Contents
Chapter 1Introduction1
§1.01Overview1
§1.02Financial Accounting Vs. Tax Accounting1
§1.03Why Learn Tax Accounting?2
§1.04Tax Records Maintenance2
Chapter 2Tax Accounting Doctrines5
§2.01Annual Accounting Doctrine5
§2.02Claim Of Right Doctrine6
(a)Effect Of Doctrine7
(b)Circumstances Where Doctrine Applies7
(c)Uncertainty Of Income Status Or Amount7
(d)Restrictions On Disposition8
(e)Funds Received By Agent Or Trustee9
(f)Prepaid Income Issues9
(g)Bona Fide Nature Of Claim9
(h)Repayment Of Claim-Of-Right Income9
(1)Generally9
(2)Agreement To Repay10
(3)Deduction In Case Of Repayment11
(i)Pending Disputes11
(j)Violations Of Law; Illegitimate Claims12
§2.03Section 1341 Relief For Repayment Of Claim Of Right Receipts12
(a)Generally12
(b)Conditions Necessary For Section 1341 Relief13
(c)Tax Calculation Under Section 134115
(d) $3,000 Limitation16
§2.04The Arrowsmith Doctrine16
§2.05The Tax Benefit Rule18
Chapter 3The Entity’s Tax Year21
§3.01Introduction21
§3.02Calendar Year21
§3.03Fiscal Year21
§3.04Adoption, Change Or Retention Of Taxable Year21
(a)Adoption Of Taxable Year21
(b)Change Of Taxable Year22
(c)Retention Of Taxable Year22
(d)Commissioner’s Pronouncements22
(e)Approval Of Commissioner23
(1)Generally23
(2)“Business Purpose”23
(3)Natural Business Year23
(4)Ruling Requests24
(5)Automatic Approvals26
§3.05Required Tax Year(s)27
§3.06Ownership Taxable Year28
§3.07Corporations28
(a)Generally28
(b)Initial Tax Year29
(c)Personal Service Corporations29
(d)S Corporations30
§3.08Partnerships30
(a)Generally30
(b)Rule #1: Majority Interest Rule31
(c)Rule # 2: Principal Partner Rule31
(d)Rule # 3: Least Aggregate Deferral Rule31
(1)Generally31
(2)Procedural Requirements33
(3)Special De Minimis Rule34
§3.09Section 444 Election34
(a)Generally34
(b)Filing Requirements34
(c)Required Payments/Distributions35
(1)Generally35
(2)Required Payment For Partnership Or S Corporation35
(3)Required Distribution For Personal Service Corporation36
(4)Failure To Make Required Payments36
(d)Ending The Election36
§3.10Back-Up Section 444 Elections37
(a)Generally37
(b)Making The Election37
(c)Activating The Election37
§3.11Correction Of Erroneous Tax Year37
Chapter 4Methods Of Accounting39
§4.01Overview39
§4.02The Timing Issue40
§4.03Selecting An Accounting Method40
§4.04Book Conformity Rule40
§4.05Conversion Work Papers41
§4.06“Material Items”43
(a)Generally43
(b)Immaterial Items43
(c)“Different” Items44
§4.07“Clear Reflection Of Income”44
§4.08“Consistency” And “Predictability”45
(a)Generally45
(b)Multiple Businesses45
(c)Computational Errors45
§4.09“Adopted” Accounting Method45
(a)Generally45
(b)Mechanics Of Adoption46
(c)New Entities46
§4.10Restrictions On Use Of Accounting Methods46
Chapter 5The Cash Receipts And Disbursements Method47
§5.01Generally47
§5.02Income Recognition47
§5.03Cash Equivalency Doctrine48
(a)Generally48
(b)Receipt Of Property50
(1)Generally50
(2)Intangible Property50
(c)Fair Market Value50
§5.04Constructive Receipt Doctrine52
(a)Generally52
(b)Economic Benefit Doctrine52
(c)Power To Collect53
(d)Substantial Limitations Or Restrictions54
§5.05Check “Income”56
§5.06Interest Income57
§5.07Dividend Income58
§5.08Rental Income58
