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Accounting Periods

Bus 223F

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What is the purpose of an accounting period?

Allow for reporting of taxable income on a regular basis

Allow for a consistent treatment for calculating taxable income and tax

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How long should the period be?

A consecutive period of 12 months unless it is a short period (such as first or last tax year or one that results from a change in period)

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What possible abuses might occur if taxpayers had full control over selecting their accounting period?

Might select one that does not tie to books

Might end in middle of a month Might not be 12 months long Might end on 2/29

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Should a natural business year be used?

How to define and identify? Look for time when sales peak (end of

natural year) Should at least be a calendar year or

fiscal year

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Should period be same as for books?

Advantages: No special journal

entries or add’l set of books needed to computer taxable income

Less chance of taxpayer abuse

Disadvantages: No extra tax

planning opportunities

May create too much work for preparer

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What if business uses a 52/53 week year for books?

Ok to use for tax (441(f)) Is a fiscal year

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What is appropriate period for a passthrough entity?

One that doesn’t result in too much opportunity for owners to defer reporting of the passthrough entity income

Fiscal or calendar year Note – partnerships and S

corporations have required tax years

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What is appropriate period for individuals without a business?

Calendar year Same that records are based on –

usually calendar year

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How should t/p notify IRS of its accounting period?

On initial return Problem – what if file it late, even if

after the extended due date? How will you prove the year?

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Possible problems with use of annual accounting period

1. Later event relates to a prior year event2. Later event is fundamentally

inconsistent with earlier treatment3. Relief if have to later repay income

reported in earlier year under claim of right and tax rate higher in earlier year

4. Error in NOL carryforward5. Later inconsistent positions – mitigation

of statute

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Arrowsmith and Relation Back

Q - In current tax year, Partnership P recovered $3,000 from a shareholder derivative suit brought against a corporation for mismanagement that affected the stock price. P sold the stock two years earlier at a loss. How should P report the $3,000?

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Tax Benefit Rule

§111 + Hillsboro National Bank/Bliss Dairy case (USSC 1983) Hillsboro – “fundamentally inconsistent”

approach EX – Sole proprietor, cash method, signs

contract 12/1/09 to rent a storage site starting 1/1/10 and deducts in 2009. In January 2010, one of 2 events occurs:

A) site burns to ground B) SP decides to use personally insteadQ – how to treat these events in 2009 and 2010

in light of tax benefit rule?

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Claim of right - §1341

Requirements: (1) an item included in gross income in prior tax

year because it appeared that taxpayer had unrestricted right to such item;

(2) a deduction is allowed in current tax year because it turns taxpayer did not have an unrestricted right to such item or to a portion of such item; and

(3) amount of such deduction exceeds $3,000

See section for details on how to calculate tax for current year.

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Rationale for §1341

“The legislative history of section 1341 indicates that it was enacted to adequately compensate a taxpayer for the tax he paid for a prior year when he subsequently has been obliged to restore amounts he had included in gross income in the prior year because it appeared that he had an unrestricted right to such amount. Senate Report No. 1622, Eighty-third Congress, at pages 118 and 451. See also 108 Congressional Record 22531 (daily edition, October 5, 1962) (Senator Kerr). Thus, the purpose of section 1341 was to place such a taxpayer at least in no worse a tax position than he would have been had he never received the income originally.” [Rev. Rul. 77-344]

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NOL adjustments

Realize mistake made in prior year in which NOL arose and that NOL is being carried forward. Should the NOL be corrected? YES – Rev. Rul. 56-285

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Inconsistent positions and mitigation of statute of limitations

§§1311-1314 §1311(a) – “(a) General rule. If a determination

(as defined in section 1313) is described in one or more of the paragraphs of section 1312 and, on the date of the determination, correction of the effect of the error referred to in the applicable paragraph of section 1312 is prevented by the operation of any law or rule of law, other than this part and other than section 7122 (relating to compromises), then the effect of the error shall be corrected by an adjustment made in the amount and in the manner specified in section 1314.

