I. Classification and Limitations of Employee Expenses
A. Nature of the Employment Relationships
1.) Significant tax consequences flow from the characterization of a taxpayer as an employee vs. self-employed (independent contractors)
Ex : A self-employed individual will be responsible for self-employment tax which is much higher than an employee’s hare of social security tax.
2.) A taxpayer is considered an employee where the employer has the right to direct and control both the end result and the way the result is accomplished.
B. Limitations on Un-reimbursed employee expenses.
1.) Un-reimbursed employee expenses are classified as misc: Itemized deductions. The total of miscellaneous itemized deductions is reduced by 2%, of AGI before any tax benefit is reached.
2.) Therefore, un-reimbursed employee business expenses may provide not tax benefit if total misc. itemized deductions do not exceed 2% of AGI, or if total itemized deductions do not exceed the standard deduction. These expenses may also be affected by the phase-out of itemized deductions for certain high-income taxpayers.
III. Travel Expenses
A. Deductibility of travel expenses : Dependent on the nature of the expenditure and whether the employee is reimbursed.
1.) Travel expenses for self-employed individuals and fully-reimbursed employee travel expenses are deducted for AGI
2.) Un-reimbursed employee travel expenses (whether insufficient reimbursement or no reimbursement occurs) are deducted as a misc. itemized deduction subject to the 2% non-deductible floor.
B. Definition of Travel Expenses
1.) Includes transportation, meals and lodging related to a trade, business, or employee status incurred while away from the taxpayer’s tax home.
2.) The deductible amount of travel expenses may be reduced if actual expenses are lavish or extravagant.
C. General Qualification Requirements
1.) Travel expenses related to a trade, business, or employee status are deductible if incurred while away from the taxpayer’s home.
2.) Transportation costs for day trips are deductible, even if the taxpayer does not stay away from home overnight.
D. Business versus Pleasure
1.) Travel expenses in combination business/ personal trips will be only partially deductible
2.) If a domestic trip is primarily business, travel expenses to and from the business destination are deductible even though there is some personal time during the trip. Expenses for personal days will not be deductible.
3.) No deduction is allowed for the travel expenses of a companion unless the companion is also an employee and the travel is business-related and otherwise deductible.
E. Foreign Travel
1.) Even more stringent allocation rules apply to the deductibility of travel expenses on foreign business/personal trips.
2.) Deductions for foreign conventions are only allowed for “directly related” activities for which the taxpayers can proved that a meeting held outside North American is reasonable.
F. Additional Limitations on Travel Expenses
1.) Additional limitations on deductions for travel expenses exist for educational travel, certain conventions and seminars, luxury water travel and charitable travel.
III. Transportation Expenses
A. Commuting cost are generally non-deductible personal expenses.
B. Commuting expenses between multiple jobs for the same taxpayers will be deductible
C. Transportation costs from an employee’s regular place of work to a temporary work site are deductible.
D. If a taxpayer has a regular place of business, commuting costs between home and temporary work sites are deductible.
E. Treatment of Automobile Expenses.
1.) Actual business auto expenses can be deducted or a standard can mileage rate (48.5 cents/mile – effective 1/1/2007)
2.) For newer cars, the deduction for actual expenses will generally exceed the standard mileage deduction.
IV. Entertainment Expenses
A. 50% disallowance for meal and entertainment expenses
1.) Deductions for business-related meals and entertainment are limited to 50% of incurred cost.
2.) Self-employed individuals and employees who are fully reimbursed may deduct entertainment expenses for AGI.
Monday, October 22, 2007
Wednesday, October 17, 2007
Ch. 8 Notes
I. Transactions that may result in losses. Realization is a prerequisite for loss.
Ex. If a taxpayer holds tock that had a $25,000 fair market value at the beginning of the tax year and a $15,000 fair market value at the end of the tax year, no loss is recognized for tax purposes, even though the value of the stock has decreased by $10,000.
A. Sale or Exchange of Property
1.) In a sale or exchange, the amount of the loss is the excess of the property’s adjusted over the amount realized.
Ex. If the taxpayers realizes $10,000 from the sale of an asset with an adjusted basis of $18,000, the realized loss is $8,000 (10,000 – 18,000)
2.) Losses incurred on the sale of personal use property are not deductible.
3.) Losses on trade on business property and investment property are deductible
B. Expropriated , Seized or Confiscated Property
1.) Property expropriated, seized or confiscated by a foreign government gives rise to a deductible loss only if the property is used in a trade or business and is held for investment.
2.) Any allowable deduction must be taken in the year of actual seizure.
3.) Any gain realized on seizure would be treated under the involuntary conversion rules.
C. Abandoned Property
1.) Abandoned property used in a trade or business or held for investment gives rise to a deductible loss.
2.) The amount of the asset at the date of abandonment.
3.) The character of the loss is ordinary, since there is no sale or exchange.
D. Worthless Securities Treated as a capital loss on the last day of the tax year.
Ex. If a calendar year taxpayer owns securities which become worthless on march 15, the tax treatment is to recognize a capital loss on Dec. 31st.
E. Demolition of Property demolition costs are to be added to the basis of the underlying property.
II. Classifying the Loss on the Taxpayer’s tax return.
A. Ordinary versus capital loss
1.) Dependent on the types of property involved and the type of transaction involved.
2.) Losses on qualifying Sec. 1244 stock are treated as ordinary ($50,000 or $100,000 limitation) rather than capital offset capital gains plus $3,000 of ordinary income.
- To qualify as Sec. 1244 stock:
The stock must be owned and issued by and individual or partnership.
The corporation must be a domestic corporation.
The stock must be issued for cash or property and not for services.
The corporation may not have derived over 50% of its gross receipts from passive income sources during the immediately preceding 5 tax years. And at the time the stock is issued, the amount of money and property contributed to both capital and paid-in surplus may not exceed $1,000,000
B. Disallowance Possibilities
1.) Certain realized losses are disallowed in special situations, including related party transactions and wash sales.
2.) Other potential disallowance situation include transfer of property in exchange for tock. Sec. 351, like-kind exchanges and partnerships (both under the (at risk) limitation and the passive loss rules.)
III. Passive Losses
A.)
1.) Passive losses may only offset passive income, not portfolio or active income
2.) Portfolio income included non-business dividends, interest, royalties, annuities, and certain gains and losses on property
3.) Credits generated from passive activities are also limited. These credits may only offset tax liabilitiy generated by passive income.
B.) Carryovers
1. Un-utilized passive losses may be used against future income or on the disposition of the passive activity interest.
2. The carryover is unlimited in amount and duration.
C.) Definition of Passive Activity
1. Includes any rental activity and any trade, business, or investment activity in which the taxpayer does not materially participate.
2. Investments in limited partnerships generate passive losses due to the legal restrictions on limited partner’s involvement in he mgt of the partnership.
C. Taxpayers subject to passive loss rules
1.) Apply to individuals, estates, trust, closely-held C corp personal service corp. and certain publicly-traded partnerships.
2.) While the passive loss rules do not apply to partnerships and S-Corp. They do apply to the owners (partners & shareholders)
IV. Casualty and Theft Losses
• Casualty defined
o A casualty loss results from an identifiable event that was sudden, unexpected or unusual.
o Qualifying casualties included fire, flood, hurricane , tornados, hail, and cyclone.
• Theft Defined
o Generally, criminal intent and violation or a state law are required to meet the definition of theft.
o Theft for tax purposes includes robbery, blackmail, extortion and ransom.
• Deductible Amount of Casualty Loss
o For personal use property the deductible amount is the lesser of the reduction in FMV or adjusted basis.
o In the total destruction of business property the deductible amount is the property’s adjusted basis.
V. Bad Debts
• Bonda-Fide debtor Creditor Relationships
o Valid and enforceable obligations to pay a fixed or determinable sum of money
• Taxpayer’s Basis in the Debt.
o Creditor must have a basis in the debt for the bad debt to be deductible
• Debt Must be Worthless
VI. Tax Planning Consideration
• Bad Debts – Taxpayers should document their determination that a particular debt is worthless.
• Casualties
o Documentation of FVC is important to support a casualty loss deduction.
Ex. If a taxpayer holds tock that had a $25,000 fair market value at the beginning of the tax year and a $15,000 fair market value at the end of the tax year, no loss is recognized for tax purposes, even though the value of the stock has decreased by $10,000.
A. Sale or Exchange of Property
1.) In a sale or exchange, the amount of the loss is the excess of the property’s adjusted over the amount realized.
Ex. If the taxpayers realizes $10,000 from the sale of an asset with an adjusted basis of $18,000, the realized loss is $8,000 (10,000 – 18,000)
2.) Losses incurred on the sale of personal use property are not deductible.
3.) Losses on trade on business property and investment property are deductible
B. Expropriated , Seized or Confiscated Property
1.) Property expropriated, seized or confiscated by a foreign government gives rise to a deductible loss only if the property is used in a trade or business and is held for investment.
2.) Any allowable deduction must be taken in the year of actual seizure.
3.) Any gain realized on seizure would be treated under the involuntary conversion rules.
C. Abandoned Property
1.) Abandoned property used in a trade or business or held for investment gives rise to a deductible loss.
2.) The amount of the asset at the date of abandonment.
3.) The character of the loss is ordinary, since there is no sale or exchange.
D. Worthless Securities Treated as a capital loss on the last day of the tax year.
Ex. If a calendar year taxpayer owns securities which become worthless on march 15, the tax treatment is to recognize a capital loss on Dec. 31st.
E. Demolition of Property demolition costs are to be added to the basis of the underlying property.
II. Classifying the Loss on the Taxpayer’s tax return.
A. Ordinary versus capital loss
1.) Dependent on the types of property involved and the type of transaction involved.
2.) Losses on qualifying Sec. 1244 stock are treated as ordinary ($50,000 or $100,000 limitation) rather than capital offset capital gains plus $3,000 of ordinary income.
- To qualify as Sec. 1244 stock:
The stock must be owned and issued by and individual or partnership.
The corporation must be a domestic corporation.
The stock must be issued for cash or property and not for services.