§5.09Lottery Prize Proceeds58
§5.10Escrow Agreements59
§5.11Deferred Payment Agreements61
§5.12Expenses-Deductions61
(a)Generally61
(b)Constructive Payment62
§5.13Note/Check Payments62
§5.14Borrowed Funds, Payment With63
§5.15Prepaid Expenses64
§5.16Prepaid Period Costs65
(a)12-Month Rule65
(b)Exceptions To 12-Month Rule67
(c)Elective Capitalization67
§5.17Interest Expenses68
(a)Prepaid Interest68
(b)Rule Of 78’s69
(1)Generally69
(2)Prepayment Of Principal70
§5.18Limitations On Cash Method’s Use71
(a)Generally71
(b)Section 467 Rental Agreements71
(c)Section 448 Entity Limitations72
(d)Qualified Personal Service Corporations72
Chapter 6The Accrual Method75
§6.01Generally75
§6.02Income Recognition75
(a)Fixed Right To Receive Income75
(b)Conditions Precedent76
(c)Conditions Subsequent77
(d)Passage Of Title And Business Practice77
(e)Amount Realized78
(f)Doubts About Collectability78
(g)Nonaccrual-Experience Method For Services Receivable79
§6.03Prepaid Income79
(a)Generally79
(b)“Trilogy Cases”80
(c)Deferral Of Income Under Rev. Proc. 71-2182
(1)Generally82
(2)Illustrative Applications83
(d)Advance Payments Under Rev. Proc. 2004-3484
(1)Generally84
(2)What Are Not Advance Payments85
(3)Permissible Methods Of Accounting85
(e)Advance Payment For Goods86
(f)Prepaid Dues Income88
(g)Prepaid Subscription Income88
§6.04Deposits As Income88
§6.05Trading Stamps And Coupons89
§6.06Service Warranty Income90
§6.07Expenses-Deductions91
(a)Generally91
(b)Fixed Liability Requirement91
(c)Contingent Liabilities92
(d)Amount Of Liability93
§6.08“Economic Performance” And Accrual Of Expenses93
(a)Generally93
(b)When Economic Performance Occurs94
(c)3 ½ Month Exception98
(d)Recurring Items Exception98
(1)Generally98
(2)Time And Manner Of Adopting The Recurring
Item Exception99
(3)Payment To Another Person99
(4)Person To Whom Payment Is Made100
(5)Miscellaneous Exceptions100
(e)Long-Term Contracts100
§6.09Real Property Taxes103
(a)Accrual Of Taxes103
(b)Limitation On Double Accrual103
§6.10Disputed Liabilities104
§6.11Deferred Compensation Deductions107
(a)Generally107
(b)Section 404 Deductions107
(c)Section 267 Deduction108
Chapter 7Change In Accounting Method109
§7.01In General109
(a)What Constitutes A Change In Accounting Method109
(b)What Is Not A Change Of Accounting110
(c)”Material Items”111
(d)Adoption Of A Method Of Accounting112
(e)Change In Underlying Facts113
§7.02Taxpayer-Initiated Changes115
(a)Generally115
(b)Two Or More Trades Or Businesses115
(c)Consolidated Groups115
(d)Audit Protection For Taxable Years Prior To Year Of Change116
(e)District Director’s Review116
§7.03Commissioner’s Consent117
(a)Generally117
(b)Procedures For Obtaining Consent117
(1)Generally117
(2)Changes Effected By Rev. Proc. 97-27118
(c)Terms And Conditions118
(d)Noncompliance With Provisions118
(e)Section 446(f) Sanctions119
(f)Effect Of Consent; Subsequent Modifications119
(g)Automatic Consent120
§7.04Taxpayer Applications For Change (Form 3115)120
(a)Generally120
(b)Protective Applications121
(c)Time For Filing121
(1)Generally121
(2)Late Filing121
(d)Where To File121
(e)User Fee122
(f)Signature Requirements122
(g)Facts And Circumstances Considered122
