tax year that is the same as the partners with majority interest. S Corporations must also adopt their tax year following a similar rule. Partnerships and S Corporations may adopt a different business year if one of two conditions can be met. The first condition is that the business purpose of the fiscal year can be demonstrated. Typically, only seasonal businesses have natural business years. The second condition is the partnership’s or S corporation’s fiscal year does not result in a deferral period of more than three months or more than the deferral period in existence before the change to the new fiscal year, whichever is shorter and the partnership or S corporation agrees to make their annual “required tax payment.” Since partnerships and S corporations do not pay income taxes (the taxes are paid by the individual owners), the required tax payment is essentially a noninterest bearing deposit with the IRS.
  • A personal service corporation is a corporation whose shareholder-employees provide personal services, such as medical, legal or consulting services, for the corporation’s patients or clients. Personal service corporations typically must adopt a calendar year end. Personal service corporations may adopt a different business year if one of two conditions can be met. The first condition is that the business purpose of the fiscal year can be demonstrated. The second condition is that the fiscal tax year results in a deferral period of no more than three months or the deferral period of the tax year being changed, whichever is shorter and the corporation pays the shareholder-employees’ salaries for the deferral period at least proportionate to the salaries received from the most recent fiscal year or the corporation limits its deduction for shareholder-employees’ salaries. Once taxpayers elect their tax year, they cannot change the tax year without consent of the IRS. During the first or last year of operations, taxpayers may experience a short year, a tax year less than twelve months. The short year return must be annualized for both revenue and expenses
  • Section 7.2 Accounting Methods The main accounting methods allowed under tax law are the cash receipts and disbursements (cash) method, the accrual method and the hybrid method. The cash method results in the recognition of revenue when cash is received and the recognition of expenses when the cash is expended. (Regular corporations, partnerships that have a regular corporate partner and tax-exempt trust with unrelated business income are generally restricted from using the cash basis.) The accrual method results in the recognition of revenue when the revenue is earned (regardless of cash receipt) and the recognition of expense when the expense is incurred (regardless of cash expenditure). Tax provisions require that cash basis taxpayers use the accrual method for interest and rent. Accrual basis taxpayers who receive certain types of prepaid income must generally recognize the income on a cash basis. A hybrid method implements both cash and accrual bases of accounting. Taxpayers must elect a method and can change only with consent of the IRS.
  • Section 7.3 Depreciation Depreciation is the allocation of the cost of an asset over the use of the asset. Many depreciation methods are used but the simplest method is straight-line depreciation. The cost of the asset is reduced by any estimated salvage value to get the depreciable base. The depreciable base is divided by the estimated useful life of the asset to derive the depreciation for the period.
  • Section 7.4 Modified Accelerated Cost Recovery System (MACRS) Accelerated tax methods allow depreciation expenses to be larger in the first years of operations and decrease over the life of the asset. Under the Modified Accelerated Cost Recovery System (MACRS), taxpayers calculate the depreciation of an asset using a table that contains a percentage rate based on the year of ownership. MACRS uses a half-year convention which means that a five year asset would be depreciated for six years since only half of the year depreciation would be allowed in year one and half in year six. Depreciation expense is reported on Form 4562.
  • Section 7.5 Election to Expense Taxpayers may elect to expense certain personal property during the year the asset is acquired. Currently, the maximum cost that be expensed in year of acquisition is $250,000 for 2008. A taxpayer who has made the election to expense must reduce the depreciable basis of the property before computing future depreciation expenses.
  • Listed property includes assets that could be used for personal, rather than strictly business reasons. Examples included: Passenger automobiles Other property used as a means of transportation, except vehicles that are not likely to be used for personal purposes, such as marked police cars. Property generally used for entertainment, recreation or amusement Computer or peripheral equipment, unless used exclusively at a regular business establishment Cellular telephones If listed property is used 50 percent or less by the business, any depreciation deduction must be calculated using the straight-line method of depreciation.
  • Same question/comment regarding Example.
