Small Business Quickfinder Handbook (2017 Tax Year) Updates for the Tax Cuts and Jobs Act of 2017 and Other Recent Guidance

Transcription

1 Quickfinder Small Business Quickfinder Handbook (2017 Tax Year) Updates for the Tax Cuts and Jobs Act of 2017 and Other Recent Guidance Replacement Pages for Two-Sided (Duplex) Printing Instructions: This packet contains marked up changes to the pages in the Small Business Quickfinder Handbook that were affected by the Tax Cuts and Jobs Act of 2017, which was enacted after the Handbook was published. Additionally, changes were made based on other guidance issued after the Handbook was published. This is a specially designed update packet for owners of the 3-ring binder version of the Handbook who have access to a printer that prints two-sided (duplex). Simply print the entire PDF file (make sure to select two-sided or duplex printing), three-hole punch the pages, and then replace the pages in your Handbook. It s that easy.

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3 2017 Tax Year Patent Pending Small Business Quickfinder Form 1120 Handbook Corporation Tax Rate Schedule Quick Tax Method and before 2018 For tax years beginning after December 31, 1992 Taxable Income % Minus $ = Tax $ 0 $ 50,000 15% minus $ 0 = Tax 50,001 75, minus 5,000 = Tax 75, , minus 11,750 = Tax 100, , minus 16,750 = Tax 335,001 10,000, minus 0 = Tax 10,000,001 15,000, minus 100,000 = Tax 15,000,001 18,333, minus 550,000 = Tax 18,333,334 and over 35 minus 0 = Tax Note: See Basics of Corporations on Page C-1 for exceptions to above tax rates and an example of how to use the Quick Tax Method. Form Fiduciary Tax Rate Schedule Quick Tax Method Taxable Income % Minus $ = Tax $ 0 $ 2,550 15% minus $ 0.00 = Tax 2,551 6, minus = Tax 6,001 9, minus = Tax 9,151 12, minus = Tax 12,501 and over 39.6 minus 1, = Tax Note: The 10% tax bracket that applies to individuals does not apply to estates and trusts. Filing Information Tax Return Return Due Extensions Form 1065: Partnership/LLC Form 1120: Corporation Form 1120S: S Corporation Form 1041: Estates and Trusts Form 706: Estates Form 709: Gift Tax Form 990: Exempt Organizations 15th day of third month following close of tax year. 15th day of fourth (third if 6/30 FY) month following close of tax year. 15th day of third month following close of tax year. 15th day of fourth month following close of tax year. Nine months after date of decedent s death. April 15th following close of tax year of gift. 15th day of fifth month following close of tax year. Note: CY calendar year end; FY fiscal year end. Form 7004 extends deadline six months. Form 7004 extends deadline six if CY (seven if 6/30 FY; six if other FY) months. Form 7004 extends deadline six months. Form 7004 extends deadline five-and-one-half months. Form 4768 extends deadline six months. Form 4868 or 8892 extends deadline six months. Form 8868 extends deadline six months. Forms: 1065, 1120, 1120S, 1041, 706, 709 and 990 Forms 706 and 709 Estate and Gift Tax Rate Schedule Quick Tax Method For gifts made and estates of decedents dying after 2012 Taxable Amount % Minus $ = Tax 1 $ 0 $ 10,000 18% minus $ 0 = Tax 10,001 20, minus 200 = Tax 20,001 40, minus 600 = Tax 40,001 60, minus 1,400 = Tax 60,001 80, minus 2,600 = Tax 80, , minus 4,200 = Tax 100, , minus 6,200 = Tax 150, , minus 9,200 = Tax 250, , minus 14,200 = Tax 500, , minus 29,200 = Tax 750,001 1,000, minus 44,200 = Tax 1,000,001 and over 40 minus 54,200 = Tax 1 Less applicable credit amount. See the charts at the beginning of Tab H. Estate Tax Exclusion Estate and Gift Tax Exclusion Amounts Gift Tax Exclusion 1 Annual Gift Exclusion $5,490,000 $5,490,000 $14,000 1 Plus the amount of any deceased spousal unused exclusion and/or any restored exclusion related to lifetime gifts to a same-sex spouse see Tab H Business Quick Facts Section 179 Deduction: Maximum deduction... $ 510,000 Qualifying property limit... 2,030,000 SUV deduction limit... 25,000 Depreciation Limits (First Year): Luxury autos... $ 3,160 1 Light trucks and vans... 3,560 1 Standard Mileage Rate: Business miles... $.535 Depreciation component Charitable Medical and moving Plus $8,000 if special (bonus) depreciation is claimed. TAX PREPARATION Replacement Page 1/2018

