1. Which of the following entities may not use the cash method of accounting? Answer: A C corporation that is substantially owned by its employees and whose business is selling goods with annual gross receipts in excess of $5 million for all tax years since its inception. Explain your answer!
The corporation in this question could not apply the cash method due to the fact they have in excess of $5 million average in gross receipts annually. The exception to this would be if it was a personal service corporation. To qualify as a personal service corporation it must provide substantial services in health care, accounting, architecture, engineering, or performing arts, among others.
2. Dowd, a cash-basis engineering consultant, wanted to defer income to next year. A client who was in Dowd’s office on December 31 of the current year offered to pay his $2,000 bill immediately, but Dowd told him to pay in January. A check for $5,000 from another client arrived in the mail on December 29, and Dowd told his office manager not to deposit it until January. Dowd also told his office manager not to send a client a bill for $3,000 for services performed in the current year until January of next year. How much income from these transactions should Dowd report in the current year? Dowd should report an income of $7000 ($2000 + $5000) in the current year.
Explain your answer!
He would be responsible for paying the taxes on $7000. By Treasury regulations he has unrestricted access to the funds and can control this income, even if it is not in his direct control this is still considered a constructive receipt. Therefore he is responsible for the taxes on those funds this tax year. Holding checks to defer them to the following year would not except him from paying the taxes on the funds received. In this example he does not have to actively pursue payment from a client, so whatever funds were due, but had not been received would not be taxable.
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