  • Section 7.8 Intangibles Intangible assets are assets that cannot be seen or touched. In 1993, Congress passed the Revenue Reconciliation Act (RRA) that helped better define the rules for deprecation of intangibles. The legislation created Section 197 intangibles, which are intangibles that are amortized over fifteen years regardless of estimated useful life. Examples of Section 197 intangibles are goodwill, going-concern value, workforce in place, information bases, know-how, any customer-based intangible, any license, permit or right granted by a governmental unit, any covenant not to compete, and any franchise, trademark or tradename. Some intangibles are specifically excluded from Section 197. Examples of the exclusions are interest in a corporation, partnership, trust or estate, interests in patents and copyrights, interests in land, computer software readily available for purchase by the general public, sports franchises, interest in films, sound recordings, video tapes and similar property and self-created intangible assets.
  • Same question/comment here regarding Example
  • Section 7.9 Related Parties (§ 267) When taxpayers conduct business with other taxpayers that are not independent of each other, abuse of the tax system can occur. Tax law closely regulates related party transactions. Related parties, as defined in § 267, include family members, corporations that are held by the same controlled group, owner of a corporation to the corporation and trusts, corporations and certain charitable organizations. Specifically, two types of related party transactions are restricted by § 267: sales of property at a loss and unpaid expenses and interest. Losses from the sale or exchange of property as a result of a related party transaction are not allowed. If related taxpayers are trying to avoid paying taxes by operating different accounting methods, the action is not deductible.
  • Chapter 7

    1. 1. Income Tax Fundamentals 2010 Gerald E. Whittenburg & Martha Altus-Buller 2010 Cengage Learning
    2. 2. <ul><li>Rarely, the taxpayer’s tax year will differ from calendar year </li></ul><ul><li>However, in partnership </li></ul><ul><ul><ul><li>Tax year must be the same tax year as 50% of partners </li></ul></ul></ul><ul><ul><ul><li>If majority of partners’ tax years are different, must use tax year of ‘principal partners’ </li></ul></ul></ul><ul><ul><ul><ul><li>Principal partner defined as partner with at least 5% share in profits or capital </li></ul></ul></ul></ul><ul><ul><ul><li>If principal partners have different tax years, partnership generally required to use least aggregate deferral method </li></ul></ul></ul><ul><ul><ul><li>Note: Partnerships don’t pay tax as an entity </li></ul></ul></ul>2010 Cengage Learning
    3. 3. <ul><li>Partnerships/S-Corporations may elect to adopt a different fiscal tax year from the one prescribed on previous slide, but only </li></ul><ul><ul><ul><li>If entity can demonstrate that natural business cycle easily conforms to fiscal year other than calendar year </li></ul></ul></ul><ul><ul><ul><ul><li>Such as golf course (natural cycle in Denver ends in October) </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Note: S-Corporations don’t pay tax as an entity </li></ul></ul></ul></ul>2010 Cengage Learning
    4. 4. <ul><li>Even though S-Corporations and partnerships don’t pay tax, the entity must make an estimated payment if choosing to use a fiscal year-end different from calendar year-end </li></ul><ul><ul><li>Estimated taxes are calculated as </li></ul></ul><ul><ul><ul><li>Estimated deferral period taxable income </li></ul></ul></ul><ul><ul><ul><li> x </li></ul></ul></ul><ul><ul><ul><li>(Highest individual tax rate + 1%) </li></ul></ul></ul><ul><ul><li>Estimate deferral period taxable income by using average monthly income from preceding fiscal year </li></ul></ul>2010 Cengage Learning
