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

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

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