The corporation may not have derived over 50% of its gross receipts from passive income sources during the immediately preceding 5 tax years. And at the time the stock is issued, the amount of money and property contributed to both capital and paid-in surplus may not exceed $1,000,000
B. Disallowance Possibilities
1.) Certain realized losses are disallowed in special situations, including related party transactions and wash sales.
2.) Other potential disallowance situation include transfer of property in exchange for tock. Sec. 351, like-kind exchanges and partnerships (both under the (at risk) limitation and the passive loss rules.)
III. Passive Losses
A.)
1.) Passive losses may only offset passive income, not portfolio or active income
2.) Portfolio income included non-business dividends, interest, royalties, annuities, and certain gains and losses on property
3.) Credits generated from passive activities are also limited. These credits may only offset tax liabilitiy generated by passive income.
B.) Carryovers
1. Un-utilized passive losses may be used against future income or on the disposition of the passive activity interest.
2. The carryover is unlimited in amount and duration.
C.) Definition of Passive Activity
1. Includes any rental activity and any trade, business, or investment activity in which the taxpayer does not materially participate.
2. Investments in limited partnerships generate passive losses due to the legal restrictions on limited partner’s involvement in he mgt of the partnership.
C. Taxpayers subject to passive loss rules
1.) Apply to individuals, estates, trust, closely-held C corp personal service corp. and certain publicly-traded partnerships.
2.) While the passive loss rules do not apply to partnerships and S-Corp. They do apply to the owners (partners & shareholders)
IV. Casualty and Theft Losses
• Casualty defined
o A casualty loss results from an identifiable event that was sudden, unexpected or unusual.
o Qualifying casualties included fire, flood, hurricane , tornados, hail, and cyclone.
• Theft Defined
o Generally, criminal intent and violation or a state law are required to meet the definition of theft.
o Theft for tax purposes includes robbery, blackmail, extortion and ransom.
• Deductible Amount of Casualty Loss
o For personal use property the deductible amount is the lesser of the reduction in FMV or adjusted basis.
o In the total destruction of business property the deductible amount is the property’s adjusted basis.
V. Bad Debts
• Bonda-Fide debtor Creditor Relationships
o Valid and enforceable obligations to pay a fixed or determinable sum of money
• Taxpayer’s Basis in the Debt.
o Creditor must have a basis in the debt for the bad debt to be deductible
• Debt Must be Worthless
VI. Tax Planning Consideration
• Bad Debts – Taxpayers should document their determination that a particular debt is worthless.
• Casualties
o Documentation of FVC is important to support a casualty loss deduction.
Wednesday, October 10, 2007
Ch. 7 Notes (Part I)
emized Deductions
Personal Deductible expenses: chapter 7 is principally concerned with expenses that are essentially personal in nature but which are deductible due to legislative grace
Business expenses versus itemized deductions. It is important to understand the differences between business expenses, expenses incurred for the production of income and itemized deductions.
a. Business expenses are deductible under Section 162 and are deductible for AGI. Individual taxpayers who are engaged in a trade or business deduct business expenses on schedule C of form 1040.
b. Generally, expenses incurred for the production of income are itemized deductions under Sec. 212 are reported on schedule A. however, expenses related to the production of rent or royalty income are deductions for AGI and are reported on schedule E.
c. Itemized deductions that are related to the production of income include, but are not limited to, medical expenses, state and local income and sales taxes home mortgages and investment interest, casualty losses, charitable contributions and miscellaneous itemized deductions.
Itemized Deductions versus Standard Deductions – Itemized deductions are deducted from AGI if they exceed the taxpayer’s standard deduction. If itemized deductions do not exceed the standard deduction, they are "lost because they do not produce a tax benefit.
Allowable Medical expenses.
d. Medical expenses include all preventative and diagnostic measures. Thus, the cost of an annual physical exam qualifies even though the taxpayer is in good health.
e. Cosmetic surgery (e.g. Face lifts, hair transplants for necessary cosmetic surgery in not deductible, Necessary cosmetic surgery includes procedures that ameliorate:
1. . a deformity arising from a congenital abnormality
2. a personal injury resulting from accident or trauma or
3. a disfiguring disease
c. nursing home expenses need not be performed by a nurse as long as the services are of a kind generally performed by a nurse.
5. Effect of physician recommendation: Although the recommendation of a doctor is important, it is not controlling as far as deductible expenditures are concerned. Suppose, for example a child psychiatric recommends a private school in order to alleviate the learning disorder of a taxpayer’s child, by itself this does not male the tuition paid to the private school a deductible medical expense.
further investigation is necessary, it the tax benefit the primary reason the child is in the school?
6. Deductible as a medical expense: A capital expenditure dictated by medical necessary can de deducted as a medical expense.
a) Capital expenditures for medical purposes are not capitalized and depreciated. The deduction is taken in the year the medical expense is incurred, even though the asset’s useful life may extend over a period of several years,
b) The measure of the deduction is the amount of the expenditure less the increase in value to the personal residence resulting from the expenditure. In addition, operating costs related to the capital expenditure are deductible.
C) certain qualifying home-related capital expenditures incurred to eliminate structural barriers to accommodate a physical handicap of the taxpayer, spouse, or dependent are deductible in full. Thus, in increase-in-value adjustment need not be made.
d) Past IRS pronouncement have allowed a medical expense deduction for capital modifications to cars, vans, and telephones owned by handicapped taxpayers.
Special Rule for Children of Divorced Parents. One issue mention in the text deals with a situation that can arise in the case of divorced parents with children.
Ex- Fred and Marge were divorced in 2006, and under the terms of the divorce, Marge is awarded custody of their one child Cindy. In addition to required child support payments of 3,600 during 2007, Fred pays 2,555 of Cindy’s medical expenses. Together, both Fred and Marge proved more than ½ of Cindy’s support.
Because either parent could have claimed the child as a dependent of 2007 could have claimed Cindy as a dependent if Marge has signed a waiver to this effect each parent may deduct the medical expenses he or she pay for the child. Thus, Fred can include the 2,500 that he paid for Cindy’s medical expense in computing his medical expense deduction
A) Neither the gross income nor the joint return test applies in determining dependency status for medical expense deductions.
8) Deductibility of Transportation Expenses: In connection with the deductibility of transportation expenses, consider the following:
Example: Jason living in NYC and had a circulatory condition that had resulted in several strokes in the past. Jason’s physician advises him that another winter in the northern climate could prove fatal. According, Jason travels to Florida where he and his family send the winter in a rented apartment.
Based on a classic Supreme Court case, Jason should be allowed to deduct his round-trip transportation costs between New York and Florida. However, the meals and lodging en-route any living expenses while in Florida, or expenses attributed to Jason’s family, would not be deducted.
On the other hand, a change of climate recommended by a physician or general improvement of health is not enough justification to allow the deduction of transportation expenses.
9) Transportation to and from the point of treatment. Payments for transportation to and from point of treatment for medical care are deductible as medical expenses
a) Such expenses include bus, taxi, train, or plane fare charges for ambulance service, and out of pocket expenses for the use of an automobile.
B) Instead of the actual out of pocket expense for the use of an automobile, a mileage allowance of 20 cents per mile may be used in 2007. Related tolls and parking fees are also deductible.
C) Deduction for transportation of an accompanying parent, aide, or nurse is permitted.
10) Lodging for Medical Care
a) A deduction may be allowed for lodging while away from home for medical expenses.
b) To be a deductible, the following requirements are satisfied:
1) the lodging is primarily for and essential to medical care.
2) The medical care is provided by a doctor in a licensed hospital or a similar medical facility.
3) The lodging is not lavish or extravagant under the circumstances.
4) There is no significant element of person pleasure, recreation, or vacation in the travel away from home.
The ceiling on the lodging deduction is 50 per night for each person, including the patient and traveling companion.
11) Medical insurance premiums are included with other medical expenses subject to the 7.5% of AGI floor.
a) The deductible amount included premiums paid for the taxpayer, spouse, and dependents.
b) A self-employed taxpayer may deduct 100% of medical insurance premiums as a business expense.
Personal Deductible expenses: chapter 7 is principally concerned with expenses that are essentially personal in nature but which are deductible due to legislative grace
Business expenses versus itemized deductions. It is important to understand the differences between business expenses, expenses incurred for the production of income and itemized deductions.
a. Business expenses are deductible under Section 162 and are deductible for AGI. Individual taxpayers who are engaged in a trade or business deduct business expenses on schedule C of form 1040.
b. Generally, expenses incurred for the production of income are itemized deductions under Sec. 212 are reported on schedule A. however, expenses related to the production of rent or royalty income are deductions for AGI and are reported on schedule E.
c. Itemized deductions that are related to the production of income include, but are not limited to, medical expenses, state and local income and sales taxes home mortgages and investment interest, casualty losses, charitable contributions and miscellaneous itemized deductions.
Itemized Deductions versus Standard Deductions – Itemized deductions are deducted from AGI if they exceed the taxpayer’s standard deduction. If itemized deductions do not exceed the standard deduction, they are "lost because they do not produce a tax benefit.
Allowable Medical expenses.
d. Medical expenses include all preventative and diagnostic measures. Thus, the cost of an annual physical exam qualifies even though the taxpayer is in good health.
e. Cosmetic surgery (e.g. Face lifts, hair transplants for necessary cosmetic surgery in not deductible, Necessary cosmetic surgery includes procedures that ameliorate:
1. . a deformity arising from a congenital abnormality
2. a personal injury resulting from accident or trauma or
3. a disfiguring disease
c. nursing home expenses need not be performed by a nurse as long as the services are of a kind generally performed by a nurse.
5. Effect of physician recommendation: Although the recommendation of a doctor is important, it is not controlling as far as deductible expenditures are concerned. Suppose, for example a child psychiatric recommends a private school in order to alleviate the learning disorder of a taxpayer’s child, by itself this does not male the tuition paid to the private school a deductible medical expense.
further investigation is necessary, it the tax benefit the primary reason the child is in the school?