    5. 5. <ul><li>Example </li></ul><ul><li>San Juan River Expeditions Inc., an S-Corp, has taxable income of $360,000 for the year ended 9/30/09 with a three-month deferral period. The company made a $15,000 payment last year. What’s their current required tax payment? </li></ul>2010 Cengage Learning
    6. 6. <ul><li>Example </li></ul><ul><li>San Juan River Expeditions Inc., an S-Corp, has taxable income of $360,000 for the year ended 9/30/09 with a three-month deferral period. The company made a $15,000 payment last year. What’s their current required tax payment? </li></ul><ul><li>Solution </li></ul><ul><li>The required tax payment = </li></ul><ul><li>(Estimated taxable income in deferral period x 36%) - prior year’s tax payment </li></ul><ul><li>Deferral period is 3 months (October – December) </li></ul><ul><li>[($360,000/12) x 3 months] = $90,000 ($90,000 x 36%) = $32,400 </li></ul><ul><li>($32,400 - 15,000) = $17,400 estimated tax payment due in current year </li></ul>2010 Cengage Learning
    7. 7. <ul><li>A Personal Service Corporation (PSC) is a corporation with shareholder-employee(s) whom provide a personal service, such as architects or dentists </li></ul><ul><li>Generally must adopt calendar year </li></ul><ul><li>However, can adopt a fiscal year if </li></ul><ul><ul><li>Can prove business purpose </li></ul></ul><ul><ul><li>or </li></ul></ul><ul><ul><li>Fiscal year results in a deferral period of less than 3 months and </li></ul></ul><ul><ul><ul><li>Shareholders’ salaries for deferral period are proportionate to salaries received during rest of the period or </li></ul></ul></ul><ul><ul><ul><li>Corporation limits its salaries deduction </li></ul></ul></ul>2010 Cengage Learning See next slide
    8. 8. <ul><li>Purpose is to keep the PSC from deducting one year’s salary in first nine months </li></ul><ul><li>If salaries don’t remain constant, the PSC can only deduct pro rata amount </li></ul><ul><ul><li>Based on a required formula </li></ul></ul>2010 Cengage Learning
    9. 9. <ul><li>If taxpayer has a short year (other than first/last year of operation), tax is calculated based on following example: </li></ul><ul><ul><ul><li>In 2009, Flo-Mex changes from a calendar year to tax year ending 9/30. For the short period 1/1/09 – 9/30/09, Flo-Mex’s taxable income = $20,000. </li></ul></ul></ul><ul><ul><ul><ul><li>Calculate tax for the short period </li></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Annualize TI $20,000 x 12/9 = 26,667 </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Tax on annualized TI $26,667 x 15%* = 4,000 </li></ul></ul></ul></ul></ul><ul><ul><ul><ul><ul><li>Allocate tax to short period $4,000 x 9/12 = $3,000 </li></ul></ul></ul></ul></ul><ul><li>Individual taxpayers rarely change tax years </li></ul><ul><li>*Chapter 1, page 1-3 </li></ul>2010 Cengage Learning
    10. 10. <ul><li>There are three acceptable accounting methods for reporting taxable income </li></ul><ul><ul><li>Cash </li></ul></ul><ul><ul><li>Hybrid </li></ul></ul><ul><ul><li>Accrual </li></ul></ul><ul><li>Must use one method consistently </li></ul><ul><ul><li>Make an election on your first return by filing using a particular method </li></ul></ul><ul><ul><li>Must obtain permission from IRS to change accounting methods </li></ul></ul>must use same method for tax & books 2010 Cengage Learning
