Accounting Periods & Methods & Depreciation
Income Tax Fundamentals 2009
Gerald E. Whittenburg &
Martha Altus-Buller
Student’s Copy
2009 Cengage Learning

Problem when taxpayer’s tax year differs from
calendar year – quite rare
• Partnerships don’t pay tax as an entity
 Tax year must be the same tax year as 50% of partners
 If majority of partners’ tax years are different, must use
tax year of principal partners
 Principal partner is partner with at least 5% share in profits or
capital
 If principal partners have different tax years, partners
required to use least aggregate deferral method (see pp.
7-2 – 7-3)
2009 Cengage Learning
2009 Cengage Learning

A Personal Service Corporation (PSC) is a
corporation with shareholder-employees whom
provide a personal service
• For example, architects or dentists
Generally must adopt calendar year
 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
 Corporation limits its deduction [see next slide]
2009 Cengage Learning
2009 Cengage Learning

If taxpayer has a short year [other than first/last
year of operation], tax calculated based on
following example:
 Example: In 2008, Fed-Mex changes from a calendar
year to tax year ending 9/30. For the short period
1/1/07 – 9/30/07, Fed-Mex’s TI = $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
2009 Cengage Learning
2009 Cengage Learning

There are three acceptable accounting methods
for reporting taxable income [TI]
• Cash
• Hybrid
must use same method
for tax & books
• Accrual

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
2009 Cengage Learning
2009 Cengage Learning
 Accrual method
• Recognize income when earned and can be
reasonably estimated
• Recognize deduction 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
2009 Cengage Learning
2009 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
2009 Cengage Learning
2009 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
Computer, cars and light
trucks, R&D equipment, certain energy
property & certain equipment
Mostly business furniture & equipment
& property with no ADR life
*See book for Asset Depreciation Range [ADR] classifications
2009 Cengage Learning
2009 Cengage Learning

Depreciation is determined using IRS tables
• Table 2 on p. 7-9
• Salvage value not used in MACRS
• Tables based on half-year convention
 1/2 year depreciation taken in year of acquisition
 1/2 year depreciation taken in final year

May elect to use tables based on straight-line
instead
• Table 3 on p. 7-10

Must use either MACRS or straight-line for all
property in a given class placed in service during
that year
2009 Cengage Learning
2009 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]
2009 Cengage Learning
2009 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 (Table 4 on p. 7-12)
• Used for real estate acquired after 1986
 Treats all acquisitions/dispositions as occurring
mid-month [mid-month convention]
27.5 years: Residential rental
 39 years:
Nonresidential

2009 Cengage Learning
2009 Cengage Learning

§179 allows immediate expensing of qualifying
property
• For 2008, 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 $ for $
 For example, if assets purchased in current year = $900,000,
then $100,000 reduction in §179 capability so limited to
$250,000 – 100,000 = $150,000 election to expense and the
remaining $750,000 of basis is depreciated over assets’ useful
lives.
• Cannot take §179 expense in excess of taxable
income
2009 Cengage Learning
2009 Cengage Learning
When using with regular MACRS, take §179 first,
then reduce basis to calculate MACRS
 For example

• In 2008, NanoPaint Inc. placed a seven-year piece of
property into service costing $342,000 when taxable
income = $1.25 million. Total asset purchases =
$417,000. 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 14.29% MACRS rate
 [$250,000] + [$92,000 x 14.29%] = $263,147 total
2009 Cengage Learning
2009 Cengage Learning