6. Deductible as a medical expense: A capital expenditure dictated by medical necessary can de deducted as a medical expense.
a) Capital expenditures for medical purposes are not capitalized and depreciated. The deduction is taken in the year the medical expense is incurred, even though the asset’s useful life may extend over a period of several years,
b) The measure of the deduction is the amount of the expenditure less the increase in value to the personal residence resulting from the expenditure. In addition, operating costs related to the capital expenditure are deductible.
C) certain qualifying home-related capital expenditures incurred to eliminate structural barriers to accommodate a physical handicap of the taxpayer, spouse, or dependent are deductible in full. Thus, in increase-in-value adjustment need not be made.
d) Past IRS pronouncement have allowed a medical expense deduction for capital modifications to cars, vans, and telephones owned by handicapped taxpayers.
Special Rule for Children of Divorced Parents. One issue mention in the text deals with a situation that can arise in the case of divorced parents with children.
Ex- Fred and Marge were divorced in 2006, and under the terms of the divorce, Marge is awarded custody of their one child Cindy. In addition to required child support payments of 3,600 during 2007, Fred pays 2,555 of Cindy’s medical expenses. Together, both Fred and Marge proved more than ½ of Cindy’s support.
Because either parent could have claimed the child as a dependent of 2007 could have claimed Cindy as a dependent if Marge has signed a waiver to this effect each parent may deduct the medical expenses he or she pay for the child. Thus, Fred can include the 2,500 that he paid for Cindy’s medical expense in computing his medical expense deduction
A) Neither the gross income nor the joint return test applies in determining dependency status for medical expense deductions.
8) Deductibility of Transportation Expenses: In connection with the deductibility of transportation expenses, consider the following:
Example: Jason living in NYC and had a circulatory condition that had resulted in several strokes in the past. Jason’s physician advises him that another winter in the northern climate could prove fatal. According, Jason travels to Florida where he and his family send the winter in a rented apartment.
Based on a classic Supreme Court case, Jason should be allowed to deduct his round-trip transportation costs between New York and Florida. However, the meals and lodging en-route any living expenses while in Florida, or expenses attributed to Jason’s family, would not be deducted.
On the other hand, a change of climate recommended by a physician or general improvement of health is not enough justification to allow the deduction of transportation expenses.
9) Transportation to and from the point of treatment. Payments for transportation to and from point of treatment for medical care are deductible as medical expenses
a) Such expenses include bus, taxi, train, or plane fare charges for ambulance service, and out of pocket expenses for the use of an automobile.
B) Instead of the actual out of pocket expense for the use of an automobile, a mileage allowance of 20 cents per mile may be used in 2007. Related tolls and parking fees are also deductible.
C) Deduction for transportation of an accompanying parent, aide, or nurse is permitted.
10) Lodging for Medical Care
a) A deduction may be allowed for lodging while away from home for medical expenses.
b) To be a deductible, the following requirements are satisfied:
1) the lodging is primarily for and essential to medical care.
2) The medical care is provided by a doctor in a licensed hospital or a similar medical facility.
3) The lodging is not lavish or extravagant under the circumstances.
4) There is no significant element of person pleasure, recreation, or vacation in the travel away from home.
The ceiling on the lodging deduction is 50 per night for each person, including the patient and traveling companion.
11) Medical insurance premiums are included with other medical expenses subject to the 7.5% of AGI floor.
a) The deductible amount included premiums paid for the taxpayer, spouse, and dependents.
b) A self-employed taxpayer may deduct 100% of medical insurance premiums as a business expense.
Tax Notes CH. 7 Continued (part II)
Ch. 7
c. Tax Payers may also include premiums paid on qualified long-term care insurance contracts in medical expenses. For 2007, the per-person limits range from $290 for taxpayers age 40 and under to $3,680 for taxpayers over the age of 70 ( see IRS publication 502)
12. General Rule – Regardless of the taxpayer’s method of accounting, medical expenses are deductible only in the third year paid.
a. Exception for medical expenses of a decedent. An exception to this rule is contained in sec. 213 © Under this provision, the medical expenses of decedent may be deducted in the year incurred if paid by the estate or surviving spouse within one year of death.
i. Do not conclude, however that all such medical expenses can be deducted on a decedent’s final income tax return.
ii. Ex. Daniel a calendar year taxpayer, died on March, 10, 2007. At the time of his death, Daniel owed 4,200 of medical expenses incurred as follows: 1,200 in 2006 and 3,000 in 2007. If these expenses are paid (either by Daniel’s estate or Daniel’s surviving spouse) within one yea of March 10, 2007, $1,200 can be claimed on Daniel’s 2006 form 1040 and 3,000 on Daniel’s’ final 2007 1040 form.
b. Exception for future medical services. No deduction will be allowed for payment of medical care to be rendered in the future unless the taxpayer is under an obligation to make the payment.
i. Whether an obligation to make the payment exists depends upon the policy of the physician or the institution furnishing the medical care.
ii. The IRS does not allow a deduction for the portion of a lump-sum prepayment allocable to medical care made to a retirement home under a life care plan.
13. Points to Emphasize
a. Expense and reimbursement in same tax year. If the medical expense and its reimbursement occur in the same tax year, the reimbursement must be taken in account in arriving at the medical expense deduction for that year.
b. Anticipated reimbursement. Unlike casualty insurance recoveries, medical expense reimbursements do not have to be anticipated. Consequently though a taxpayer is positive that the medical expense will be reimbursed, the reimbursement is not considered until received.
c. Reimbursement received in subsequent tax year. If the reimbursement is received in a subsequent year, much taxpayer confusion exists as to the proper tax treatment.
i. Undoubtedly, many taxpayers will honestly regard the reimbursement as being devoid of tax consequences. The rationalization might be: “I merely got back what I paid so why should it be taxed?”
ii. Another erroneous approach would be to offset the reimbursement against the medical expenses for the year of reimbursement.
d. Taxpayer Compliance. – Due to the likelihood of taxpayer error, the IRS has for many years urged Congress to require information reporting (e.g. Form 1099) on insurance companies that offer medical coverage.
e. Tax Benefit Rule/ The proper way to handle a subsequent-year reimbursement is to apply the tax benefit rule.
HEALTH SAVINGS ACCOUNTANTS (HSA’s)
14. Certain employees and self-employed taxpayers may deduct payments to HSA’s as deductions for AGI. The HAS must be used in connection with high deductible policies. The purpose of this provision is to assist in the control of health costs.
a. High Deductible policies for tax years beginning in 2007 are those with deductibles not less that $1,100 (In 2006 $1,050) for self-only coverage or @2,200 deducting and other out-of-pocket costs (excluding premiums) under the plan does not exceed $5,500 for self-only coverage ($11,000 for family coverage).
b. HAS distributions are not taxable if used by the recipient to pay for amounts not covered by a high deductible plan, but distributions used for other purposes are included in gross income and are subject to an additional 10% penalty if made before age 65, death or disability. Earnings on HSAs are not subject to taxation unless distributed. Distributions made by reason of death or disability and distribution made after the beneficiary becomes eligible for Medicare are taxed but not penalized.
c. The deductible amount for HAS contributions is subject to limitations.
i. The amount of the monthly limitation for self-only coverage in 2007 is the lesser of one-twelfth of the annual deductible under the high-deductible plan or @,850. For family coverage in 2007, the annual deduction is limited to the lesser of one-twelfth of the annual deductible under the high-deductible plan or $5,650. For an eligible taxpayer who has attained age 55 by the end of the tax year, the limit on annual contributions in 2007 is increased by $800 ($900 in 2008 and $1,000 after 2008)
d. An HAS is portable. Taxpayers who switch jobs can take their HSAs with them.
TAXES
15. A Tax versus a Fee.
a. A fee for personal use is not deductible as a tax under Sec. 164
b. Thus, fees for god licenses, automobile inspection, automobile titles and registration, hunting and fishing licenses, parking meter deposits, postage, etc. are not deductible unless incurred as a business expense under Sec. 162 or for the production of income under sec. 212.
16. Examples of Deductible and nondeductible Taxes
a. The following are examples of deductible taxes: state and local income or state and local sales, personal property, real estate and intangible property taxes.
b. Examples of nondeductible taxes: Social Security, Federal income and estate and inheritance taxes.
c. Taxes incurred in connection with trade or business or production of income activities are deductible, even if the same tax is not deductible as an itemized deduction.
PROPERTY TAXES
17. Timing of Deduction and by Whom.
a. Taxes on real and personal property are generally deductible only by the person against whom the tax imposed.
b. Cash basis taxpayers may deduct these taxes in the year of actual payment, and accrual basis taxpayers may deduct them in the year when economic performance has occurred.
c. Assessments on real property (e.g. for streets, sidewalks, curbing) are not deductible but added to the adjusted basis of the property.
c. Tax Payers may also include premiums paid on qualified long-term care insurance contracts in medical expenses. For 2007, the per-person limits range from $290 for taxpayers age 40 and under to $3,680 for taxpayers over the age of 70 ( see IRS publication 502)
12. General Rule – Regardless of the taxpayer’s method of accounting, medical expenses are deductible only in the third year paid.
a. Exception for medical expenses of a decedent. An exception to this rule is contained in sec. 213 © Under this provision, the medical expenses of decedent may be deducted in the year incurred if paid by the estate or surviving spouse within one year of death.
i. Do not conclude, however that all such medical expenses can be deducted on a decedent’s final income tax return.
ii. Ex. Daniel a calendar year taxpayer, died on March, 10, 2007. At the time of his death, Daniel owed 4,200 of medical expenses incurred as follows: 1,200 in 2006 and 3,000 in 2007. If these expenses are paid (either by Daniel’s estate or Daniel’s surviving spouse) within one yea of March 10, 2007, $1,200 can be claimed on Daniel’s 2006 form 1040 and 3,000 on Daniel’s’ final 2007 1040 form.
b. Exception for future medical services. No deduction will be allowed for payment of medical care to be rendered in the future unless the taxpayer is under an obligation to make the payment.
i. Whether an obligation to make the payment exists depends upon the policy of the physician or the institution furnishing the medical care.
ii. The IRS does not allow a deduction for the portion of a lump-sum prepayment allocable to medical care made to a retirement home under a life care plan.