    11. 11. <ul><li>Cash receipts/disbursements method </li></ul><ul><ul><li>This method most common for individuals </li></ul></ul><ul><ul><li>Recognize income when cash actually/constructively received </li></ul></ul><ul><ul><li>Recognize deduction in year of payment </li></ul></ul><ul><ul><ul><li>Exception: can’t deduct prepaid rent or interest </li></ul></ul></ul><ul><ul><li>Can’t use cash basis if taxpayer is a </li></ul></ul><ul><ul><ul><li>C corporation </li></ul></ul></ul><ul><ul><ul><li>Partnership with a corporation as a partner </li></ul></ul></ul><ul><ul><ul><li> or </li></ul></ul></ul><ul><ul><ul><li>Tax exempt trusts with unrelated business income </li></ul></ul></ul><ul><ul><ul><ul><li>Doesn’t apply to certain organizations </li></ul></ul></ul></ul>2010 Cengage Learning
    12. 12. <ul><li>Accrual method </li></ul><ul><ul><li>Recognize income when earned and can be reasonably estimated </li></ul></ul><ul><ul><li>Recognize deductions when incurred and can be reasonably estimated </li></ul></ul><ul><li>Hybrid method </li></ul><ul><ul><li>An example of a hybrid taxpayer is one that utilizes cash method for receipts and disbursements, but accrual for cost of products sold </li></ul></ul>2010 Cengage Learning
    13. 13. <ul><li>Depreciation is a process of allocating and deducting the cost of assets over their useful lives </li></ul><ul><ul><li>Does not mean devaluation of asset </li></ul></ul><ul><ul><li>Land is not depreciated </li></ul></ul><ul><li>Maintenance vs. depreciation </li></ul><ul><ul><li>Maintenance expenses are incurred to keep asset in good operating order </li></ul></ul><ul><ul><li>Depreciation refers to deducting part of the original cost of the asset </li></ul></ul><ul><ul><li>Complete Form 4562 to reflect depreciation </li></ul></ul>2010 Cengage Learning
    14. 14. <ul><li>Straight-line depreciation is easiest </li></ul><ul><ul><li>(Cost of asset – salvage value)/Years in estimated life </li></ul></ul><ul><li>Modified Accelerated Cost Recovery System (MACRS) allows capital assets to be written off over a period identified in tax law </li></ul><ul><ul><li>Accelerated method used for all assets except real estate </li></ul></ul>2010 Cengage Learning
    15. 15. <ul><li>With MACRS, each asset is depreciated according to an IRS-specified recovery period </li></ul><ul><ul><li>3 year ADR* midpoint of 4 years or less </li></ul></ul><ul><ul><li>5 year Computers, cars and light trucks, R&D equipment, certain energy property & certain equipment </li></ul></ul><ul><ul><li>7 year Mostly business furniture & equipment & property with no ADR life </li></ul></ul><ul><ul><li>* See Table 1 for Asset Depreciation Ranges (ADR) for all classes of assets </li></ul></ul>2010 Cengage Learning
    16. 16. <ul><li>Depreciation is determined using IRS tables </li></ul><ul><ul><li>Table 2 </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>That means 1/2 year depreciation taken in year of acquisition and 1/2 year taken in final year </li></ul></ul></ul><ul><li>May elect to use tables based on straight-line instead </li></ul><ul><li>Must use either MACRS or straight-line for all property in a given class placed in service during that year </li></ul>2010 Cengage Learning
    17. 17. <ul><li>Example 1: On March 15, Zumiz Co. purchased furniture for $180,000; what is the recovery period and depreciation? (assume no bonus depreciation taken) </li></ul><ul><li>Use Table 1 to see it’s a 7-year asset </li></ul><ul><li>Use Table 2 to get percentages </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 February 3, Bling LLC bought computer for $12,000; what is the recovery period and depreciation? (assume no bonus depreciation taken) </li></ul><ul><li>Use Table 1 to see it’s a 5-year asset </li></ul><ul><li>Use Table 2 to get percentages </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>2010 Cengage Learning
