business income review

8/19/2019 Business Income Review

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Business Income Review

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Sole Proprietor and Corporation


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• In Bus 484 we will mostly focus on corporate business income, but we willsometimes also discuss personal business income.

• Reardless of t!e "e!icle t!at is used to earn t!e business income, t!e sameunderlyin concepts apply.

Business Income

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• #or t!e purpose of t!e e$ample we will co"er today, we will use t!e corporate ta$calculation steps.

1% &et Income per #inancial Statements'% &et Income for (a$ Purposes )&I#(%

*% (a$able Income )(I%

4% (a$es Payable

+% (a$es win )Refund%

• -s we are ust calculatin &I#( and (I today, we don/t !a"e to worry about t!ecorporate ta$ rate.

• 0e will re"iew t!e corporate ta$ rate and t!e corporate ta$ calculation in more

detail ne$t class.

Business Income

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Consists of the following:

•Re"enue Income2 Sole Proprietor 3 cas! or accrual accountin

Corporation 3 accrual accountin

•$penses 5ust be incurred in order to earn income.

5ust be reasonable.

$penses incurred t!at benefit t!e s!are!older or 6owner7 are not deductible. 5eals and entertainment e$penses t!at in"ol"e employees or s!are!olders are +9

deductible.

:olf ;ues are 9 deductible.

Sole Proprietor 3 can use cas! or accrual accountin

Corporation 3 must use accrual accountin

If accrual accountin is used, t!en income ta$ reser"es can be utili


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• 0!en a business disposes of property t!e transaction can eit!er be treated asbusiness income or as a capital transactions )i.e. capital ainloss%.

• In order to determine t!is CR- would loo= at t!e followin2 Business/s intention for t!e asset )used to produce product or ser"ice, or used to re>

sell it%.

?ow often does t!e business buy and sell t!is type of asset.

;id t!e business do any supplemental wor= on t!e property to increase it/s re>sale"alue.

0!at is t!e business/s obecti"es in t!eir articles of incorporation

• (!is distinction is important as business income is 19 ta$ed, w!ere as capitalains are +9 ta$ed.

Business Income "s. Capital

:ains

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Businesses operate on an accrual basis unless t!ey @ualify for a reser"e t!at isallowable under t!e income ta$ act2

• I(- ')1%)m% 3 Reser"e for undeli"ered oods and ser"ices

• I(- ')1%)n% 3 Reser"e for unpaid amounts

• I(- ')1%)l% 3 Reser"e for bad debts

Reser"es

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• - reser"e is a deduction for a future e"ent.

• :eneral Rules2

Reser"es are only deductible for ta$ if t!ey are specifically mentioned in I(-'. 5eanin a business can only use reser"es t!at are specificallymentioned in t!e Income (a$ -ct )I(-%.

If a reser"e is deducted from income in '1*, it is t!en added to income in'14.

• 0!yA (!e business is allowed to remo"e amounts from income in '1* and notbe ta$ed on t!em as t!ey tec!nically don/t meet income criteria for ta$ in '1*. In'14 w!en t!ey meet income criteria for ta$ t!ey will be included in income.

Reser"es

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Example #1:

•;urin '1* o"ac Inc. !ad sales of *,, wit! 4, for oods to be

deli"ered ne$t year )'14%.

•;urin '14, t!e remainin 4, of t!e oods were deli"ered.

•(!e entire *, was included in t!e business/s &et Income.

•&ote 3 t!is reser"e does not factor in if t!e entire *, was recei"ed or not in'1*.

Reser"es 3 Dndeli"ered :ood

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Example #1 – Solution:

•(!e first @uestion to as= yourself if !ow muc! of t!is re"enue met re"enue

reconition criteriaA

•(!e business !as only earned 'E, of t!e *,.

•(!e business was also most li=ely only paid 'E,Fbut t!is doesn/t affect if t!e

reser"e for undeli"ered oods can be applied or not.

Reser"es 3 Dndeli"ered :ood

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Example #2:

•;urin '1* o"ac Inc., sold an item for *, but !ad a payment plan wit! t!e

purc!aser to recei"e payment in t!ree 1, instalments in '1*, '14, and'1+.

Reser"es 3 Dncollected -mounts

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•201 > include *, in income for ta$ and t!en deduct ', from income

for ta$. (!erefore a net of 1, is included.

•201! > include 1, in income for ta$.

•201" > include 1, in income for ta$.


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Income

'1* income for ta$es *,

'1* income uncollected )',%

'14 income collected 1,

'1+ income collected 1,

-ctual net income for ta$ for '1*, '14 G '1+ *,


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Hour are probable as=in yourself !ow is t!is different t!an reular accountsrecei"ableA

•(!e main difference is reular -R !as an areed upon payment date of between* to E days.

•0!ereas t!e terms of t!is type of transaction !a"e payment terms t!at stretc! waybeyond 6normal7 -R terms.