(h)Incomplete Applications123
(i)Conference Requests123
(j)IRSDiscretion To Process Application123
(k)Taxpayers Under Examination123
(1)Prohibition On Filing123
(2)90-Day Window Period124
(3)120-day Window period124
(4)District Director’s Consent124
(5)Taxpayer Before An Appeals Office125
(6)Taxpayer Before A Federal Court125
(7)Terms And Conditions Of Change125
(l)Prior Applications125
(1)Generally125
(2)LIFO Inventory Method Change125
(3)Changes Not Made126
§7.05Consent Agreements126
(a)Generally126
(b)Signature Requirements126
(c)Rejection By Taxpayer127
§7.06Year Of Change127
§7.07Section 481 Adjustment127
(a)Generally127
(b)Historical Background127
(c)Application Of Adjustment128
§7.08Section 481(a) Adjustment Period129
(a)Generally129
(b)Short Period As A Separate Taxable Year129
(c)Shortened Or Accelerated Adjustment Periods130
§7.09IRS-Initiated Changes130
(a)Generally130
(b)Change In Sub-Method131
(c)Prior Year Changes131
(d)Criminal Investigations/Proceedings131
(e)Examining Agent’s Discretion131
(f)Treatment Of Accounting Method Issues131
(g)Selection Of New Method Of Accounting131
(h)Year Of Change132
(i)Section 481(a) Adjustment132
(j)Audit Protection132
(k)Example132
§7.10Automatic Consent Procedures133
§7.11Hat Creek Problem134
Chapter 8Inventory153
§8.01Overview153
§8.02“Best Accounting Practice”153
§8.03“Clear Reflection Of Income”154
§8.04Election Of Accounting Method155
§8.05Unacceptable Accounting Methods155
§8.06Use To Determine “Gross Income”156
§8.07Cost Flow Assumptions/Methods157
(a)Generally157
(b)Specific Identification Method157
(c)FIFO Method158
(d)LIFO Method159
§8.08Valuation Methods159
(a)Generally159
(b)“At Cost” Valuations160
(1)What Is “Cost”160
(2)Discounts160
(3)Advance Rebates160
(4)Acquisition Costs160
§8.09Lower-Of-Cost-Or-Market Valuation160
(a)Generally160
(b)Market Value Determination160
(c)“Normal” Goods160
(d)Excess Inventory160
(e)“Subnormal” Goods162
(1)Generally162
(2)Tax Treatment: Net Realizable Value162
(3)Year Of Worthlessness163
(4)Recordkeeping Requirements163
(5)Illustration Of Method163
§8.10Inventoriable Items164
§8.11Noninventoriable Items164
§8.12Periodic Physical Counts165
§8.13Spare Parts165
(a)Inventory Treatment165
(b)Non-Inventory Treatment165
§8.14Containers165
§8.15Supplies166
§8.16Shrinkage167
(a)Deduction In Year Of Loss167
(b)Shrinkage Estimates167
§8.17Passage Of Title To Goods167
(a)Generally167
(b)Inclusion Rules168
(c)Judicial Decisions168
(d)C.O.D. Sales168
(e)Consignments169
(f)Sale Or Return Contracts169
(g)Shipments On Approval169
(h)Where Title Is Not Controlling169
§8.18Cash Basis Taxpayers169
(a)Historical Position Of The IRS169
(b)“Substantial Identity Of Result” Doctrine171
(c)Retreat From Historical Position: Recent Developments172
§8.19Qualifying Small Business Taxpayer173
(a)Qualifying Small Business Taxpayer Exception173
(b)Qualifying Small Business Taxpayer175
(c)Average Annual Gross Receipts175
(d)Inventoriable Item Defined176
(e)Open Accounts Receivable Defined176
(f)Automatic Change For Taxpayers176
(g)Single Form 3115176
(h)Section 481(a) Adjustment177
Chapter 9Uniform Capitalization Rules179
§9.01Overview179
§9.02Application Of Rules179