    18. 18. <ul><li>Mid-quarter convention is required if taxpayer purchases 40% or more of total assets (except real estate) in the last quarter of tax year </li></ul><ul><ul><li>Must apply this convention to every asset purchased in the year </li></ul></ul><ul><ul><li>Excludes real property and §179 property </li></ul></ul><ul><ul><li>Must use special mid-quarter tables </li></ul></ul><ul><ul><ul><li>Found at major tax service such as Commerce Clearing House (CCH) or Research Institute of America (RIA) </li></ul></ul></ul>2010 Cengage Learning
    19. 19. <ul><li>Reinstated for two years only (2008-2009) </li></ul><ul><li>Additional depreciation is available for assets purchased in 2008-2009 </li></ul><ul><li>Available for assets with recovery period of twenty years or less plus computer software, leasehold improvements and water utility property </li></ul><ul><li>Amount = 50% of adjusted basis </li></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>2010 Cengage Learning
    20. 20. <ul><li>Example </li></ul><ul><li>Nicole purchases a cherry desk and executive chair for use in her engineering firm on July 16, 2009 for $8,150. What is her depreciation for 2009 using half-year convention and MACRS tables? 2010? Assume Nicole didn’t take bonus depreciation. </li></ul><ul><li>How would 2009 depreciation change if she had taken 50% bonus depreciation? </li></ul>2010 Cengage Learning
    21. 21. <ul><li>Example </li></ul><ul><li>Nicole purchases a cherry desk and executive chair for use in her engineering firm on July 16, 2009 for $8,150. What is her depreciation for 2009 using half-year convention and MACRS tables? 2010? Assume Nicole didn’t take bonus depreciation . </li></ul><ul><li>How would 2009 depreciation change if she had taken 50% bonus depreciation? </li></ul><ul><li>Solution </li></ul><ul><li>Using Table 1, we can see that business furniture has a 7-year life. Table 2 shows the percentages to use for recovery years 1 and 2; therefore </li></ul><ul><li>2009 depreciation = $1,165 ($8,150 x .1429) </li></ul><ul><li>2010 depreciation = $1,996 ($8,150 x .2449) </li></ul><ul><li>If bonus depreciation were taken: </li></ul><ul><li>2009 depreciation = 50% bonus depreciation + MACRS % to remaining basis </li></ul><ul><li>$8,150 x 50% = $4,075 bonus depreciation </li></ul><ul><li>$4,075 x .1429 = $582 MACRS depreciation </li></ul><ul><li> Total depreciation = $4,657 ($4,075 + $582) </li></ul>2010 Cengage Learning
    22. 22. <ul><li>Real assets depreciated based on a recovery period depending on type of property </li></ul><ul><ul><li>Real assets are depreciated using the straight-line method with a mid-month convention </li></ul></ul><ul><ul><ul><li>Mid-month convention assumes all </li></ul></ul></ul><ul><ul><ul><li>Used for real estate acquired after 1986 </li></ul></ul></ul><ul><li>27.5 years Residential rental </li></ul><ul><li>39 years Nonresidential </li></ul>2010 Cengage Learning
    23. 23. <ul><li>Example </li></ul><ul><li>Gwen purchased a triplex on 8/1/09 for $290,000 (including land cost of $50,000). What is her depreciation for 2009? 2010? </li></ul>2010 Cengage Learning
    24. 24. <ul><li>Example </li></ul><ul><li>Gwen purchased a triplex on 8/1/09 for $290,000 (including land cost of $50,000). What is her depreciation for 2009? 2010? </li></ul><ul><li>Solution </li></ul><ul><li>Since land is not depreciable, only $240,000 may be multiplied by percentages from Table 4 (27.5-year residential real property). The purchase occurred in the eighth month; therefore, depreciation equals </li></ul><ul><li>2009 $240,000 x 1.364% = $3,274 </li></ul><ul><li>2010 $240,000 x 3.636% = $8,726 </li></ul>2010 Cengage Learning
