Chapter 7
Accounting Periods & Methods &
Depreciation
Income Tax Fundamentals 2011
Gerald E. Whittenburg &
Martha Altus-Buller
Student Copy
2011 Cengage Learning
Accounting Periods
 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
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Tax Year for
Personal Service Corporation

A Personal Service Corporation (PSC) is a
corporation with shareholder-employee(s) who
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
See next slide
and
 Shareholders’ salaries for deferral period are proportionate
to salaries received during rest of the period
or
 Corporation limits its salaries deduction
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Short Period Taxable Income (TI)

If taxpayer has a short year (other than first or last
year of operation), tax is calculated based on
following example:
° In 2010, Flo-Mex changes from a calendar year to tax
year ending 9/30. For the short period 1/1/10 – 9/30/10,
Flo-Mex’ taxable income = $20,000*
Steps to calculate tax for the short period
Annualize TI
$20,000 x 12/9 = 26,667
Estimated 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
*Note: Calculations for short year TI requires special adjustments
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Accounting Methods

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
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Accounting Methods (continued)
 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
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Depreciation
 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
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Personal Property
Recovery Periods
 With
MACRS, each asset is depreciated according to
an IRS-specified recovery period
◦ 3 year ADR* midpoint of 4 years or less
◦ 5 year
Computers, cars and light
trucks, R&D equipment, certain energy
property & certain equipment
◦ 7 year
Mostly business furniture & equipment
and property with no ADR life
*See Table 7.1 on page 7-9 for Asset Depreciation
Ranges (ADR) for recovery periods for all classes of assets
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Calculating Depreciation
for Personal Property
 Depreciation
is determined using IRS tables
◦ MACRS rates found in Table 7.2 on page 7-10
◦ Rates multiplied by cost (salvage value not used in
MACRS)
◦ Tables based on half-year convention
 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 (percentages in Table 7.3 on page 711)
Note: Must use either MACRS or straight-line for all
property in a given class placed in service during that year
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Mid-Quarter Convention

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)
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50% Bonus Depreciation
Reinstated for 2008-2010
 Additional depreciation immediately available
 Applies to 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
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Real Estate
 Real
assets depreciated based on a
recovery period – 2 types of real property
o
o
o
27.5 years Residential real estate
39 years
Nonresidential real estate
Real assets are depreciated using the straightline method with a mid-month convention
 Mid-month convention assumes all purchases
made in middle of month
 Used for real estate acquired after 1986
 Rates found on Table 7.4 on page 7-13
Note: Different rates apply for real property acquired
before 1981 and after 1980 but before 1987
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Election to Expense - §179

§179 allows immediate expensing of qualifying property
◦ For 2010, the annual amount allowed is $500,000
◦ 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 >
$2,000,000, then reduce §179 expense dollar for dollar
 For example, if assets purchased in current year = $2.1 million,
taxpayer must reduce §179 by $100,000. Therefore, election
to expense is limited to = $400,000 ($500,000 – 100,000). The
remaining $1.7 million of basis is depreciated over assets’
useful lives (including bonus depreciation) if applicable.
◦ Cannot take §179 expense in excess of taxable income
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Election to Expense - §179

When using with regular MACRS, take §179 first,
then reduce basis to calculate bonus depreciation,
then reduce basis to calculate MACRS
 For example
◦ In 2010, NanoPaint Inc.’s taxable income = $1.25 million.
They placed a 7-year piece of property into service costing
$842,000 – it was their only asset purchase in 2010. What
is total depreciation, including election to expense?
◦ Assuming bonus depreciation will be claimed – first take
$500,000 deduction under §179, reduce basis to
$342,000, then multiply by 50% to get bonus depreciation
and then remaining basis ($171,000) by .1429 from
MACRS tables
 Total depreciation and Section 179 = $695,436
($500,000 + 171,000 + *24,436) = $695,436
*(remaining basis of $171,000 x .1429)
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