4 Small Business Quickfinder Handbook 2017 Thomson Reuters/Tax & Accounting. Thomson Reuters, Checkpoint, Quickfinder and the Kinesis logo are trademarks of Thomson Reuters and its affiliated companies. ISSN ISBN X P.O. Box Carrollton, TX Phone Fax tax.thomsonreuters.com The Small Business Quickfinder Handbook is published by Thomson Reuters. Reproduction is prohibited without written permission of the publisher. Not assignable without consent. The Small Business Quickfinder Handbook is to be used as a first-source, quick reference to basic tax principles used in preparing business tax returns. This handbook s focus is to present often-needed reference information in a concise, easyto-use format. The summaries, highlights, examples, tax tips and other information included herein are intended to apply to the average small business taxpayer only. Information included is general in nature and we acknowledge the existence of many exceptions in the area of business taxes. The information this handbook contains has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. The author/publisher is not engaged in rendering legal, accounting or other advice and will not be held liable for any actions or suit based on this handbook. For further information regarding a specific situation, see applicable IRS publications, rulings, regulations, court cases and Code sections applicable to that situation. This handbook is not intended to be used as your only reference source Employer Retirement Plan Contribution Limits Profit Sharing 401(k) SIMPLE IRA SEP Employee Elective Deferral: < Age 50 Age 50 N/A N/A Employer Contribution: Per Participant Total Deductible Contribution Lesser of: 100% of comp or $54,000 25% of total comp 2 paid to all participants $18,000 $24,000 Lesser of: 100% of comp or $54,000 25% of total comp 2 paid to all participants (excluding employee deferrals) 1 20% of net SE income for self-employed. 2 Limited to $270,000 per participant. $12,500 $15,500 N/A N/A N/A Lesser of: 25% 1 of comp or $54,000 Either: 25% of total 1) 100% match comp 2 paid to up to 3% of all participants comp or 2) 2% of comp 2 IRS Hotlines and Toll-Free Numbers Abusive Tax Shelter Hotline (fax) Business and Specialty Tax Line E-Help Desk EFTPS Hotline FBAR Help Line Forms 706 and 709 Help Line Forms and Publications Information Return Reporting Practitioner Priority Service Refund Hotline Tax-Exempt and Government Entities Taxpayer Advocate TeleTax Topic Join our Quickfinder Community Do you have a client-specific question? Visit tax.thomsonreuters. com/quickfinder. Click on Community to join. Post questions, comment on posts and share insights. You can also follow thought leaders, set community notifications, search for specific topics and even share files, links and videos. Employer Identification Numbers (EINs) Responsible Parties All EIN applications (online, telephone, fax or mail) must disclose the name and taxpayer identification number (TIN) (that is, an SSN, EIN or ITIN) of the true principal officer, general partner, grantor, owner or trustor (responsible party). This is the individual or entity that controls, manages or directs the applicant entity and the disposition of its funds and assets. A nominee (someone given limited authority to act on behalf of an entity, usually for a limited period of time such as during formation) is not a responsible party, is not authorized by the IRS to obtain EINs and should not be listed on the Form SS-4. Only one EIN per responsible party per day may be requested. Online The internet EIN application is the IRS s preferred method for taxpayers to apply for and obtain an EIN. Go to the Apply for an Employer Identification Number (EIN) Online section of the IRS website. Once the application is completed, the information is validated during the online session, and an EIN is issued immediately. The online application process is available for all entities whose principal business, office or agency, or legal residence (in the case of an individual), is located in the U.S. or U.S. territories. The principal officer, general partner, grantor, owner, trustor, etc. must have a valid TIN (SSN, EIN or ITIN) in order to use the online application. Fax An EIN can be received by fax within four business days. Complete and fax Form SS-4 to the IRS using the Fax numbers listed in the Where to File Your Taxes (for Form SS-4) section of the IRS website. Mail Complete Form SS-4 and mail to the IRS using the addresses listed in the Where to File Your Taxes (for Form SS-4) section of the IRS website. The processing time frame for an EIN application received by mail is four weeks. Telephone International Applicants Only International applicants may call between 6:00 a.m. and 11:00 p.m. (ET) M F to obtain their EIN. The person making the call must be authorized to receive the EIN and answer questions concerning Form SS-4. Type of Depositor Deposit Due Dates Reason Classified Payroll Deposit Deadlines (Form 941) Monthly 15th