    25. 25. <ul><li>§179 allows immediate expensing of qualifying property </li></ul><ul><ul><li>For 2009, the annual amount allowed is $250,000 </li></ul></ul><ul><ul><li>Qualifying property is tangible personal property used in a business </li></ul></ul><ul><ul><ul><li>But not real estate or property used in residential real estate rental business </li></ul></ul></ul><ul><li>§179 election to expense is limited by 2 things </li></ul><ul><ul><li>If cost of qualifying property placed in service in a year > $800,000, then reduce §179 expense dollar for dollar </li></ul></ul><ul><ul><ul><li>For example, if assets purchased in current year = $900,000 taxpayer must reduce §179 by $100,000. Therefore, election to expense is limited to = $150,000 ($250,000 – 100,000). The remaining $750,000 of basis is depreciated over assets’ useful lives. </li></ul></ul></ul><ul><ul><li>Cannot take §179 expense in excess of taxable income </li></ul></ul>2010 Cengage Learning
    26. 26. <ul><li>When using with regular MACRS, take §179 first, then reduce basis to calculate MACRS </li></ul><ul><li>For example </li></ul><ul><ul><li>In 2009, NanoPaint Inc.’s taxable income = $1.25 million. They placed a 7-year piece of property into service costing $342,000 – it was their only asset purchase in 2009. What is total depreciation, including election to expense? </li></ul></ul><ul><ul><li>Assuming bonus depreciation not claimed – first take $250,000 deduction under §179, reduce basis to $92,000, then multiply by .1429 from MACRS tables </li></ul></ul><ul><ul><ul><li>Total depreciation expense = $263,147 ($250,000) + ($92,000 x .1429) </li></ul></ul></ul>2010 Cengage Learning
    27. 27. <ul><li>Example </li></ul><ul><li>On 7/11/09, O’Neill Machinery LLC purchases a tooling machine (7-year asset) for $259,000. The taxable income from the business is $445,500. What is the company’s total depreciation deduction for the current year, including §179 and MACRS? Assume no bonus depreciation. </li></ul>2010 Cengage Learning
    28. 28. <ul><li>Example </li></ul><ul><li>On 7/11/09, O’Neill Machinery LLC purchases a tooling machine (7-year asset) for $259,000. The taxable income from the business is $445,500. What is the company’s total depreciation deduction for the current year, including §179 and MACRS? Assume no bonus depreciation. </li></ul><ul><li>Solution Asset purchases didn’t exceed $800,000, so no reduction in §179 availability: </li></ul><ul><li>Cost $259,000 </li></ul><ul><li>§179 expense ( 250,000) </li></ul><ul><li>Adjusted depreciable basis 9,000 </li></ul><ul><li>x Table % 14.29% </li></ul><ul><li>MACRS $1,286 </li></ul><ul><li>Total depreciation= $251,286 </li></ul><ul><li>$250,000 [§179] + $1,286 [MACRS] </li></ul>2010 Cengage Learning
    29. 29. <ul><li>Special rules exist to limit deductions on assets that lend themselves to personal use , called ‘listed property’ </li></ul><ul><ul><li>Cars and trucks/vans under 6000 lbs. gross vehicle weight with specific exclusions </li></ul></ul><ul><ul><li>Computers (unless used exclusively at business) </li></ul></ul><ul><ul><li>Equipment used for entertainment, recreation or amusement </li></ul></ul><ul><ul><li>Cell phones </li></ul></ul><ul><li>If asset used <= 50% for business (or if use falls to below 50% in subsequent years) must use straight-line </li></ul><ul><li>If asset used > 50% for business, must use MACRS </li></ul><ul><li>Separate section (Part V) on page 2 of Form 4562 </li></ul>2010 Cengage Learning
    30. 30. <ul><li>IRS limits annual depreciation expense that may be claimed on passenger auto </li></ul><ul><li>Maximum allowed amount is luxury auto limits x business use % </li></ul><ul><li>Luxury auto limits are quite low </li></ul><ul><ul><li>Annual depreciation limit on ‘luxury’ autos placed into service in 2009 </li></ul></ul><ul><ul><ul><li>2009 - $2,960 (or $10,960 if taking bonus depreciation * ) </li></ul></ul></ul><ul><ul><ul><li>2010 - $4,800 </li></ul></ul></ul><ul><ul><ul><li>2011 - $2,850 </li></ul></ul></ul><ul><ul><ul><li>2012 and subsequent years - $1,775 </li></ul></ul></ul><ul><ul><ul><li>* Only allowed if used more than 50% in business and purchased new during 2009 </li></ul></ul></ul>2010 Cengage Learning
