Timing of Income & Deductions - "When"

General Principles

A TP is requied to compute taxable income using the method of accounting which he reularly uses to compute income in keeping his books

The method chosen by TP must clearly reflect income; if hte method the TP chooses does not clearly reflect income, the IRS may require the TP to change to a method which does

Once a method is chosen, it may not be changed w/o prior approval from the IRS

Two Accounting Methods

Cash Method: Easy

i. Measure by actual receipt of actual expense

>A TP using the cash method generally includes items of GI in teh taxable year in which they are actually or constructivly received or expensed

Accural Method Hard

i. Look at all events to see when legal right or obligation has arisen

ii. A TP using the accrual method generally includes items in GI in teh taxable year in which all events have fix his right to receive the item and fix the amount of the item

iii. MORE accurate because you only account for when you receive the right to income

iv. Large corporations are required ot use Accural Accounting

"Taxable Year" 441(a)

i. Every year stands alons; when year is over its over

>You are arguing year X in front of Tax Ct, you can't argue another year b/c IRS has to start all over to argue another year in TC

Matching Principle 451(a), 461(a)

451 = General Rule for Taxable Year of Inclusion

461 = General Rule for Taxable Year of Deduction

TRUC

A company cannot benefit for running over Tort liabilty can only use cash method

Separation of INCOME from DEDUCTION

a. Income items governed by 451

b. Rules for accounting fo deductions under 461

c. Notice timing differences b/w income and deduciton

Exceptions To Cash Method

i. Tax Benefit Rule - Codified in 111

>Recover the tax benefit taken in rior year and add it back to income

>This is phrased as an exclusion, if in year 1, you obtain a tax benefit, then in year 2, he tax benefit is undone: THAT IS INCOME in YEAR 2

ii. Claim of Right (1341): Claim item of income in which you have a claim of right to it (NORTH AMERICAN OIL)

>You have the money in hand, but there is a dispute as to whether you actually should have it in this year

iii. Recapture Rules - When you must recapture previous deductions

Issues in Cash Method

1. What is Cash

i. Cash and Cash equivalents; Checks, Credits Cards (are cash), and course, bills

>Anything people treat as it face value

ii. Crytpo

>Notice 2014-21, not cash or cash equivalent -> Treated by property governed by 1001, you get a basis.

iii. Promissiry Notes (Promist ot Pay))

>Income when promise is made or when promise is fulfilled

> Form is not the TEST (COWDEN)

a. It is the functionality [economic substance/value] it can provide (discounted price, not face value

b. Look at substance of hte transactoin

c. Talbin Case (Promise to pay is income at the time it is made, at face value)

d. A promissory note represents evidence of indebteness is not the same as cash. MUST HAVE FMV (Williams -- promise is income at time its paid)

When are you receiving income? 451

i. Burden is on TP to establish timing

ii. A TP using the cash method must include items of GI in teh taxable year in which he receives the item regardless of whether the amin is paid in cash, by check, or with property other than money

CONTROL - The December 31st ploy IMAIN TEST)

If you get a check on 12/31 -> Its income then, unless made from someone insolvent or bank refuses to cash. If you can make economic use of it then you have control over it and then it is income for you at that point.

EXCEPTION

Rule 451(h) - Lottery Winner Rule

i. If you elect to take payment over time, you can include it in income over time even though you are entitled to all of it immediately

Constructive Receipt

Reg. 1.451-2 and also look at 1.446-1(c)(1)(i)

i. An item is constructively received by a TP when it is credited to his account, set apart fro him, otherwise mad availabe so that he may draw on it at any time, but is not constructively received if its actual receipt is subject to substantial limitations or restrictions (Reg. 1.451-2(a), Hornung)

Deductions: When are you paying it

461

i. December ploy works here Rev Rule 54-465

a. A TP using hte cash method generally may take allowable deductions int eh taxable year in which actual payment takes place 461(a)

ii. You pay it when you give up control fo the cash or cash equivalent.

iii. A check is considered to be paid when the check is deliverd, unless the check is not subsequently honored or paid, there are restrictions as to the time and manner of payment ofthe check.

Mailbox Rule

Payment is considered to be made when a check is mailed rathe than on the date the recipient receives it. This only applies ot the mailing of the check.

Control is only lost when the payee has the item of when the USPS has it. Rev. Ru. 54-465

Expense v. Capital Expenditure

i. Safe Harbor Rule

a. 12 month safe harbor which Tp is not required to capitalize amts paid ot create or enhance an intangible asset the amts do not create or enhance any right or benefit fo the TP that extends beyond the earlier of:

1. 12 months after the 1st date on which the TP realizes the right/benefit, or

2. The end of the taxable year following the taxable year in which the payment is made

Pre Paid Interest 461(g)

Tells you when to take the deduction

i. General rule is that you can't deduct immediately, but the execption is points (prepaid interest) paid principal residence

ii. If you prepay other items( rent, etc) doesn't give you an immediate deduction, you have to take it ratably over time you receive the benefit Reg. 1.461-1(a)(1)