day of following month 1) Total federal payroll taxes were $50,000 or less in the lookback period or 2) New employer. Semiweekly Payday on: Wednesday, Thursday, Friday Payday on: Saturday, Sunday, Monday, Tuesday Due on: Following Wednesday Due on: Following Friday Total federal payroll taxes were more than $50,000 in the lookback period. Exceptions: Employer accumulates less than $2,500 in taxes during the current or preceding quarter: Deposit as above or send payment with quarterly tax return. Employer accumulates $100,000 or more in taxes during deposit period: Deposit due on next day (that is not a Saturday, Sunday or legal holiday) after the day on which the $100,000 threshold is reached. Employers notified by the IRS to file Form 944 that accumulate less than $2,500 in taxes during the fourth quarter: Pay fourth quarter tax liability with Form 944. See IRS Pub. 15 for deposit penalties and exceptions under Depositing Taxes. Updates For supplemental information to the material in this handbook, please refer to the Handbook Updates section of our website: tax.thomsonreuters.com/quickfinder. If you have any questions We welcome comments and questions from readers. However, our response is limited to verification of specific information presented in the Quickfinder Handbooks. We cannot give advice on a client s tax situation or provide information beyond the contents of this publication. Questions must be submitted in writing by mail, fax or online at tax.thomsonreuters.com/quickfinder (click on Content Questions). Research editors are not available to answer questions over the phone.

5 Replacement Page 1/2018 Reference Materials and Worksheets Where to File: Business Returns Filing Addresses 2017 Returns...Page A-1 Principal Business Activity Codes Forms 1065, 1120 and 1120S...Page A-1 Business Quick Facts Data Sheet...Page A-1 Types of Payments Where to Report...Page A-2 Guide to Information Returns...Page A-3 Cash and Accrual Accounting Methods Treating Commonly Encountered Items...Page A-6 S Corporation Shareholder s Adjusted Basis Worksheet...Page A-7 Partner s Adjusted Basis Worksheet...Page A-8 Tax Info for Partnership, Corporation, LLC and LLP Returns...Page A-9 Transferor s Section 351 Statement... Page A-11 Tab A Topics Tax Info Sheet for Gift Tax Returns...Page A-12 Estate Inventory Worksheet...Page A-13 Reconciliation of Income Reported on Final Form 1040 and Estate s Fiduciary Return (or Beneficiary s Return)...Page A-14 Allocation of Indirect Costs to Ending Inventory Under IRC Sec. 263A...Page A-15 Business Valuation Worksheet...Page A-16 Foreign Asset Reporting Forms 8938 and FinCEN Page A-17 Types of Foreign Assets and Whether They are Reportable...Page A-17 Worksheet to Allocate Purchase/Sale Price to Specific Assets...Page A-18 Where to File: Business Returns Filing Addresses 2017 Returns Note: At the time of publication, the IRS had not released the 2017 filing addresses for business returns. This information will be posted to the Handbook Updates section of tax.thomsonreuters.com/quickfinder when available. Principal Business Activity Codes Forms 1065, 1120 and 1120S Note: At the time of publication, the IRS had not released the 2017 principal business activity codes for business returns. This information will be posted to the Handbook Updates section of tax.thomsonreuters.com/quickfinder when available. Business Quick Facts Data Sheet FICA/SE Taxes Maximum earnings subject to tax: Social Security tax $ 128,400 $ 127,200 $ 118,500 $ 118,500 $ 117,000 Medicare tax No Limit No Limit No Limit No Limit No Limit Maximum tax paid by: Employee Social Security $ 7, $ 7, $ 7, $ 7, $ 7, SE Social Security 15, , , , , Employee or SE Medicare No Limit No Limit No Limit No Limit No Limit Business Deductions Section 179 deduction limit $ 1,000,000 $ 510,000 $ 500,000 $ 500,000 $ 500,000 Section 179 deduction SUV limit (per vehicle) 25,000 25,000 25,000 25,000 25,000 Section 179 deduction qualifying property phase-out threshold 2,500,000 2,030,000 2,010,000 2,000,000 2,000,000 Depreciation limit autos (1 st year with special depreciation) 18,000 11,160 11,160 11,160 11,160 Depreciation limit autos (1 st year with no special depreciation) 10,000 3,160 3,160 3,160 3,160 Depreciation limit trucks and vans (1 st year with special depreciation) 18,000 11,560 11,560 11,460 11,460 Depreciation limit trucks and vans (1 st year with no special depreciation) 10,000 3,560 3,560 3,460 3,460 Retirement Plans SIMPLE IRA plan elective deferral limits: Under age 50 at year end $ 12,500 $ 12,500 $ 12,500 $ 12,500 $ 12,000 Age 50 or older at year end 15,500 15,500 