13. Points to Emphasize
a. Expense and reimbursement in same tax year. If the medical expense and its reimbursement occur in the same tax year, the reimbursement must be taken in account in arriving at the medical expense deduction for that year.
b. Anticipated reimbursement. Unlike casualty insurance recoveries, medical expense reimbursements do not have to be anticipated. Consequently though a taxpayer is positive that the medical expense will be reimbursed, the reimbursement is not considered until received.
c. Reimbursement received in subsequent tax year. If the reimbursement is received in a subsequent year, much taxpayer confusion exists as to the proper tax treatment.
i. Undoubtedly, many taxpayers will honestly regard the reimbursement as being devoid of tax consequences. The rationalization might be: “I merely got back what I paid so why should it be taxed?”
ii. Another erroneous approach would be to offset the reimbursement against the medical expenses for the year of reimbursement.
d. Taxpayer Compliance. – Due to the likelihood of taxpayer error, the IRS has for many years urged Congress to require information reporting (e.g. Form 1099) on insurance companies that offer medical coverage.
e. Tax Benefit Rule/ The proper way to handle a subsequent-year reimbursement is to apply the tax benefit rule.
HEALTH SAVINGS ACCOUNTANTS (HSA’s)
14. Certain employees and self-employed taxpayers may deduct payments to HSA’s as deductions for AGI. The HAS must be used in connection with high deductible policies. The purpose of this provision is to assist in the control of health costs.
a. High Deductible policies for tax years beginning in 2007 are those with deductibles not less that $1,100 (In 2006 $1,050) for self-only coverage or @2,200 deducting and other out-of-pocket costs (excluding premiums) under the plan does not exceed $5,500 for self-only coverage ($11,000 for family coverage).
b. HAS distributions are not taxable if used by the recipient to pay for amounts not covered by a high deductible plan, but distributions used for other purposes are included in gross income and are subject to an additional 10% penalty if made before age 65, death or disability. Earnings on HSAs are not subject to taxation unless distributed. Distributions made by reason of death or disability and distribution made after the beneficiary becomes eligible for Medicare are taxed but not penalized.
c. The deductible amount for HAS contributions is subject to limitations.
i. The amount of the monthly limitation for self-only coverage in 2007 is the lesser of one-twelfth of the annual deductible under the high-deductible plan or @,850. For family coverage in 2007, the annual deduction is limited to the lesser of one-twelfth of the annual deductible under the high-deductible plan or $5,650. For an eligible taxpayer who has attained age 55 by the end of the tax year, the limit on annual contributions in 2007 is increased by $800 ($900 in 2008 and $1,000 after 2008)
d. An HAS is portable. Taxpayers who switch jobs can take their HSAs with them.
TAXES
15. A Tax versus a Fee.
a. A fee for personal use is not deductible as a tax under Sec. 164
b. Thus, fees for god licenses, automobile inspection, automobile titles and registration, hunting and fishing licenses, parking meter deposits, postage, etc. are not deductible unless incurred as a business expense under Sec. 162 or for the production of income under sec. 212.
16. Examples of Deductible and nondeductible Taxes
a. The following are examples of deductible taxes: state and local income or state and local sales, personal property, real estate and intangible property taxes.
b. Examples of nondeductible taxes: Social Security, Federal income and estate and inheritance taxes.
c. Taxes incurred in connection with trade or business or production of income activities are deductible, even if the same tax is not deductible as an itemized deduction.
PROPERTY TAXES
17. Timing of Deduction and by Whom.
a. Taxes on real and personal property are generally deductible only by the person against whom the tax imposed.
b. Cash basis taxpayers may deduct these taxes in the year of actual payment, and accrual basis taxpayers may deduct them in the year when economic performance has occurred.
c. Assessments on real property (e.g. for streets, sidewalks, curbing) are not deductible but added to the adjusted basis of the property.
Wednesday, September 26, 2007
Audit Students!!! Notes from Sept 25
Generally Accepted Auditing Standards
General Standards
• Adequate Training & Proficiency
o Must be a CPA
o If Not a CPA – but you need to have taken classes somewhere else in an accounting degree.
• Independence In Mental Attitude
o In Fact/ In Appearance
• Financial Relationship –
Stock ownership
Being in charge of their internal control
• i.e. Internal Auditor
• or if you have designed their internal control systems.
Family Relationship
Employee or Manager
• A board member
• Due Professional Care
o Every audit work paper is reviewed by the superior
*Equity Funding Case
The Company had 1/3 real insurance policy and 2/3rd were fake
It was found that their policies were fake
• What was the Gross negligence that occurred?
1. The audit firm decided to send out confirmations to determine the validity of the policyies
• A Confirmation is a letter that is sent out under the supervision of the audit firm to to a third party, where the third party is directed to respond directly to the office of the auditor
• Two Types of confirmations
o Positive Confirmation – Asks for a response whether or not the information on the confirmation is accurate
o Negative Confirmation – Only respond to our auditors if the information is not correct.
• The briefcases with the information for the policies was left at the clients office unlocked so the numbers were changed on the policies
2. The confirmed a bank in Chicago.
• 10,000,000 in the bank in Chicago? Equity
•
Standards of Field Work
• The Auditor must adequately plan the work and must properly supervise any assistants.
o Adequate Planning –
• Past Financial Reports
• Information about the industry
• What is becoming obsolete
• How does the company do business
o Audit Program
• (see book)
o Properly Supervise any Assistants
• Inform the assistants of what are the related parties
• When problems arise, ask questions.
• The auditor must obtain a sufficient of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud and to design the nature, timing, and extent of further audit procedures.
Understanding of internal control and design nature, extent, and timing of further audit procedures
• Design Nature
• Extent
• Timing
The Audit has two phases
• The Preliminary Phase
o Happens a few months before the end of the year.
• The Final Phase
More work at the end of the year, then at the beginning of the year.
Substantive Tests – 2 types
• Tests of Details of transactions and balances
o Bank Reconciliations
• Analytical Procedures
o This years results vs. other industries results
• The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit – Reasonable Basis for an opinion
Standards of Reporting
• The auditor must state in the auditor’s report whether the financial statements are presented in accordance with GAAP
• The auditor must identify in the auditor’s report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period.
o The footnotes are considered an integral part of the financial statements
o The SEC made it so that the auditors
• When the auditor determines that informative disclosures are not reasonable adequate, the auditor must so state in the auditor’s report
o Informative disclosure
• The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor’s report. When the auditor cannot express and overall opinion, the auditor should state the reasons therefore in the auditor’s report. In all cases where an auditor’s name is associated with financial statements, the auditor should clearly indicated the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking, in the auditor’s report.
o 5 kinds of opinions
• Unqualified Opinion – FS Present fairly in accordance with GAAP
• Disclaimer of Opinion – No Opinion can be given (for example when internal controls are so poor no evidence can be given)
• Qualified Opinion Scope Limitation - when the auditor did not observe the beginning taking of inventory, but because the auditor was hired after the beginning of the year, he/she was not there to witness.
It is possible to satisfy yourself as to the beginning inventory by counting at the end of the year with the inventory at the beginning of the year.
Explain, “Except for…..” how you were able to apply your
• Adverse Opinion
The financial statements are not in accordance with GAAP
In the opinion paragraph, you state the reasons that departed from GAAP and how things would be changed
• Qualified Opinion Departure from Debt
****GLIEM questions on Standards
SORRY THAT'S ALL I HAVE!!
Auditing Standard no. 5
• Has an example of an eternal control report
General Standards
• Adequate Training & Proficiency
o Must be a CPA
o If Not a CPA – but you need to have taken classes somewhere else in an accounting degree.
• Independence In Mental Attitude
o In Fact/ In Appearance
• Financial Relationship –
Stock ownership
Being in charge of their internal control
• i.e. Internal Auditor
• or if you have designed their internal control systems.
Family Relationship
Employee or Manager
• A board member
• Due Professional Care
o Every audit work paper is reviewed by the superior
*Equity Funding Case
The Company had 1/3 real insurance policy and 2/3rd were fake
It was found that their policies were fake
• What was the Gross negligence that occurred?
1. The audit firm decided to send out confirmations to determine the validity of the policyies
• A Confirmation is a letter that is sent out under the supervision of the audit firm to to a third party, where the third party is directed to respond directly to the office of the auditor
• Two Types of confirmations
o Positive Confirmation – Asks for a response whether or not the information on the confirmation is accurate
o Negative Confirmation – Only respond to our auditors if the information is not correct.
• The briefcases with the information for the policies was left at the clients office unlocked so the numbers were changed on the policies
2. The confirmed a bank in Chicago.
• 10,000,000 in the bank in Chicago? Equity
•
Standards of Field Work
• The Auditor must adequately plan the work and must properly supervise any assistants.
o Adequate Planning –
• Past Financial Reports
• Information about the industry
• What is becoming obsolete
• How does the company do business
o Audit Program
• (see book)
o Properly Supervise any Assistants
• Inform the assistants of what are the related parties
• When problems arise, ask questions.
• The auditor must obtain a sufficient of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud and to design the nature, timing, and extent of further audit procedures.
Understanding of internal control and design nature, extent, and timing of further audit procedures
• Design Nature
• Extent
• Timing
The Audit has two phases
• The Preliminary Phase
o Happens a few months before the end of the year.
• The Final Phase
More work at the end of the year, then at the beginning of the year.
Substantive Tests – 2 types
• Tests of Details of transactions and balances
o Bank Reconciliations
• Analytical Procedures
o This years results vs. other industries results
• The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit – Reasonable Basis for an opinion
Standards of Reporting
• The auditor must state in the auditor’s report whether the financial statements are presented in accordance with GAAP
• The auditor must identify in the auditor’s report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period.
o The footnotes are considered an integral part of the financial statements
o The SEC made it so that the auditors
• When the auditor determines that informative disclosures are not reasonable adequate, the auditor must so state in the auditor’s report
o Informative disclosure
• The auditor must either express an opinion regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditor’s report. When the auditor cannot express and overall opinion, the auditor should state the reasons therefore in the auditor’s report. In all cases where an auditor’s name is associated with financial statements, the auditor should clearly indicated the character of the auditor’s work, if any, and the degree of responsibility the auditor is taking, in the auditor’s report.
o 5 kinds of opinions
• Unqualified Opinion – FS Present fairly in accordance with GAAP
• Disclaimer of Opinion – No Opinion can be given (for example when internal controls are so poor no evidence can be given)
• Qualified Opinion Scope Limitation - when the auditor did not observe the beginning taking of inventory, but because the auditor was hired after the beginning of the year, he/she was not there to witness.