    31. 31. <ul><li>Definition of passenger auto includes any 4-wheeled vehicle manufactured primarily for use on public streets and weighing less than 6000 lbs. </li></ul><ul><ul><li>Some SUVs weigh more than 6000 lbs. can be expensed under §179 </li></ul></ul><ul><ul><li>Beginning 10/22/04, can ‘only’ expense $25,000 and then depreciate remainder using five year MACRS percentages </li></ul></ul><ul><ul><ul><li>These SUVs will qualify for 50% bonus depreciation in 2009 </li></ul></ul></ul>2010 Cengage Learning
    32. 32. <ul><li>Example </li></ul><ul><li>On 3/15/09, Jim purchased a new automobile for $50,000; it is a passenger auto weighing less than 6000 lb. The automobile is used 60% for business and Jim wants to know how much depreciation to claim if he elects out of the bonus depreciation rules. </li></ul>2010 Cengage Learning
    33. 33. <ul><li>Example </li></ul><ul><li>On 3/15/09, Jim purchased a new automobile for $50,000; it is a passenger auto weighing less than 6000 lb. The automobile was used 60% for business and Jim wants to know how much depreciation to claim if he elects out of the bonus depreciation rules. </li></ul><ul><li>Solution </li></ul><ul><li>Regular depreciation ($50,000 x 20% * ) 10,000 </li></ul><ul><li>Times business use percentage 60% X .60 </li></ul><ul><li>Possible depreciation 6,000 </li></ul><ul><li>“ Luxury auto” limitation (60% of $2,960) $ 1,776 </li></ul><ul><li>* From MACRS tables, cars are 5-year assets </li></ul>2010 Cengage Learning
    34. 34. <ul><li>§197 intangible assets are acquired by purchase </li></ul><ul><ul><li>Amortized over 15-years beginning in month acquired , includes assets such as </li></ul></ul><ul><ul><ul><li>Goodwill (value attributable to expected continuation of customers’ patronage) </li></ul></ul></ul><ul><ul><ul><li>Covenant not to compete </li></ul></ul></ul><ul><ul><li>Many intangible assets are excluded from § 197 </li></ul></ul><ul><ul><ul><li>May not amortize self created assets like patents and copyrights </li></ul></ul></ul>2010 Cengage Learning
    35. 35. <ul><li>Example </li></ul><ul><li>FionaWear Inc. purchased a small textile company in May 2009 for $980,000. $54,000 of the purchase price was allocated to goodwill in the buy-sell agreement. How much goodwill may FionaWear amortize in 2009? </li></ul>2010 Cengage Learning
    36. 36. <ul><li>Example </li></ul><ul><li>FionaWear Inc. purchased a small textile company in May 2009 for $980,000. $54,000 of the purchase price was allocated to goodwill in the buy-sell agreement. How much goodwill may FionaWear amortize in 2009? </li></ul><ul><li>Solution </li></ul><ul><li>$54,000/15 years = $3,600/12 months = $300 per month </li></ul><ul><li>§197 amortization $300 x 8 months = $2,400 </li></ul>2010 Cengage Learning
    37. 37. <ul><li>Restricted transaction between related parties include </li></ul><ul><ul><li>Recognizing losses on sales between related parties </li></ul></ul><ul><ul><li>One accrual basis and one cash basis taxpayer as pertains to expensing unpaid expenses and interest </li></ul></ul><ul><li>Related parties are: </li></ul><ul><ul><li>Family members such as s pouses, lineal descendants, siblings </li></ul></ul><ul><ul><li>A corporation and more than 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>Complex ‘constructive ownership’ rules </li></ul></ul>2010 Cengage Learning
    38. 38. <ul><li>Losses disallowed 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><ul><li>May not avoid tax when one taxpayer uses cash method for expenses and interest and the other taxpayer uses accrual method </li></ul>2010 Cengage Learning
    39. 39. 2010 Cengage Learning My head hurts!

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