15,500 15,500 14, (k), 403(b), 457 and SARSEP elective deferral limits: Under age 50 at year end $ 18,500 $ 18,000 $ 18,000 $ 18,000 $ 17,500 Age 50 or older at year end 24,500 24,000 24,000 24,000 23,000 Profit-sharing plan/sep contribution limits 55,000 54,000 53,000 53,000 52,000 Compensation limit (for employer contributions to profit-sharing plans) 275, , , , ,000 Defined benefit plans annual benefit limit 220, , , , ,000 Key employee compensation threshold 175, , , , ,000 Highly compensated threshold 120, , , , ,000 Estate and Gift Taxes Estate tax exclusion $11,200,000 3 $ 5,490,000 3 $5,450,000 3 $5,430,000 3 $5,340,000 3 Gift tax exclusion 11,200, ,490, ,450, ,430, ,340,000 3 GST tax exemption 11,200,000 5,490,000 5,450,000 5,430,000 5,340,000 Gift tax annual exclusion 15,000 14,000 14,000 14,000 14,000 1 See Tab 3 in the 1040 Quickfinder Handbook for an expanded Quick Facts Data Sheet. Not used. 2 Amount not released by IRS at publication time. Tax professionals should watch for developments. 3 Plus the amount of any deceased spousal unused exclusion and/or any restored exclusion related to lifetime gifts to a same-sex spouse see Tab H Tax Year Small Business Quickfinder Handbook A-1

6 Types of Payments Where to Report Source: 2017 General Instructions for Certain Information Returns (Forms 1096, 1097, 1098, 1099, 3921, 3922, 5498, and W-2G). A Tax Year Small Business Quickfinder Handbook

7 After December 22, 2017, any contribution made by a governmental entity or civic group also is taxable to the corporation. Instead of four equal installment payments, estimates can be based on an annualized income method or the adjusted seasonal installment method. See Annualized Income Methods below. For more on the adjusted seasonal installment method, see the instructions to Form 2220 and IRS Pub Estimated payments must be made by the following dates: First payment... 15th day of the fourth month Second payment... 15th day of the sixth month Third payment... 15th day of the ninth month Fourth payment... 15th day of the 12th month For calendar-year corporations, those dates are April 15, June 15, September 15 and December 15. If the 15th of the month due date falls on a Saturday, Sunday or legal holiday, the installment is due on the next business day. Annualized Income Methods Corporations can compute current-year tax for each estimated tax installment under one of three annualized income methods: (1) Standard, (2) Option 1 and (3) Option 2. [IRC Sec. 6655(e)] An election to use either of the optional periods is effective only for the tax year for which it is made. The election must be made on or before the date required for paying the first installment for the tax year. Corporate Annualization Methods and Periods Methods Form 8842 Installment Periods Number Name Required First Second Third Fourth 1 Standard No Option 1 Yes Option 2 Yes Note: Each installment is based on annualized income for the number of months given the method. For example, if using the Standard method the third installment is based on annualized income from the first six months. Related forms: Form 8842 (Election To Use Different Annualization Periods for Corporate Estimated Tax) is filed to make the election to use optional methods 1 or 2. Form 1120-W. Used by corporations to estimate amount of required payments. This form is retained in the corporation s records and not filed with the IRS. Form Used to figure underpayment penalty or to show exception to penalty under the annualized income method. Quick Refund of Estimated Tax A corporation that has overpaid its estimated tax may apply for a quick refund if the overpayment is: 1) At least 10% of its expected income tax liability and 2) At least $500. To apply for a quick refund, complete Form 4466 (Corporation Application for Quick Refund of Overpayment of Estimated Tax). Mail Form 4466 to the IRS service center specified in the instructions of Form 4466 before the 16th day of the fourth month after the end of the tax year, and before the tax return is filed. Attach a second copy to the corporation s tax return. An extension of time to file the tax return will not extend the time to file Form Capital Contributions Contributions to capital of a corporation are called paid-in capital. A corporation does not recognize gain or loss when it issues stock in exchange for cash or property. (IRC Sec. 1032) Shareholders do not recognize gain or loss upon contribution of cash in exchange for stock. Shareholders may recognize gain or loss upon exchange of property for stock. When services are performed in exchange for stock, the fair market value (FMV) of the service is taxable compensation. The amount included in income becomes the shareholder s stock basis. Contributions to capital by nonshareholders. The basis of property contributed to a corporation by a nonshareholder is zero. For example, if a municipality gives land to a corporation as inducement to locate there, the corporation accounts for the property as a contribution to capital with zero basis. If cash is contributed by a nonshareholder, basis in the corporation s assets is reduced by the amount of the contribution. Note: Contributions made by a customer or potential customer are taxable income to the corporation, not capital contributions. See IRS Pub. 542 for more information about contributions from nonshareholders. Transfers of Property Generally, when property is transferred to a corporation in exchange for stock, the transaction is treated as if the property were sold to the corporation at FMV. Example: Ed exchanges property with FMV of $10,000 and adjusted basis of $4,000 for 70% of PIE Corporation s stock. Ed recognizes $6,000 gain on the transaction. His basis in stock received is $10,000. Nontaxable Exchange of Property for Stock Section 351 Transfers In a nontaxable Section 351 exchange, the corporation takes the transferor s basis in the transferred property. No gain or loss is recognized if one or more persons transfer cash or property to a corporation solely in exchange for stock if the person or persons control the corporation immediately after the exchange. Control is defined as owning at least 80% of the voting stock and 80% of all other classes of stock. Example: Mr. Bean owns a sole proprietorship, which contains assets with FMV of $10,000 and basis of $2,000. He changes the business entity to a corporation, and transfers the assets from the sole proprietorship to the corporation in exchange for 100% of the corporation s stock. The exchange qualifies under IRC Sec. 351, and no gain is recognized on the transaction. Note: Nonrecognition treatment under IRC Sec. 351 does not apply to: (1) transfer of property to an investment company, (2) transfer of property in a bankruptcy in exchange for stock used to pay creditors or (3) stock received in exchange for the corporation s debt or for interest on the corporation s debt that accrued while the transferor held the debt. Basis. See Basis of Property Exchanged for Corporate Stock on Page C-4. Generally, a corporation s basis in property received under IRC Sec. 351 is equal to the transferor s basis. However, IRC Sec. 362(e) includes a carryover basis limitation to prevent (1) the importation of built-in losses into the U.S. by transferors who are not subject to U.S. tax and (2) the double deduction of a single economic loss by transferring built-in loss property to a corporation in a carryover basis transaction with the transferee deducting a loss on the sale of the property and the transferor deducting a loss on the sale of stock. Replacement Page 1/ Tax Year Small Business Quickfinder Handbook C-3

8 Tax-Free Exchanges Under Section 351 Transferors have at least 80% control after the exchange Shareholder s basis in stock received Corporation s basis in property received equals: [IRC Sec. 358(a)] equals: [IRC Sec. 362(a)] + Adjusted basis of property transferred + Recognized gain + Cash paid + Liabilities assumed Cash received FMV of property received Liabilities transferred Basis of Property Exchanged for Corporate Stock + Adjusted basis of the property in the hands of the transferor + Gain recognized by the transferor Note: Shareholders who transfer property to a corporation in a Section 351 exchange recognize gain only up to the amount of boot received (money or property other than the corporation s stock). Liability relief is not considered boot for determining gain under these rules [IRC Sec. 357(a)]. However, gain may be recognized if liabilities exceed basis of the contributed property [IRC Sec. 357(c)]. See Property Subject to Liabilities below. Taxable Exchanges That Do Not Qualify Under Section 351 Shareholder s basis in stock received equals FMV of stock received which is measured by: + FMV of property transferred (adjusted basis plus or minus gain or loss recognized by the transferor) + Cash paid Note: The general rule of Section 1001 (gain or loss equals difference between amount realized and adjusted basis) applies. Corporation s basis in property received equals FMV of the property received, which is measured by: + Adjusted basis of the property in the hands of the transferor + Gain recognized by the transferor Loss recognized by the transferor Notes: Shareholders