Final Study Guide - Chapter 6 Taxable Income from Business Operation Business Profit as Taxable Income Taxable income = gross income allowable

Final Study Guide - Chapter 6 Taxable Income from Business...

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Chapter 6 – Taxable Income from Business Operation Business Profit as Taxable Income Taxable income = gross income - allowable deductions o Gross income = all income from whatever source derived Any accession of wealth or increase in net worth o Allowable deduction = all ordinary and necessary expenses paid or incurred during the taxable year in carrying on trade or business The Taxable Year Generally corresponds to their annual accounting period for financial statement purposes o Calendar Year: January-December o Fiscal Year: and 12-month period ending on the last day of any month besides December New business entity establishes taxable year by filing an initial return and first return is generally for a period of less than 12-months To change the taxable year a firm must get permission from IRS and file short-form tax return o The firm must annualize their income to reflect what 12 months of operating would have generated then use the applicable tax rates to calculate tax liability based off of actual results Methods of Accounting Method of Accounting: a consistent system for determining the point in time at which items of income and deductions are recognized o IRS allows cash, accrual, or hybrid method o May not change their method without written approval from the IRS Tax Policy Objectives and Preferences Want to align tax law with policy objectives o Allow no deduction for contributions to political parties or campaigns, payments for fines or penalties, illegal bribes or kickbacks, and civil law settlements o 50% deduction for meals and entertainment expenses Since no or partial deduction is allowed there is a permanent unfavorable book tax difference Tax Preferences: items that corporations are allowed to exclude from taxable income and creates a favorable permanent book/tax difference o Key-person life insurance and municipal bond interest however expenses related to them are also non-deductible Domestic Production Activities Deduction: exemption of 9% of revenue derived from sales of property manufactured, produced, grown, or extracted in the United States Cash Method of Accounting Firms record revenue and expenses in the year that they were actually paid o Receipt and payment of noncash creates revenue or expenses equal to the value of their payment
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Constructive Receipt Income is received when a person has unrestricted access and control to the income even if it is not in the actual possession of the person Constructive receipt applies when income is credited to a taxpayers account, set apart for him, or otherwise made available so the taxpayer can draw on it during the taxable year o Cannot defer income recognition by holding checks and waiting to deposit until the next taxable year Prepaid Expenses and Income 12-month rule: if an expenditure results in a benefit with a duration of 12 months or less and does not extend past the following taxable year then it can be expensed o
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