It is possible to satisfy yourself as to the beginning inventory by counting at the end of the year with the inventory at the beginning of the year.
Explain, “Except for…..” how you were able to apply your
• Adverse Opinion
The financial statements are not in accordance with GAAP
In the opinion paragraph, you state the reasons that departed from GAAP and how things would be changed
• Qualified Opinion Departure from Debt
****GLIEM questions on Standards
SORRY THAT'S ALL I HAVE!!
Auditing Standard no. 5
• Has an example of an eternal control report
Ch. 5 Property Transactions
Chapter 5 Property Transactions
1
in 2003 changes were enacted in SS 1(h) that eliminated the 8% and 10& and 20% alternative tax rates for transactions after May 5 2003, and created the 5% and 15 % alternative tax rates for such transactions . as a result for 2004 and later years there are 4 possible alternative tax rates on net long term capital gains: 5%, 15%, 25% and 28%.
II rationale for separate reporting of capital gains and losses a) two reasons 1) first the alternative tax on net capital gain provisions may generate lower tax than the regular income tax, when a non-corporate taxpayer ‘s taxable income includes some net capital gain, the alternative tax computation may yield a lower tax.
2) second, separate reporting is required because capital losses that exceed capital gains are only deducted to the extent of $3000 per year.
III
General scheme of taxation
a) classification of a capital asset determined on 3 items. A) the tax status of the property (capital assets , SS 1231 asset, or ordinary asset)
b) the manner of the property disposition (sale, exchange, casualty, that theft and condemnation)
c) the holding period of the property, ( short term or long term)
IV
Holding period
a) the long term holding period is more than one year
b) the short term holding period is one year or less.
V
Capital assets
a) personal use assets: all personal use assets and most investment assets are capital assets. The gain generated from personal use assets is generally taxable but the losses are not deductible.
b) Definition of capital assets; capital assets are all assets except for the following assets listed in SS 121.
a)inventory or property held for sale in the ordinary cause of business.
b) accounts and notes receivables.
c) depreciable property or real estate used in a business
d) certain copyrights : literary; musical or artistic compositions or letters memoranda or similar property
e) certain government publication
f) supplies of a type regularly used or consumed in the ordinary course of business
VI
Effect of judicial action
a) Judicial interpretation. Because the Code lists only the assets that are not capital assets, courts as often required to interpret whether specific assets fit into any of the categories.
a) The Supreme Court, follows a literal interpretation of the categories.
b) Because of the uncertainty associated with the capital asset definition, congress has enacted several code sections to classify the definition.
c) Asset purpose use
1) For instance if a stamp collector purchases stamps because she/he appreciates their beauty, she/he is probably acquiring them for personal use. Thus, the stamps are automatically capital assets because they are personal use assets.
2) On the other hand, the stamp dealer from whom the collector buys the stamps holds the stamps as inventory. Section 1221 defines inventory as not a capital asset. Thus, by default, the stamp dealer’s inventory is an ordinary asset no statute actually defines the inventory as an ordinary asset directly.
VII
Statutory expansions
a) Dealers in securities generally securities held by dealers are considered inventory and not given capital gain or losses treatment.
b) If a dealer clearly identifies certain securities as being held for investment, the securities are capital assets.
c) The securities must be clearly identified as investment by the close of business on the date of acquisition for gain purposes.
d) If at any time the securities have been clearly identified by the dealer as securities held for investment, the losses are capital losses.
e) Real property subdivided for sale. Generally, owners who substantially develop real property are considered dealers and their property is treated as inventory.
1) Special relief is provided in SS 1237 for investors in limited development activity.
2) Capital gain treatment is allowed under SS 1237 if all the following requirements are met:
1) taxpayer is not a regular C corporation
2) taxpayer us not a real estate dealer
3) No substantial improvements may be made to the real estate. substantial generally means more than a 10% increase in the value of a lot
4) Taxpayer must hold the real estate for 5 years (except for inherited property).
1
in 2003 changes were enacted in SS 1(h) that eliminated the 8% and 10& and 20% alternative tax rates for transactions after May 5 2003, and created the 5% and 15 % alternative tax rates for such transactions . as a result for 2004 and later years there are 4 possible alternative tax rates on net long term capital gains: 5%, 15%, 25% and 28%.
II rationale for separate reporting of capital gains and losses a) two reasons 1) first the alternative tax on net capital gain provisions may generate lower tax than the regular income tax, when a non-corporate taxpayer ‘s taxable income includes some net capital gain, the alternative tax computation may yield a lower tax.
2) second, separate reporting is required because capital losses that exceed capital gains are only deducted to the extent of $3000 per year.
III
General scheme of taxation
a) classification of a capital asset determined on 3 items. A) the tax status of the property (capital assets , SS 1231 asset, or ordinary asset)
b) the manner of the property disposition (sale, exchange, casualty, that theft and condemnation)
c) the holding period of the property, ( short term or long term)
IV
Holding period
a) the long term holding period is more than one year
b) the short term holding period is one year or less.
V
Capital assets
a) personal use assets: all personal use assets and most investment assets are capital assets. The gain generated from personal use assets is generally taxable but the losses are not deductible.
b) Definition of capital assets; capital assets are all assets except for the following assets listed in SS 121.
a)inventory or property held for sale in the ordinary cause of business.
b) accounts and notes receivables.
c) depreciable property or real estate used in a business
d) certain copyrights : literary; musical or artistic compositions or letters memoranda or similar property
e) certain government publication
f) supplies of a type regularly used or consumed in the ordinary course of business
VI
Effect of judicial action
a) Judicial interpretation. Because the Code lists only the assets that are not capital assets, courts as often required to interpret whether specific assets fit into any of the categories.
a) The Supreme Court, follows a literal interpretation of the categories.
b) Because of the uncertainty associated with the capital asset definition, congress has enacted several code sections to classify the definition.
c) Asset purpose use
1) For instance if a stamp collector purchases stamps because she/he appreciates their beauty, she/he is probably acquiring them for personal use. Thus, the stamps are automatically capital assets because they are personal use assets.
2) On the other hand, the stamp dealer from whom the collector buys the stamps holds the stamps as inventory. Section 1221 defines inventory as not a capital asset. Thus, by default, the stamp dealer’s inventory is an ordinary asset no statute actually defines the inventory as an ordinary asset directly.
VII
Statutory expansions
a) Dealers in securities generally securities held by dealers are considered inventory and not given capital gain or losses treatment.
b) If a dealer clearly identifies certain securities as being held for investment, the securities are capital assets.
c) The securities must be clearly identified as investment by the close of business on the date of acquisition for gain purposes.
d) If at any time the securities have been clearly identified by the dealer as securities held for investment, the losses are capital losses.
e) Real property subdivided for sale. Generally, owners who substantially develop real property are considered dealers and their property is treated as inventory.
1) Special relief is provided in SS 1237 for investors in limited development activity.
2) Capital gain treatment is allowed under SS 1237 if all the following requirements are met:
1) taxpayer is not a regular C corporation
2) taxpayer us not a real estate dealer
3) No substantial improvements may be made to the real estate. substantial generally means more than a 10% increase in the value of a lot
4) Taxpayer must hold the real estate for 5 years (except for inherited property).
Tuesday, September 25, 2007
For Audit Students!!!! Ch.
Here you go guys, these are the notes from the 18th.
----
Please excuse the question marks but I use microsoft office and there is a note taker that never really translates. If you need anymore help with the notes I can send them directly, email me via ao22156n@pace.edu.
-----
Standard Opinion
• Is called the the Standard Report/Standard Unqualified Opinion
o This is the best opinion given
o Why Called Unqualified?
• Unqualified has a different definition
Opinion without reservations, nothing is holding the opinion back.
o Every word of the opinion has been litigated and the main point of the opinion is sent to the court
THE OPINION
• The Opinion should be addressed to the Board of Directors
o Management must be included in the audit
o Auditing from the top of the company down.
• ***Board of Directors should be audited too, so says Newman. They should be looking at the internal control in the board of directors.
o Every CPA firm rearranges except PWC.
• Report Characteristics
o Title
• If for a non public company, it say independent auditor’s report
• If for a public company, then the report says Registered Independent Auditor’s Report
o 1 Paragraph
• Introductory paragraph
You will find
• The company being audited
• The financial statements and their dates
• Management is responsible for the financial statements
• The auditors are responsible for the audit.
• Comparative Statements
• Statements from a prior year as well as the current years, assuming you are the auditor from the prior year
• Must change opinion from prior year if necessary
• Most Current year is listed first
• The name of the company, you must be precise!
*A corporation is incorporated in a state
• If they’re not a national company
• Our Responsibility is Opinion
• You are allowed to just audit balance sheet, however you need to be able to audit the accounts on the balance sheet.
o Have to be able to audit the sub-system of that statement
• i.e. Accounts receivable
• Second Paragraph
Outlines the scope of what the audit contained
Audit is in accordance with (always write out) Generally Accepted Accounting Standards (GAAS)
• Qualitative, conceptual foundation for performing audit
• These standards have existed for many years
• There are ten standards
o The first professional standard incorporated these standards
o Not like GAAP, where there a lot of debate on the make up of the standards
When SOX was passed the PCAOB was created.
o The Organization that was supposed to oversee auditing
o They had to require an audit of internal control
o Section 404 of the act, stated that there was to be an audit of financial controls, as well as of the statements
o The PCAOB, immediately decided to aggrandize themselves, they decided that they would issue new standards.
• “We’ll take your[auditing standards board] standards and call them interim standards”
• So the ASB decided to apply their standards to non-public companies.