(a) Generally179
(b) Exemptions179
§9.03Taxpayers/Activities To Which Rules Are Applicable180
(a)Generally180
(b)Trade Or Businesses Application180
(1)Generally180
(2)Tax Planning Considerations181
(c)Production Activities181
(1)Generally181
(2)Taxpayers Engaged In “Production Activities”182
§9.04Property Subject To Unicap182
(a)Generally182
(b)“Small Reseller” Exemptions183
(1)Generally183
(2)“Average Annual Gross Receipts” Determination183
(3)Resellers With Production Activities183
(4)Property Produced Under Contract184
(c)Long-Term Contract Exemption184
(d)Property Provided Incident To Services Exemption184
(e)Small Producers Exemption185
(f)Examples185
§9.05Costs Subject To Unicap186
(a)Generally186
(b)Definitions187
(1)Section 471 Costs187
(2)Section 263A Costs187
(3)Additional Section 263A Costs188
(c)Producers188
(d)Resellers188
(e)Costs Not Capitalized188
§9.06Purchasing Costs189
§9.07Labor Costs189
§9.08Handling Costs189
(a)Generally190
(b)Processing Costs190
(c)Assembling Costs190
(d)Repackaging Costs190
(e)Transportation Costs190
(f)Costs Not Capitalized191
§9.09Storage Costs191
(a)Generally191
(b)On-Site Storage Facilities192
(c)Off-Site Storage Facilities192
(d)Dual-Function Storage Facilities192
§9.10Service Costs193
(a)Generally193
(b)Capitalizable Service Costs193
(c)Deductible Service Costs193
§9.11 Mixed Service Costs194
(a)Generally194
(b)Allocation Of Costs194
(1)Generally194
(2)De Minimis Rule195
(3)Taxpayers With Both Production And Resale Activities195
(4)Entire Cost Of Department195
(5)“Facts And Circumstances” Method195
§9.12Simplified Service Cost Methods 197
(a)Producers197
(1)Generally197
(2)Operational Rules197
(3)Production Cost-Based Method198
(4)Labor Cost-Based Method198
(5)Examples198
(b)Resellers199
(1)Generally199
(2)Operational Rules199
(3)Formula To Be Applied199
§9.13Allocation Of Direct And Indirect Costs200
(a)Generally200
(b)Restrictions200
(c)Disallowed Methods200
(d)Multiple Trades Or Businesses201
(e)Taxpayers With Both Production And Resale Activities201
(f)Entire Cost Of Department201
§9.14Simplified Production Method Without Historical
Absorption Ratio Election201
(a)Generally201
(b)Application Of Method201
(c)Examples202
§9.15 Simplified Resale Method Without Historic Absorption Ratio Election203
(a)Generally203
(b)Combined Absorption Ratio203
(c)Storage And Handling Absorption Ratio204
(d)Purchasing Absorption Ratio204
(e)Section 471 Costs Remaining On Hand At Year-End205
(f)Examples205
§9.16Interest Capitalization Rules207
(a)Generally207
(b)“Interest” Defined207
(c)Eligible Debt207
(1)Generally207
(2)Categories Of Debt207
(d)Avoided Cost Method208
(e)De Minimis Exception208
(f)Treatment Of Capitalized Interest208
(g)Units Of Property208
(h)Functionally Interdependent Components209
(i)Installation Activity209
(j)Common Features209
(k)Computation Periods210
(l)Measurement Dates210
(m)Rules Of Interest Capitalization210
(1)Rule 1210
(2)Rule 2211
(3)Rule 3213
Chapter 10Installment Method/Sales217
§10.01Generally217
§10.02Benefits/Detriments217
§10.03Application Of Method218
(a)Generally218
(b)Exceptions218
§10.04Taxpayers Not Applying Method219
(a)Generally219
(b)Cash Basis Taxpayers219
