Ch. 6: Taxable Income From Business Operations

Taxable Income

Gross income minus allowable deductions for the taxable year.

Gross Income

Realized increases in wealth from whatever source derived.

• In the business context, from sales of goods, performance of services, and investments of capital.

Calendar Year

The 12-month period from January 1 through December 31.

Fiscal Year

Any 12-month period ending on the last day of any month except December.

Short- Period Return

A tax return for a taxable year consisting of less than 12 months.

Method of Accounting

A consistent system for determining the point in time at which items of income and deduction are recognized for tax purposes.

Recognition

Inclusion of an item of income or deduction in the computation of taxable income.

Business Interest Limitation

Business interest in excess of 30 percent of adjusted taxable income is not currently deductible.

Key- Person Life Insurance Policies

Insurance purchased by a firm on the life of a high-level employee

• Frm is the beneficiary of the policy.

Qualified Business Income (QBI)

Active trade or business income from non-service businesses eligible for the Section 199A deduction.

Cash Method of Accounting

An overall method of accounting under which revenue is accounted for when payment is received and expenses are accounted for when payment is made.

Constructive Recepit

The point at which a taxpayer has unrestricted access to and control of income, even if the income item is not in the taxpayer’s actual possession.

Hybrid Method of Acconting

An overall method of accounting that combines the accrual method for purchases and sales of inventory and the cash method for all other transactions

Personal Service Corporation

Closely held corporation owned by individuals who perform services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting for the corporation’s clientele

• Subject to a flat 35 percent tax rate.

Generally Accepted Accounting Principles (GAAP)

The set of accounting rules developed by the Financial Accounting Standards Board (FASB) and adhered to by the public accounting profession.

Accrual Method of Accounting

An overall method of accounting under which revenues are realized in the year the earnings process is complete and expenses are matched against revenues in the year the liability for the expense is incurred.

Realization

Income is taken into account when the earnings process with respect to the income is complete and an event or transaction occurs that provides an objective measurement of the income.

Permanent Difference

A difference between financial statement income and taxable income that does not reverse over time.

Temporary Difference

A difference between financial statement income and taxable income that reverses over time.

Deferred Tax Asset (DTA)

The excess of tax payable over tax expense per books resulting from a temporary difference between book income and taxable income.

Deferred Tax Liability (DTL)

The excess of tax expense per books over tax payable resulting from a temporary difference between book income and taxable income.

Prepaid Income

Payment for goods and services made in advance of the provision of the goods or performance of the services.

All-Events Test

The test for determining if an accrued expense is deductible

• Satisfied if the liability on which the accrued expense is based is fixed, the amount of the liability is determinable with reasonable accuracy, and economic performance with respect to the liability has occurred.

Economic Performance

The third requirement of the all-events test

Payment Liabilities

Accrued liabilities for which economic performance does not occur until payment is made

Recurring Item Exception

An exception to the economic performance requirement under which a liability is considered incurred in a taxable year in which it meets the first two requirements of the all-events test and economic performance occurs within 8½ months after year-end.

Allowance Method

The GAAP method for computing bad debt expense

• Expense is based on the estimated losses from current year receivables.

Direct Write-Off Method

The method for determining a bad debt deduction required by the tax law

• Receivables that are written off as uncollectible during the year are deductible

Tax Benefit Rule

The recovery of an amount deducted in an earlier year must be included in gross income in the year of recovery.

Net Operating Loss (NOL)

An excess of allowable deductions over gross income.

NOL Carryforward

A net operating loss allowed as a deduction in the years following the year of loss

• Amount deductible is limited to 80 percent of taxable income.

Excess Business Loss Limitation

Limit on the deductibility of excess business losses of non-corporate taxpayers.