• But the PCAOB, could not write the standards
They wrote number 2
The US Chamber of congress was upset about standard 2, (which requires two audits)
Then standard 2 was replaced with standard 5
• Which advocates a top down approach
• Start by studying the internal controls that effect the whole company
The PCAOB has 5 standards
• We conducted our audit in accordance with Generally Accepted Accounting Standards or PCAOB standards.
• Reasonable Assurance whether free of material mistakes
o REASONABLE ASSURANCE
• With due care, the with careful preparation
• Appropriate Procedures
• What a reasonable business person would expect
o FREE OF MATERIAL MISTAKES
• Only auditing at the materiality level
• At one time we used to take 5% of net income, and say that’s what’s material for this company.
• Qualitative aspects that are important in relation to materiality
A company has an upward trend
A small adjusting entry would lead to a change in earnings per share could result in a loss of EPS
Currently there is a whole new area of materiality in regards to the public service
Staff Accounting Bulletin 99 (SAB99)
o Examine on Test Basis Evidence
• Why on a test basis, 3 presumptions
• You only have a certain number of days after the end of the year before you need to turn in the financial reports
1. Evidence produced where there is good internal control is more powerful than the opposite
2. Evidence from outside the company is stronger than information then information that’s on the books
3. Anything that the auditor does, is presumed to be stronger than anything the client does.
• You do not just accept what the client does, you need to clarify the expectations and goals.
Less Testing is done then before, because of mechanical progress. The clients and the auditor’s materials can be compared much easier
Because of this presumption, something that we have done cannot be thrown out at the first sight of non-agreement.
o Assess Principals Used and Estimates
• We are expected to be the experts in GAAP
• If you are a supervisor, and certain entries are not making sense, you have to show on a flow chart the illustration of the transaction.
• Assessing the Estimates
o Financial Statement Presentation
• Based on GAAP
o Reasonable Basis for our Opinion
• We are not saying that we are doing a forensic audit
o Opinion Paragraph
• The financial statements present fairly in accordance with GAAP
o Signature
• Always of the firm
o The Date
• The last day you are at the client’s office
• Why the last field day?
Because we are responsible from the end of the last field day
End of the Year----------------Subsequent Period------------------Last Day
Subsequent Events
o The time between the last field day and the end of the year.
o Unless the client has initially asked us to send their results to the their bank, we do not. And if we do agree, then the level of risk of the audit increases.
o Also get a Management Representation Letter
• Signed by the CFO and CEO
It says, that these financial statements are our[Management’s] responsibility
o The Client is Required to put in the stock holder’s report a Management Discussion and Analysis.
----
Please excuse the question marks but I use microsoft office and there is a note taker that never really translates. If you need anymore help with the notes I can send them directly, email me via ao22156n@pace.edu.
-----
Standard Opinion
• Is called the the Standard Report/Standard Unqualified Opinion
o This is the best opinion given
o Why Called Unqualified?
• Unqualified has a different definition
Opinion without reservations, nothing is holding the opinion back.
o Every word of the opinion has been litigated and the main point of the opinion is sent to the court
THE OPINION
• The Opinion should be addressed to the Board of Directors
o Management must be included in the audit
o Auditing from the top of the company down.
• ***Board of Directors should be audited too, so says Newman. They should be looking at the internal control in the board of directors.
o Every CPA firm rearranges except PWC.
• Report Characteristics
o Title
• If for a non public company, it say independent auditor’s report
• If for a public company, then the report says Registered Independent Auditor’s Report
o 1 Paragraph
• Introductory paragraph
You will find
• The company being audited
• The financial statements and their dates
• Management is responsible for the financial statements
• The auditors are responsible for the audit.
• Comparative Statements
• Statements from a prior year as well as the current years, assuming you are the auditor from the prior year
• Must change opinion from prior year if necessary
• Most Current year is listed first
• The name of the company, you must be precise!
*A corporation is incorporated in a state
• If they’re not a national company
• Our Responsibility is Opinion
• You are allowed to just audit balance sheet, however you need to be able to audit the accounts on the balance sheet.
o Have to be able to audit the sub-system of that statement
• i.e. Accounts receivable
• Second Paragraph
Outlines the scope of what the audit contained
Audit is in accordance with (always write out) Generally Accepted Accounting Standards (GAAS)
• Qualitative, conceptual foundation for performing audit
• These standards have existed for many years
• There are ten standards
o The first professional standard incorporated these standards
o Not like GAAP, where there a lot of debate on the make up of the standards
When SOX was passed the PCAOB was created.
o The Organization that was supposed to oversee auditing
o They had to require an audit of internal control
o Section 404 of the act, stated that there was to be an audit of financial controls, as well as of the statements
o The PCAOB, immediately decided to aggrandize themselves, they decided that they would issue new standards.
• “We’ll take your[auditing standards board] standards and call them interim standards”
• So the ASB decided to apply their standards to non-public companies.
• But the PCAOB, could not write the standards
They wrote number 2
The US Chamber of congress was upset about standard 2, (which requires two audits)
Then standard 2 was replaced with standard 5
• Which advocates a top down approach
• Start by studying the internal controls that effect the whole company
The PCAOB has 5 standards
• We conducted our audit in accordance with Generally Accepted Accounting Standards or PCAOB standards.
• Reasonable Assurance whether free of material mistakes
o REASONABLE ASSURANCE
• With due care, the with careful preparation
• Appropriate Procedures
• What a reasonable business person would expect
o FREE OF MATERIAL MISTAKES
• Only auditing at the materiality level
• At one time we used to take 5% of net income, and say that’s what’s material for this company.
• Qualitative aspects that are important in relation to materiality
A company has an upward trend
A small adjusting entry would lead to a change in earnings per share could result in a loss of EPS
Currently there is a whole new area of materiality in regards to the public service
Staff Accounting Bulletin 99 (SAB99)
o Examine on Test Basis Evidence
• Why on a test basis, 3 presumptions
• You only have a certain number of days after the end of the year before you need to turn in the financial reports
1. Evidence produced where there is good internal control is more powerful than the opposite
2. Evidence from outside the company is stronger than information then information that’s on the books
3. Anything that the auditor does, is presumed to be stronger than anything the client does.
• You do not just accept what the client does, you need to clarify the expectations and goals.
Less Testing is done then before, because of mechanical progress. The clients and the auditor’s materials can be compared much easier
Because of this presumption, something that we have done cannot be thrown out at the first sight of non-agreement.
o Assess Principals Used and Estimates
• We are expected to be the experts in GAAP
• If you are a supervisor, and certain entries are not making sense, you have to show on a flow chart the illustration of the transaction.
• Assessing the Estimates
o Financial Statement Presentation
• Based on GAAP
o Reasonable Basis for our Opinion
• We are not saying that we are doing a forensic audit
o Opinion Paragraph
• The financial statements present fairly in accordance with GAAP
o Signature
• Always of the firm
o The Date
• The last day you are at the client’s office
• Why the last field day?
Because we are responsible from the end of the last field day
End of the Year----------------Subsequent Period------------------Last Day
Subsequent Events
o The time between the last field day and the end of the year.
o Unless the client has initially asked us to send their results to the their bank, we do not. And if we do agree, then the level of risk of the audit increases.
o Also get a Management Representation Letter
• Signed by the CFO and CEO
It says, that these financial statements are our[Management’s] responsibility
o The Client is Required to put in the stock holder’s report a Management Discussion and Analysis.
Wednesday, September 19, 2007
Ch.4 Notes (continued)
Employer Sponsored Accident and Health Plans
• If the individual carries insurance for costs and losses associated with personal injuries and health problems, collection on this policy are exempt.
• As an exception to the general exclusion rule, reimbursement for medical expenses that were deductible (as an itemized deduction) are taxed to the extent of the prior deductions (under the tax benefit rule)
• As a further exception, if the amount received is for the cost of elective cosmetic surgery the amounts received are subject to tax.
Meals and Lodging
• Importance to Certain Employee
o This exclusion is important for certain classifications of employees (e.g. waiters, police personnel)
o Partners and Proprietors
• Exclusion is available only to employees not partners or proprietors.
(Armstrong v. Phinney, 68-1 UST PG 9355)
o Incorporated Farmers
• The IRS has acknowledged that a farmer who incorporates the farm, and becomes an employee of the corporation may be able to qualify for the lodging exclusion.
o Requirements for Exclusion treatment
• The meals and/or lodging
Furnished by the employer
ON the employee’s business premises
For the convenience for the employee
o Employee of an educations institution
• Such an employee can exclude the value of campus housing provided by the employer if the employee pay annual rents equal to/or greater than 5% of the appraised value of the facility.
o Ministers of the Gospel
• Ministers can exclude the following:
The rental value of a home furnished as compensation
A Rental Allowance paid to them as compensation to the extent the allowance is used to rent or provide a home
• Other Employee Fringe Benefits
o Specific Benefits
• The employer does not have to included in gross income tax value of child and dependent care services paid ofr by the employer and incurred to enable the employe to work.
• The value of the use of an athletic facility by employer, their spouses, and their dependent children may be excluded. The facilities must be in the employer’s premises and substantially all of the use of the facilities must be by employees and their family member
• Foreign Earned Income
o One Time Election
• Once the taxpayer elects the exclusion, it applies to all subsequent years.
• The only situation in which the taxpayer would probably not make the election is where his foreign income exceeds the exclusion limit
• Tax Benefit Rule
o State Income Tax Refunds
• The refund is taxable only if the taxpayers itemized deductions in the year to which the refund relates
• Taxpayers can use this rule to their advantage. For example a taxpayer expects his/her income to decrease significantly for the next tax year, For the current year, s/he can make a generous payment of estimated state income taxes, part of which will be income as a refund in the next tax year
o Claim of Right - The converse of the tax benefit rule
• The taxpayer has reported income received under claim of right, may deduct amounts sh/he must repay in a subsequent tax period
• Income from Discharge of Indebtedness
o Transfer of property in satisfaction of debt vs. debt adjustment. One is a taxable exchange and the income from debt adjustments an be deferred (through basis adjustments)
o Forgiveness of Student Loan
• If the statoroty requirements are satisfied the amount of student loan that is forgiven may be excluded.