§1312 – inconsistency generally is double reporting or omission of income or expense

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Accounting periods – IRC provisions

§441 – Period for computation of taxable income

§442 – Change of annual accounting period §443 – Returns for a period of less than 12

months §444 - Election of taxable year other than

required taxable year §7519 - Required payments for entities electing

not to have required taxable year §280H - Limitation on certain amounts paid to

employee-owners by personal service corporations electing alternative taxable years

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Definitions in IRC §441 and 1.441-1

Taxable year Annual accounting period

Calendar year Fiscal year

12 months ending on last day of any month other than December

52/53 week year

Required tax year

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When change period …

Will have a short period EX – change from 12/31 to 6/30

File for 12/31/09 Next return is for 1/1/10 to 6/30/10 Subsequent return is back to full year

(7/1/10 to 6/30/11)

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Issues to be addressed when have a short TY caused by period change

Annualize TI and regular tax and AMT calculations

Does it count as a full year in counting loss and credit carryover periods? Generally yes Recall special rule in RP 2004-34

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X Corp changes TY from calendar year to Saturday closest to 12/31 (1/2/2010)

X may add the 2 days to its 12/31/10 return

Guidance in 441 regs

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Required tax years – 1

Entity Required TY Per IRC §

PSC Calendar year unless establish business purpose or can make 444 election

441(i)1.441-3

S Corp Calendar year unless establish business purpose or can make 444 election

1378

P/S (see later slide) 706(b)(1)1.706-1

C other than PSC

Any

Trust Generally must use calendar year except for tax-exempt trusts and charitable trusts

645

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Required tax years - 2

C other than PSC

Any

Trust Generally must use calendar year except for tax-exempt trusts and charitable trusts

645

Members of affiliated group filing consolidated return

1.442-1(c) – automatic change procedure for sub required to change its TY1.1502-76(a) – consolidated return must be filed on basis of common parent’s annual acctg period. Each sub must adopt parent’s TY for first consolidated return year for which sub is included. If any member is on 52/53 week TY, if get advance consent, req for same TY deemed satisfied if TYs of all members of group end within same 7-day period. RP 89-56, as modified by RP 2006-21.

1.1502-76

1.442-1(c)

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Partnership required TY

Must use first one of following which exists: Majority interest TY TY of all principal partners (ptr with

interest in p/s profits or capital > 5%) TY resulting in least aggregate deferral

(see regs) Unless p/s establishes business

purpose for a different TY or makes a 444 election

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Majority interest tax year – 706(b)(4)

(A) Majority interest taxable year defined. For purposes of paragraph (1)(B)(i) —

(i) In general. The term “majority interest taxable year” means the taxable year (if any) which, on each testing day, constituted the taxable year of 1 or more partners having (on such day) an aggregate interest in partnership profits and capital of more than 50 percent.

(ii) Testing days. The testing days shall be— (I) the 1st day of the partnership taxable year (determined

without regard to clause (i) ), or (II) the days during such representative period as the Secretary

may prescribe. (B) Further change not required for 3 years. Except as

provided in regulations necessary to prevent the avoidance of this section , if, by reason of paragraph (1)(B)(i) , the taxable year of a partnership is changed, such partnership shall not be required to change to another taxable year for either of the 2 taxable years following the year of change.

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Ptr A owns 60% uses 6/30 TYPtr B owns 40% uses calendar year

Partnership AB must use 6/30 See §706; P/s has a majority interest

tax year

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Required year for ABC Partnership?

Partner Ownership % Tax year

A 33% 12/31

B 33% 6/30

C 34% 9/30

No majority interest TY or principal partners TY, so must apply least aggregate deferral determination from 706 regs.

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Basics of §444

Enacted in 1987 to address “workload compression”

Only for S corp, PSC and P/s Allows for no more than 3 months deferral from

required TY EX – p/s required TY = 9/30

§444 options are 8/31, 7/31 or 6/30 If already using required TY, too late typically to

make 444 election P/S and S corp – must make required payments

under §7519 At highest individual rate + 1 percentage point Basically keeping a non-interest bearing deposit at IRS

PSC must make required distributions under §280H

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Changing Accounting Period

Check 442 and regs and the applicable revenue procedures, as modified

Automatic change procedures exist Generally cannot have changed in prior 48 month

period Special rules if taxpayer owns interest in

passthrough entity If generate NOL in short tax year, generally, may

not carry it back To help ensure that taxpayers don’t change periods

to purposefully create an NOL to carryback. Form 1128

If non-automatic, owe user fee Watch due date