who are not in control of a corporation immediately after a transfer recognize gain or loss as if they sold the property at its FMV to the corporation. Corporations never recognize gain or loss on the receipt of money or property in exchange for their own stock. (IRC Sec. 1032) Group transfers. The 80% control test may be met by a group of investors, and the group can include current shareholders. However, a transfer from a current shareholder is not recognized for purposes of the 80% rule if (1) a small amount is transferred, and (2) the purpose is to qualify the other transferors for nonrecognition treatment [Reg (a)(1)(ii)]. The amount transferred will not be considered a small amount if the amount transferred equals or exceeds 10% of the FMV of stock already owned or to be received for services by the transferor. (Rev. Proc , Sec. 3.07) Example: Al owns 100% of Offline, Inc., which has stock valued at $25,000. Bob wants to purchase a 50% ownership interest in the corporation by means of contributing equipment with a FMV of $25,000 in exchange for stock. Bob s basis in the equipment is $5,000. Al and Bob want the transaction to qualify for nonrecognition treatment under IRC Sec. 351 so that Bob will not have a taxable gain. Al contributes $2,500 in cash for additional stock. It is necessary for Al (the existing shareholder) to transfer an asset with a FMV of at least 10% of the FMV of the corporation in order to include his stock in the 80% control test and have the transaction be recognized under IRC Sec As a group, Al and Bob meet the 80% ownership rule, and the transaction qualifies for nonrecognition treatment. If Al does not make a capital contribution in exchange for stock, or if he purchases only a small amount, the 80% control test will not be met and Bob will recognize a $20,000 gain on the transaction. Solely in exchange for stock. Nonrecognition of gain applies only to amounts transferred solely in exchange for stock. If the shareholder receives cash or other property, gain is recognized up to the amount of cash or FMV of other property received. Securities are considered property for purposes of IRC Sec Example: Wilbur and Orville enter into an agreement to purchase 100% of the stock of Wright Corporation. Wilbur agrees to contribute $6,000 cash on July 31 in exchange for 50 shares of stock. Orville agrees to contribute property with a FMV of $6,000 and an adjusted basis of $2,000 on October 31 in exchange for 50 shares of stock. Since Wilbur and Orville control Wright Corporation immediately after the transfer and since the exchanges were made in accordance with a predetermined agreement, Section 351 treatment applies. Neither shareholder recognizes gain on the exchange. Wilbur s basis in stock is $6,000. Orville s basis in stock is $2,000. Holding period. A corporation s holding period for an asset received in a Section 351 transfer includes the time the asset was held by the transferor. Likewise, a shareholder s holding period for stock acquired in a 351 transfer includes the period the shareholder held the property before the exchange. (IRC Sec. 1223) Property Subject to Liabilities In a Section 351 exchange, if a shareholder contributes property subject to liabilities, the shareholder s basis in the stock received is reduced by the amount of liability relief (IRC Sec. 358). If liabilities exceed the shareholder s adjusted basis in the property, gain is recognized on the excess and the shareholder s basis in the stock is zero. Exception: Under IRC Sec. 357(c)(3), liability relief is not included in the computation if the payment of the liability would give rise to a deduction. Example: Shelly transfers property with FMV of $20,000 and adjusted basis of $12,000 to Magnolia Corporation in exchange for 80% of its stock. In addition to stock, she receives $3,000 in cash. Although the transfer qualifies under IRC Sec. 351, Shelly recognizes gain of $3,000. Her basis in the stock is $12,000 (adjusted basis of property transferred, plus gain, less cash received). The corporation s basis in the property is $15,000 (transferor s basis plus gain recognized by transferor). Immediately after the exchange. The phrase immediately after the exchange does not necessarily require simultaneous exchanges as long as the transfers are made pursuant to a predetermined agreement. [Reg (a)(1)] C Tax Year Small Business Quickfinder Handbook