(c)Accrual Basis Taxpayers219
§10.05Computation Of Gain 219
(a)Generally219
(b)Gross Profit220
(c)Selling Price220
(d)Contract Price220
(e)Qualifying Indebtedness220
(f)Payment220
(g)Selling Expenses221
§10.06Recapture Income221
§10.07Contingent Payment Sales222
(a)Generally222
(b)Stated Maximum Selling Price223
(1)Generally223
(2)Reduction/Recomputation Of Price224
(c)Sales With Fixed Payment Period224
(d)Sales With No Maximum Selling Price Or Fixed Payment Period225
(e)Income Forecast Method225
(1)Generally225
(2)Calculations226
(3)Video Gaming227
(f)Other Rules227
§10.08Dealer Rules228
(a)Generally228
(b)Dealers In Real Property228
(c)Dealers In Personal Property228
(d)Farm Property229
(1)Generally229
(2)Carrying Charges229
(e)Residential Lots And Timeshares229
(1)Generally229
(2)Interest Charges229
(3)Carrying Charges230
§10.09Related Party Rules230
(a)Generally230
(b)Sale To Related Person Followed By Second Disposition231
(c)Involuntary Dispositions232
§10.10Non-Dealer Rules232
(a)Generally232
(b)The Interest Rule232
(1)Generally232
(2)Application Of Rule232
(3)Computation Of Interest233
(c)The Pledge Rule234
§10.11Mortgages And Other Liabilities234
(a)Generally235
(b)Assumption Of Mortgage235
(c)Wrap-Around Mortgages236
§10.12Disposition Of Installment Obligations237
§10.13Modification Of Installment Obligations238
(a)Generally238
(b)Minor Modifications/Non-Taxable Dispositions239
(c)Substantial Modifications/Taxable Dispositions240
(d)Transfers Of Installment Obligations At Death240
(e)Debt Instrument Modifications Under Section 1001241
§10.14Default And Repossession Of Real Property241
Chapter 11Long-Term Contracts243
§11.01Generally243
§11.02Manufacturing Contracts243
(a)More Than 12 Months To Complete243
§11.03Construction Contracts243
(a)Generally243
(b)De Minimis Construction Activities244
§11.04Completed Contract Method (CCM)244
(a)Home Construction Contracts244
(b)Small Contractors245
§11.05Percentage Of Completion Method (PCM)245
(a)Application Of Method245
(b)Exceptions246
(1)Exempt Contracts246
(2)Residential Construction Contracts246
(c)Computation Of Income246
(1)Computational Steps246
§11.0610-Percent Method248
§11.07Look-Back Method249
(a)Generally249
(b)Exceptions250
(c)Operation Of Method251
(d)Reporting Of Interest251
(e)Tax Treatment Of Interest252
§11.08Special Rules252
(a)Terminated Contracts252
(b)Mid-Contract Change In Taxpayer252
(1)Step-In-The-Shoes Transaction252
(2)Constructive Completion Transaction253
§11.09Accounting Method Change253
Chapter 12Domestic Manufacturing Deduction255
§12.01Generally255
§12.02Application Of Deduction255
§12.03Eligible Taxpayers256
§12.04Qualified Production Activities Income257
§12.05Domestic Production Gross Receipts257
(a)Generally257
(b)MPGE “In Significant Part”258
§12.06Qualified Production Income259
§12.07Allocation Of Gross Receipts259
(a)General Method259
(b)Simplified Methods260
(1)Generally260
(2)Small Taxpayers260
(c)De Minimis Rule260
§12.08Expanded Affiliated Groups261
§12.09Partnerships261
(a)Generally261
(b)Disallowed Deductions262
§12.10S Corporations262
(a)Generally262
(b)Disallowed Deductions263
§12.11Filling In Form 8903263
Exhibits265