J.K. Lasser's Small Business Taxes 2018. Barbara Weltman
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the look-back method and its complications. You can elect not to use the look-back method if the estimated income and expenses are within 10 % of the actual income and expenses. Once this election is made, it applies to all future contracts. In order to make the election, you must make the recalculations of the actual income and expenses for the prior years to see if the 10 % threshold has been satisfied.
The cash and accrual methods of accounting are the most commonly used methods. There are, however, other accounting methods.
INSTALLMENT METHOD ACCOUNTING
If you sell property and receive payments over time, you generally can account for your gain on the installment method. More specifically, the installment method applies if one or more payments are received after the year of the sale. Gain is reported when payments are received. The capital gain rate applicable to the gain on the installment received in the current year is the rate to which the taxpayer is now subject. For example, say a sole proprietor makes an installment sale in 2012, with a payment term of 7 years. In 2017, the sole proprietor is considered to be a high-income taxpayer whose capital gain rate is 20 %. This is the rate imposed on the gain from the installment received in 2017, even though this taxpayer had a 15 % capital gain tax rate in the year of the sale. This method can be used by taxpayers who report other income and expenses on the cash or accrual method.
Example
You sell business property and figure your gain to be $10,000. Under the terms of sale you receive $5,000 in 2017, the year of sale, and $5,000 in 2018. You report one-half of your gain, or $5,000, in 2017 and the other half of your gain, $5,000, in 2018.
However, if the sale involves depreciable property, the recapture rules trigger the immediate reporting of this portion of the gain – without regard to payments received. Recapture rules are discussed in Chapter 6.
The installment method applies only to gains on certain sales; it generally cannot be used for inventory sales even though payment is received over time. The installment method does not apply to losses. It cannot be used by dealers in personal property or for real estate held for resale to customers.
You can elect not to report on the installment basis and instead report all of the gain in the year of sale. The election is made simply by reporting all of the gain on the appropriate tax form or schedule. Once made, however, this election is generally irrevocable. The election out of installment reporting may make sense, for example, if an owner is subject to the 15 % capital gains rate in the year of the installment sale but expects to be a high-income taxpayer subject to the 20 % capital gains rate in one or more of the years in which installment payments will be received. Of course, tax reform occurring after the year of an installment sale complicates the election out decision.
MARK-TO-MARKET ACCOUNTING
Traders in securities (often referred to as “day traders”) can use a special accounting method that enables them to report paper transactions rather than waiting for actualized gains and losses, and losses no longer are limited to the extent of capital gains and up to $3,000 of ordinary income. Under mark-to-market accounting, gains and losses are reported on Form 4797 (rather than on Schedule D). These include completed trades throughout the year as well as paper gains and losses in securities held at the end of the year (these are treated as if they had been sold on December 31).
A trader is someone who seeks to profit from daily market swings rather than long-term appreciation, interest, or dividends. The trader's activities must be substantial and carried on with continuity and regularity.
Make the mark-to-market election by filing a statement attached to your return for the prior year, stating you are making the election under Code Sec. 475(f) and the year for which it is effective. For example, if you want the election to start in 2018, you must attach this statement to your 2017 income tax return. Those who are not required to file a return for 2017 should place such statement in their books and records no later than March 15, 2018, and then attach a copy to the 2018 return. The election is treated as a change in accounting method.
In the past, a revocation of a mark-to-market election could only be made with IRS consent, which required the payment of a hefty user fee. Now a revocation in order to return to the realization method (reporting gains and losses when realized) can be made using the automatic change in accounting method, which merely requires a notification of revocation statement to be attached to the tax return (or the filing extension request) for the year preceding the year of the change. Details about what the notification statement must include are in Revenue Procedure 2015–14.
OTHER ACCOUNTING METHODS
These include, for example: Special Accounting for Multi-Year Service Warranty Contracts and Special Rules for Farmers.
DISCOUNTS YOU RECEIVE
When vendors or other sellers give you cash discounts for prompt payment, there are two ways to account for this discount, regardless of your method of accounting. They are:
1. Deduct the discount as a purchase in figuring the cost of goods sold.
2. Credit the discount to a special discount income account you set up in your records. Any balance in this account at the end of the year is reported as other income on your return.
Trade discounts are not reflected on your books or tax returns. These discounts are reductions from list price or catalog prices for merchandise you purchase. Once you make the choice, you must continue to use it in future years to account for all cash discounts.
DISCOUNTS YOU GIVE
When you reduce the price of your goods and services, you cannot deduct the price reduction. Your gross receipts are reduced accordingly, so you simply report less income.
Uniform Capitalization Rules
Regardless of your method of accounting, special tax rules limit your ability to claim a current deduction for certain expenses. These are called the uniform capitalization rules, referred to as the UNICAP rules for short. The uniform capitalization rules are a form of accounting method that operates in coordination with the accrual method, but overrides it. In essence, these rules require you to add to the cost of property certain expenses – instead of currently deducting them. The cost of these expenses, in effect, are recovered through depreciation or amortization, or as part of the costs of goods sold when you use, sell, or otherwise dispose of the property. The uniform capitalization rules are complex. Important things to recognize are whether you may be subject to them and that expenses discussed throughout this book may not be currently deductible because of the application of the uniform capitalization rules.
Unless one of the exceptions is applicable, you must use the uniform capitalization rules and add certain expenses to the basis of property if you:
● Produce real property or tangible personal property for use in your business or for sale to customers (producers), or
● Acquire property for resale (resellers).
EXCEPTIONS TO THE UNICAP RULES
There are many exceptions to the uniform capitalization rules. Small businesses may be able to escape application of the uniform capitalization rules by relying on one of these exceptions.
● You do not have to capitalize costs if the property you produce is for your personal or nonbusiness use.
● You do not have to capitalize costs if you acquire property for resale and your average annual gross receipts do not exceed $10 million (small reseller exception). If a reseller has been in business for less than 3 years, application of the exception is determined by annual gross receipts for the shorter period.
● Creative expenses incurred by freelance authors, photographers, and artists are not subject to the uniform capitalization rules. According to the IRS, this exception does not apply to a musician's demo tape or other sound recording.
● There is a de minimis exception for certain producers who use a simplified method and whose