• If the individual carries insurance for costs and losses associated with personal injuries and health problems, collection on this policy are exempt.
• As an exception to the general exclusion rule, reimbursement for medical expenses that were deductible (as an itemized deduction) are taxed to the extent of the prior deductions (under the tax benefit rule)
• As a further exception, if the amount received is for the cost of elective cosmetic surgery the amounts received are subject to tax.
Meals and Lodging
• Importance to Certain Employee
o This exclusion is important for certain classifications of employees (e.g. waiters, police personnel)
o Partners and Proprietors
• Exclusion is available only to employees not partners or proprietors.
(Armstrong v. Phinney, 68-1 UST PG 9355)
o Incorporated Farmers
• The IRS has acknowledged that a farmer who incorporates the farm, and becomes an employee of the corporation may be able to qualify for the lodging exclusion.
o Requirements for Exclusion treatment
• The meals and/or lodging
Furnished by the employer
ON the employee’s business premises
For the convenience for the employee
o Employee of an educations institution
• Such an employee can exclude the value of campus housing provided by the employer if the employee pay annual rents equal to/or greater than 5% of the appraised value of the facility.
o Ministers of the Gospel
• Ministers can exclude the following:
The rental value of a home furnished as compensation
A Rental Allowance paid to them as compensation to the extent the allowance is used to rent or provide a home
• Other Employee Fringe Benefits
o Specific Benefits
• The employer does not have to included in gross income tax value of child and dependent care services paid ofr by the employer and incurred to enable the employe to work.
• The value of the use of an athletic facility by employer, their spouses, and their dependent children may be excluded. The facilities must be in the employer’s premises and substantially all of the use of the facilities must be by employees and their family member
• Foreign Earned Income
o One Time Election
• Once the taxpayer elects the exclusion, it applies to all subsequent years.
• The only situation in which the taxpayer would probably not make the election is where his foreign income exceeds the exclusion limit
• Tax Benefit Rule
o State Income Tax Refunds
• The refund is taxable only if the taxpayers itemized deductions in the year to which the refund relates
• Taxpayers can use this rule to their advantage. For example a taxpayer expects his/her income to decrease significantly for the next tax year, For the current year, s/he can make a generous payment of estimated state income taxes, part of which will be income as a refund in the next tax year
o Claim of Right - The converse of the tax benefit rule
• The taxpayer has reported income received under claim of right, may deduct amounts sh/he must repay in a subsequent tax period
• Income from Discharge of Indebtedness
o Transfer of property in satisfaction of debt vs. debt adjustment. One is a taxable exchange and the income from debt adjustments an be deferred (through basis adjustments)
o Forgiveness of Student Loan
• If the statoroty requirements are satisfied the amount of student loan that is forgiven may be excluded.
Tuesday, September 18, 2007
Ch.4 Notes ...Enjoy
A. Gifts - The major reason for excluding gifts from income is to prevent the tax laws from interfering with an individual’s decision to make gifts, especially gifts to family members
• Definition – Gift = The courts look to the reasons for making the payment or transferring the property
o Was the payment made out of “Love, Affection, or Generosity?”
o The answer to the question requires an analysis of the facts to determine the donor’s intent.
• Past Services
o If payment is made to the estate, the employer is not indicating a desire to benefit a particular person.
o If there is an obligation to make the payment, there can be no gift.
• Contractual Obligation
o In Robertson v. US
A “prize” case which proceeded section 74, the court found that a cash award offered for the best musical composition was taxable.
• ¨Business Association
o The taxpayer will generally have a difficult task of proving a gift if the amount is received from one who conducts business with the taxpayer.
• Employee
o A Payment by an employer to an employee cannot be treated as a gift
• Burden of Proof
o Generally the person who excludes the payments from income must carry the burden of proof as to the donor’s intent.
B. Life Insurance Proceeds
• Proceeds payable to the beneficiary by reason of the death of the insured are excludible from gross income
o Exceptions to exclusions treatment
• Exclusion does not apply if an individual cashes in his or her own policy or if there has been a prior transfer for valuable consideration
o Buy – Sell agreements
• The law allows for non-taxable transfer in circumstance to facilitate buy-sell and stock redemption agreements
These agreements are frequently used by closely held corporations to assume a market for the stock when a shareholder dies
The agreements also assume that the remaining shareholder will not be forced to deal with an heir or another purchaser of stock
o Exception for accelerated death benefits
• Terminally ill taxpayers definition is satisfied if a medical doctor certifies the individual as having an illness that is reasonably expected to cause death within 24 months
• Chronically ill taxpayer – definition is satisfied if being unable to perform without assistance certain activities of daily living.
C. Scholarships
• Service whether the payments are excludable, depends on why the payments are being made. (similar to gift analysis)
o 1. If the payments of an exchange for services rendered to the payor, rather than to merely aid the recipient the income cannot be excluded
o 2. Labeling the payment as a “Scholarship” doesn’t control the outcome.
• The excludible items tuition and related expenses (such as books and supplies and equipment for conclusion of the course
• Room and Board –
o Value of room and board cannot be excluded under the scholarship rule
• Candidate for a degree.
o The recipient must be a candidate for a degree at an accredited educational institution.
• Timing.
o The amount eligible for exclusion may not be known at the time the money is received, therefore the transaction is held open until the educational expenses are paid.
• Disguised Compensation
o If the scholarship is only available to the children of the employees, then the amount paid is included in the gross income of the parent employee.
D. Compensation for Injuries and Sickness
• Damages are intended to restore the person to his or her their former position before the unfortunate event occurred, and thus receipt of the damage award does not result in economic gain.
o A. Amounts received from Property Losses
• Amounts received to restore for a loss of property are generally treated as proceeds from the sale of property
o B. Goodwill
• Usually Taxable
o C. Loss of Income
• Payments for the loss of income are taxed the same as the income replaced
o D. Workers Compensation Benefits
• Excludible from gross income
o E. Personal Injury
• Such damages must be in the nature of compensation damages
• Compensation damages awarded in account of emotional distress are not received in account of physical injuries or physical sickness and thus cannot be excluded.
o F. Punitive Damages
• Always taxable
• These are amounts the person who caused the harm must pay to the victim as punishment for outrageous conduct.
E. Employee
• Sponsored accident and Health Plans
o If the individual carrier insurance for costs and losses associate with physical injuries and health problems, collection on this policy are exempt.
• Definition – Gift = The courts look to the reasons for making the payment or transferring the property
o Was the payment made out of “Love, Affection, or Generosity?”
o The answer to the question requires an analysis of the facts to determine the donor’s intent.
• Past Services
o If payment is made to the estate, the employer is not indicating a desire to benefit a particular person.
o If there is an obligation to make the payment, there can be no gift.
• Contractual Obligation
o In Robertson v. US
A “prize” case which proceeded section 74, the court found that a cash award offered for the best musical composition was taxable.
• ¨Business Association
o The taxpayer will generally have a difficult task of proving a gift if the amount is received from one who conducts business with the taxpayer.
• Employee
o A Payment by an employer to an employee cannot be treated as a gift
• Burden of Proof
o Generally the person who excludes the payments from income must carry the burden of proof as to the donor’s intent.
B. Life Insurance Proceeds
• Proceeds payable to the beneficiary by reason of the death of the insured are excludible from gross income
o Exceptions to exclusions treatment
• Exclusion does not apply if an individual cashes in his or her own policy or if there has been a prior transfer for valuable consideration
o Buy – Sell agreements
• The law allows for non-taxable transfer in circumstance to facilitate buy-sell and stock redemption agreements
These agreements are frequently used by closely held corporations to assume a market for the stock when a shareholder dies
The agreements also assume that the remaining shareholder will not be forced to deal with an heir or another purchaser of stock
o Exception for accelerated death benefits
• Terminally ill taxpayers definition is satisfied if a medical doctor certifies the individual as having an illness that is reasonably expected to cause death within 24 months
• Chronically ill taxpayer – definition is satisfied if being unable to perform without assistance certain activities of daily living.
C. Scholarships
• Service whether the payments are excludable, depends on why the payments are being made. (similar to gift analysis)
o 1. If the payments of an exchange for services rendered to the payor, rather than to merely aid the recipient the income cannot be excluded
o 2. Labeling the payment as a “Scholarship” doesn’t control the outcome.
• The excludible items tuition and related expenses (such as books and supplies and equipment for conclusion of the course
• Room and Board –
o Value of room and board cannot be excluded under the scholarship rule
• Candidate for a degree.
o The recipient must be a candidate for a degree at an accredited educational institution.
• Timing.
o The amount eligible for exclusion may not be known at the time the money is received, therefore the transaction is held open until the educational expenses are paid.
• Disguised Compensation
o If the scholarship is only available to the children of the employees, then the amount paid is included in the gross income of the parent employee.
D. Compensation for Injuries and Sickness
• Damages are intended to restore the person to his or her their former position before the unfortunate event occurred, and thus receipt of the damage award does not result in economic gain.
o A. Amounts received from Property Losses
• Amounts received to restore for a loss of property are generally treated as proceeds from the sale of property
o B. Goodwill
• Usually Taxable
o C. Loss of Income
• Payments for the loss of income are taxed the same as the income replaced
o D. Workers Compensation Benefits
• Excludible from gross income
o E. Personal Injury
• Such damages must be in the nature of compensation damages
• Compensation damages awarded in account of emotional distress are not received in account of physical injuries or physical sickness and thus cannot be excluded.
o F. Punitive Damages
• Always taxable
• These are amounts the person who caused the harm must pay to the victim as punishment for outrageous conduct.
E. Employee
• Sponsored accident and Health Plans
o If the individual carrier insurance for costs and losses associate with physical injuries and health problems, collection on this policy are exempt.