•(!e reser"e also !as a ma$ of * years, meanin all t!e income associated wit! t!ee"ent t!at caused t!e reser"e must be included in &I#( wit!in * years of t!e initialtransaction.


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Example #:

•(!is reser"e follows t!e same loic as t!e re"enue reser"e, but

In '1* a year>end deduction is permitted for anticipated bad debts.

In '14, t!e actual bad debt is deducted.

In '14 t!e old reser"e is included in business income and t!en a new reser"e isestablis!ed and deducted.

Reser"es 3 Bad ;ebts

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Example #: continue$%

• -t ;ec *1, '1*, o"ac Inc. estimates t!at ', of its +, accounts

recei"able will be uncollectible.

•;urin '14, write>offs of accounts recei"able total ','.

•n ;ec *1, '14, it is estimated t!at ',+ of t!e E',+ accounts recei"able

will be un>collectible.


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Example # – Solution:

•'1* > deduct ', from income for ta$ )'1* estimate for '14 ta$ year%.

•'14 > add ', to income for ta$ )'1* estimate for '14 ta$ year%.

•'14 > deduct ',' from income for ta$ )'1* actual%.

•'14 > deduct ',+ from income for ta$ )'14 estimate for t!e '1+ ta$ year%


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Example # – Solution:


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Income

Allowance expensed in 2013 for tax ($2,000)

Allowance added ac! to inco"e in 2013 fortax

$2,000

Act#al writeo% 2013 ($2,200)Act#al net expense for tax for 2013 & 2014 ($2,200)

'e 2014 esti"ate of $2,500 will also e ded#ctale for nco"e 'ax in 2015


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5any times reser"es won/t e"en come into effect because of accountin rules2

• Reser"e for undeli"ered oods and ser"ices (!e business can/t record t!e re"enue as t!e product sale would not !a"e met

re"enue reconition criteria )i.e. product !as yet to be deli"ered%.

(!is reser"e would only occur for a sole proprietor t!at operates on t!e cas!basis of accountin.

• I(- ')1%)n% 3 Reser"e for unpaid amounts (!is reser"e could occur anytime, as businesses often o into transactions

w!ere t!ey =now t!ey won/t be paid under typical -R terms.

• I(- ')1%)l% 3 Reser"e for bad debts Dsually a effect, as t!e reser"e is t!e same as t!e accountin e$pense.

Reser"es

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;etermine t!e Corporations &et Income for (a$ and (a$able Income for '1*2

$ample 1 3 Business Income

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:rocery sales +,

In"estment income *,

:ain on t!e sale of an asset 1,

;i"idend income 4,

(otal Income +8,

Cost of oods sold '+,

Salaries and waes 1, -dministrati"e e$penses 1,

;epreciation e$pense *,

Interest e$pense +,

(otal e$penses *J+,

Income before income ta$es 18+,

Income ta$es 4E,'+

&et income 1*8,K+

Co-op Inc.

Income Statement

For the Year Ended December 31, 2013


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&$$itional Info'mation ('ovi$e$:

• CC- > '+,

• &on>capital loss carry forward of *, from '1'.

• (!e 4E,'+ consists of 44, in ta$ installments to CR- and ','+ in interestand penalties paid to CR-.

• Included in t!e administrati"e e$pense was ', of meals incurred durinbusiness meetins wit! clients.

• (!e ain relates to t!e sale of buildin t!at !ad t!e followin "alue2

P; > 4, DCC > *8+,

&BL > *J, -CB > *JE,


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Solution – IF!"


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&et Income per #S 1*8,K+ -dditions2

M ;epreciation e$pense *,

M Income ta$es 4E,'+

M (a$able capital ain )4, > *JE,% N +9 ',

M Recapture )*JE, > *8+,% 11,

M +9 of meals )', N +9% 1, J,'+

;eductions2

> CC- e$pense )'+,%

> Capital ain )1,% )*+,%

IF! 1J4,

et Income #or !a$


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Solution – !a$able Income"


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&I#( 1J4,888

;educt2

> ;i"idend income )48,888%

> &on>capital loss carry forward )*8,888%

!I 1'4,888

!a$able Income


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• (!is re"iew and e$ample s!ould !a"e been pretty strai!t forward.

• If you are strulin wit! any of t!e concepts we co"ered, be sure to re"ert to t!e

!elp section on DofR Courses. (!e !elp section !as all t!e slides from Bus *84.

Business Income Re"iew

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• So far we !a"e co"ered t!e first * steps2

1% &et Income per #inancial Statements

'% &et Income for (a$ Purposes )&I#(%*% (a$able Income )(I%

4% (a$es Payable

+% (a$es win )Refund%

• In t!e ne$t class we will do a re"iew of 6Step 4 3 (a$es Payable7 and 6Step + 3(a$es win7 of t!e corporate ta$ calculation.

Corporate (a$es

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