Income Tax Fundamentals 2010
Gerald E. Whittenburg &
Martha Altus-Buller
Student Copy
2010 Cengage Learning

Partnerships/S-Corporations may elect to
adopt a different fiscal tax year from the one
prescribed on previous slide, but only
° If entity can demonstrate that natural
business cycle easily conforms to fiscal
year other than calendar year
 Such as golf course (natural cycle in Denver ends in
October)
Note: S-Corporations don’t pay tax as an entity
2010 Cengage Learning
A Personal Service Corporation (PSC) is a
corporation with shareholder-employee(s) whom
provide a personal service, such as architects or
dentists
 Generally must adopt calendar year
 However, can adopt a fiscal year if

◦ Can prove business purpose
or
◦ Fiscal year results in a deferral period of less than 3
months
and
 Shareholders’ salaries for deferral period are proportionate to
salaries received during rest of the period
or
See next slide
 Corporation limits its salaries deduction
2010 Cengage Learning

If taxpayer has a short year (other than first/last
year of operation), tax is calculated based on
following example:
° 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.
Calculate tax for the short period
Annualize TI
$20,000 x 12/9 = 26,667
Tax on annualized TI
$26,667 x 15%* = 4,000
Allocate tax to short period $4,000 x 9/12 = $3,000

Individual taxpayers rarely change tax years
*Chapter 1, page 1-3
2010 Cengage Learning

There are three acceptable accounting
methods for reporting taxable income (TI)
◦ Cash
◦ Hybrid
◦ Accrual

must use same method
for tax & books
Must use one method consistently
◦ Make an election on your first return by filing
using a particular method
◦ Must obtain permission from IRS to change
accounting methods
2010 Cengage Learning

Accrual method
◦ Recognize income when earned and can be
reasonably estimated
◦ Recognize deductions when incurred and can be
reasonably estimated

Hybrid method
◦ An example of a hybrid taxpayer is one that
utilizes cash method for receipts and
disbursements, but accrual for cost of products
sold
2010 Cengage Learning

Depreciation is a process of allocating
and deducting the cost of assets over
their useful lives
◦ Does not mean devaluation of asset
◦ Land is not depreciated

Maintenance vs. depreciation
◦ Maintenance expenses are incurred to keep
asset in good operating order
◦ Depreciation refers to deducting part of the
original cost of the asset
Complete Form 4562 to reflect depreciation
2010 Cengage Learning
 With
MACRS, each asset is depreciated
according to an IRS-specified recovery period
◦ 3 year
◦ 5 year
◦ 7 year
ADR* midpoint of 4 years or less
Computers, cars and light
trucks, R&D equipment, certain energy
property & certain equipment
Mostly business furniture & equipment
& property with no ADR life
*See Table 1 for Asset Depreciation Ranges (ADR) for all classes of
assets
2010 Cengage Learning

Depreciation is determined using IRS tables
◦ Table 2
◦ Salvage value not used in MACRS
◦ Tables based on half-year convention
 That means 1/2 year depreciation taken in year of
acquisition and 1/2 year taken in final year
May elect to use tables based on straight-line
instead
 Must use either MACRS or straight-line for all
property in a given class placed in service during
that year

2010 Cengage Learning

Mid-quarter convention is required if taxpayer
purchases 40% or more of total assets (except
real estate) in the last quarter of tax year
◦ Must apply this convention to every asset purchased in
the year
◦ Excludes real property and §179 property
◦ Must use special mid-quarter tables
 Found at major tax service such as Commerce Clearing
House (CCH) or Research Institute of America (RIA)
2010 Cengage Learning
Reinstated for two years only (2008-2009)
 Additional depreciation is available for assets
purchased in 2008-2009
 Available for assets with recovery period of
twenty years or less plus computer software,
leasehold improvements and water utility
property
 Amount = 50% of adjusted basis
 Take 50% bonus first, then regular MACRS
depreciation on remaining basis
 May elect out of bonus if anticipate need for
higher depreciation in future years
2010 Cengage Learning

Real assets depreciated based on a recovery
period depending on type of property
◦ Real assets are depreciated using the straight-line
method with a mid-month convention
 Mid-month convention assumes all
 Used for real estate acquired after 1986
27.5 years
 39 years

Residential rental
Nonresidential
2010 Cengage Learning

§179 allows immediate expensing of qualifying property
◦ For 2009, the annual amount allowed is $250,000
◦ Qualifying property is tangible personal property used in a
business
 But not real estate or property used in residential real estate
rental business

§179 election to expense is limited by 2 things
◦ If cost of qualifying property placed in service in a year >
$800,000, then reduce §179 expense dollar for dollar
 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.
◦ Cannot take §179 expense in excess of taxable income
2010 Cengage Learning
When using with regular MACRS, take §179 first,
then reduce basis to calculate MACRS
 For example

◦ 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?
◦ Assuming bonus depreciation not claimed – first take
$250,000 deduction under §179, reduce basis to
$92,000, then multiply by .1429 from MACRS tables
 Total depreciation expense = $263,147 ($250,000) +
($92,000 x .1429)
2010 Cengage Learning