Monday, September 17, 2007
Ch. 3 Revisited (con't)
•Items Specifically Included in Gross Income
A.Alimony and Separate Maintenance Payments
•For Divorces after 1984, payments are classified as alimony only if the meet the following conditions
1.The Payments are in cash
2.The decree does not specify that the payments are not alimony
3.The payer and the payee are not members of the same household at the time the payments are made
4.There is no liability on payments after the death of the payee
Under Post 1984 rules, transfer of appreciated property to a former spouse under a divorce decree are not taxable events
B.Imputed Intent on Below-Market Loan
•If a taxpayer makes a “below market interest rate” loan, there can be imputed intent. The rate of imputed intent is the rate the Federal Government pays on new borrowings
•These rules apply to the following types of loans
Gift Loans
Compensation Related Loans
Corporation Share-holder loans
Tax avoidance loans
C. Prizes and Awards are included in Gross Income (Sec. 74 IRS code)
D. Social Security Benefits. Part of it mus be included in Gross Income, and the amount is the lesser amount calculated under 2 different formulas.
A.Alimony and Separate Maintenance Payments
•For Divorces after 1984, payments are classified as alimony only if the meet the following conditions
1.The Payments are in cash
2.The decree does not specify that the payments are not alimony
3.The payer and the payee are not members of the same household at the time the payments are made
4.There is no liability on payments after the death of the payee
Under Post 1984 rules, transfer of appreciated property to a former spouse under a divorce decree are not taxable events
B.Imputed Intent on Below-Market Loan
•If a taxpayer makes a “below market interest rate” loan, there can be imputed intent. The rate of imputed intent is the rate the Federal Government pays on new borrowings
•These rules apply to the following types of loans
Gift Loans
Compensation Related Loans
Corporation Share-holder loans
Tax avoidance loans
C. Prizes and Awards are included in Gross Income (Sec. 74 IRS code)
D. Social Security Benefits. Part of it mus be included in Gross Income, and the amount is the lesser amount calculated under 2 different formulas.
Monday, September 10, 2007
Ch. 3 Notes from 9/10/07
Chapter 3
Gross Income : Inclusions
I. Gross Income – What is it?
• Definition – Sec.61(a) of the code defines gross income as “all income from whatever source derived.” But the meaning of the term income has been mostly determined by the courts.
o Usually the code in tax law is broad and it is up to the courts to determine what the
meaning is.
• Economic and Accounting Concepts of Income
o The courts have established the principal that for income to be recognized for tax purposes it must be realized, (accounting income), therefore, increases in value, which is known as economic income, would not be taxed until the property is sold or exchanged.
o Governments uses economic income for things like property taxes, is the value of the property goes down the taxes go down
• Comparison of the accounting and tax concepts of income
o Although tax and financial accounting are often parallel to each other, they have different purposes.
• The primary goal of financial accounting is to provide useful information to managers, shareholders, creditors and other interested parties known as stake holders. While the goal of Tax Accounting is the equitable collection of revenue.
• Form of Receipt: Gross Income is not limited to cash received. Income can be realized as money, property or services received.
o If you get married and you get a new house, even as a gift, you have to include this on your taxes.
o If your doctor gives you free medical service.
• The Recovery of Capital Doctrine
o Under this doctrine, the gross receipts from the sale or disposition of property are reduced by the adjusting basis of the property sold to determine gross income.
• Usually required to use the calander year to report taxes, though a fiscal year can be used, however supstantial support must be given to allow the use of fiscal year.
• Accounting Method – 3 Major Method
i Cash - Receipts and disbursements method
ii Accrual method – most corporations use this method – Income is reported in the year it is earned
iii Hybrid Method
• Accural Method
Income is considered earned:
• All events have occurred which fix the right received such income
• The amount of the income can be determine with reasonable accuracy.
• Hybrid Method
The combination of the cash and accrual method
• Mostly used by small businesses
• Exceptions applicable to Cash Basis Taxpayers
o 1. The Constructive Receipts Doctrine
• Limits and individual’s ability to postpone income recognition.
If the taxpayer is entitled to receive the income and the amount is made readily available to him or her, it must be included in gross income.
o 2. Income Set Apart or made available is not constructively received if it is subject to substantial restrictions.
o Constructively = received but not realized.
• I.E. an increase in the cash surrender value on ordinary life insurance is not taxes as the policy increases in value.
o 3. When a lender makes a loan with initial issue discount, the accrued interest must be reported each year, regardless of the taxpayers accounting method.
o 4. Interest on U.S. series E or EE savings bonds is usually deferred until the bonds mature. However, a taxpayer may make an election to include the annual increase on the bond’s reduction.
o 5. No income is realized when money is borrowed. Receipt of funds under an obligation to repay is not a taxable event
• Exceptions applicable to Accrual Basis Acounting
o 1. Prepaid Income is generally taxed in year of receipt. Many court cases have been brought against the IRS by tax payers arguing that the proper matching of revenue and expenses, requires that income be recognized only when it is earned, (basically the accrual method) The IRS has modified its position in several areas
o 2. A taxpayer can defer “advance payments for goods if the taxpayer’s method of accounting for the sale is the same for tax and financial accounting purposes.
o 3. The taxpayer can elect to defer advance payments for services to be performed by the end of the tax year following the year of receipt. \
• Income Sources
A. Personal Services Income from personal services must be included in the gross income of the person “ who performs the services>:
B. Income from Property (i.e. In trust, dividends, rent) must be included in the gross income of the owner
C. Income Received by an Agent
• Income received by a taxpayers agent is considered received by the taxpayer. Thus a cash basis taxpayer must recognize income at the time it is received by his/her agent (attorney, accountant)
D. Income from Partnerships
• S-Corporations, Trusts and Estates
• A Partner or or shareholder must “included his or her distributive share of income and deductions” from these entities.
E. Income in Community Property States
• In 9 States
Louisiana
Texas
New Mexico
California
Washington
Idaho
Nevada
Wisconsin
Marital rights to the ownership of property apply. In Alaska, spouses can choose to have the community property rules apply. Income from personal services, for example, salaries and wages, is treated as earned equally by both spouses. Income from separate property is taxable to the person who owns the property, except in Texas. Louisiana, Wisconsin and Idaho where the income from separate property is community income.
*New York State is not a community property state.
Gross Income : Inclusions
I. Gross Income – What is it?
• Definition – Sec.61(a) of the code defines gross income as “all income from whatever source derived.” But the meaning of the term income has been mostly determined by the courts.
o Usually the code in tax law is broad and it is up to the courts to determine what the
meaning is.
• Economic and Accounting Concepts of Income
o The courts have established the principal that for income to be recognized for tax purposes it must be realized, (accounting income), therefore, increases in value, which is known as economic income, would not be taxed until the property is sold or exchanged.
o Governments uses economic income for things like property taxes, is the value of the property goes down the taxes go down
• Comparison of the accounting and tax concepts of income
o Although tax and financial accounting are often parallel to each other, they have different purposes.
• The primary goal of financial accounting is to provide useful information to managers, shareholders, creditors and other interested parties known as stake holders. While the goal of Tax Accounting is the equitable collection of revenue.
• Form of Receipt: Gross Income is not limited to cash received. Income can be realized as money, property or services received.
o If you get married and you get a new house, even as a gift, you have to include this on your taxes.
o If your doctor gives you free medical service.
• The Recovery of Capital Doctrine
o Under this doctrine, the gross receipts from the sale or disposition of property are reduced by the adjusting basis of the property sold to determine gross income.
• Usually required to use the calander year to report taxes, though a fiscal year can be used, however supstantial support must be given to allow the use of fiscal year.
• Accounting Method – 3 Major Method
i Cash - Receipts and disbursements method
ii Accrual method – most corporations use this method – Income is reported in the year it is earned
iii Hybrid Method
• Accural Method
Income is considered earned:
• All events have occurred which fix the right received such income
• The amount of the income can be determine with reasonable accuracy.
• Hybrid Method
The combination of the cash and accrual method
• Mostly used by small businesses
• Exceptions applicable to Cash Basis Taxpayers
o 1. The Constructive Receipts Doctrine
• Limits and individual’s ability to postpone income recognition.
If the taxpayer is entitled to receive the income and the amount is made readily available to him or her, it must be included in gross income.
o 2. Income Set Apart or made available is not constructively received if it is subject to substantial restrictions.
o Constructively = received but not realized.
• I.E. an increase in the cash surrender value on ordinary life insurance is not taxes as the policy increases in value.
o 3. When a lender makes a loan with initial issue discount, the accrued interest must be reported each year, regardless of the taxpayers accounting method.
o 4. Interest on U.S. series E or EE savings bonds is usually deferred until the bonds mature. However, a taxpayer may make an election to include the annual increase on the bond’s reduction.
o 5. No income is realized when money is borrowed. Receipt of funds under an obligation to repay is not a taxable event
• Exceptions applicable to Accrual Basis Acounting
o 1. Prepaid Income is generally taxed in year of receipt. Many court cases have been brought against the IRS by tax payers arguing that the proper matching of revenue and expenses, requires that income be recognized only when it is earned, (basically the accrual method) The IRS has modified its position in several areas
o 2. A taxpayer can defer “advance payments for goods if the taxpayer’s method of accounting for the sale is the same for tax and financial accounting purposes.
o 3. The taxpayer can elect to defer advance payments for services to be performed by the end of the tax year following the year of receipt. \
• Income Sources
A. Personal Services Income from personal services must be included in the gross income of the person “ who performs the services>:
B. Income from Property (i.e. In trust, dividends, rent) must be included in the gross income of the owner
C. Income Received by an Agent
• Income received by a taxpayers agent is considered received by the taxpayer. Thus a cash basis taxpayer must recognize income at the time it is received by his/her agent (attorney, accountant)
D. Income from Partnerships
• S-Corporations, Trusts and Estates
• A Partner or or shareholder must “included his or her distributive share of income and deductions” from these entities.
E. Income in Community Property States
• In 9 States
Louisiana
Texas
New Mexico
California
Washington
Idaho
Nevada
Wisconsin
Marital rights to the ownership of property apply. In Alaska, spouses can choose to have the community property rules apply. Income from personal services, for example, salaries and wages, is treated as earned equally by both spouses. Income from separate property is taxable to the person who owns the property, except in Texas. Louisiana, Wisconsin and Idaho where the income from separate property is community income.
*New York State is not a community property state.
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