9 Under the Tax Cuts and Jobs Act, special allocation rules apply to PTTP distributions if the terminated S corporation (1) was an S corporation before December 22, 2017; (2) revoked its S corporation election during the two-year period beginning on December 22, 2017 and (3) had the same owners on December 22, 2017 and the revocation date. Election to distribute AE&P first. An election is available to make distributions first from AE&P. The election is made on a year-by-year basis. See Reg (f). Note: Some S corporations have a retained earnings account called previously taxed income (PTI). PTI represents undistributed earnings from pre-1983 S corporation years. See the instructions for Schedule M-2, Form 1120S, for more information. Post-Termination Transition Period When a corporation s S status terminates, a post-termination transition period (PTTP) begins [IRC Sec. 1377(b)]. During the PTTP, distributions from the AAA retain their character as nontaxable distributions (to the extent of stock basis). The distributions reduce the shareholder s basis [IRC Sec. 1371(e)(1)]. Any AAA remaining after the PTTP ends can no longer be distributed tax free. Election. With the consent of all shareholders to whom distributions are made during the PTTP, the corporation can elect to treat distributions as dividends up to the AE&P of the corporation. The election is made by attaching a statement to Form 1120 for the year the PTTP ends. The statement should contain a declaration that the corporation elects to have IRC Sec. 1371(e) (2) apply to distributions during the period, and should be signed by a corporate officer, with all shareholders who received PTTP distributions signing the consent. (Reg ) The PTTP ends the later of [IRC Sec. 1377(b)]: One year after the PTTP begins, Due date for last S corporation return, including extensions or 120 days after a court decision, agreement with the IRS or audit determination stating that the corporation did not qualify as an S corporation. the S corporation must reduce its accumulated adjustments account. (CCA ) Comparing AAA and Stock Basis How items affect a shareholder s basis in stock vs. the corporate AAA is illustrated in the following chart. Item Stock Basis AAA Original basis in stock Increase No Effect Stock purchase Increase No Effect Taxable income Increase Increase Nontaxable income Increase No Effect Capital gains Increase Increase Deductible expenses Decrease Decrease Nondeductible expenses Decrease Decrease Tax-exempt related expenses Decrease No Effect Ordinary and capital losses Decrease Decrease Depletion in excess of basis Increase Increase Depletion not in excess Decrease Decrease Nontaxable distributions (FMV) Decrease Decrease Taxable distributions of AE&P No Effect No Effect Notes: The shareholder s stock basis cannot be decreased below zero; however, the corporate AAA can be negative. The chart above assumes the S corporation has AE&P. Taxexempt income and related expenses are recorded in the OAA, not in AAA. If the corporation has no AE&P, the OAA is not used and the taxability of distributions is not determined by reference to AAA, but by the amount of stock basis (nontaxable to extent of basis; capital gain in excess of basis). Deemed Dividends If an S corporation wants to make dividend distributions, but lacks sufficient capital, the corporation may elect to make a deemed dividend. The dividend is considered to have been made on the last day of the tax year, even though no money is distributed. The amount of the deemed dividend is treated by the shareholder as dividend income, and a subsequent capital contribution that increases the basis of his stock. Election. The election is made by attaching a statement to the S corporation s timely filed original or amended Form 1120S for the year in which the distributions are made. The election is irrevocable and made on a year-by-year basis. See Reg (f). Property Distributions When property is distributed, the shareholder uses the FMV of the property to figure the tax effect and the adjustment to basis of his stock. If the property is appreciated property, the S corporation is considered to have sold the property to the shareholder at FMV, and recognizes gain accordingly. [IRC Sec. 311(b)] Reporting. An S corporation that distributes property other than cash to shareholders attaches a statement to its Form 1120S providing (1) the date the property was acquired, (2) the date of the distribution, (3) the property s FMV on the date of the distribution and (4) the corporation s basis in the property. Note: In an informal Chief Counsel Advice, the IRS says that an S corporation s disallowed loss under IRC Sec. 311(a) for distributions of stock or property that aren t in complete liquidation of its stock will be treated as a nondeductible, noncapital expense under IRC Sec. 1367(a)(2)(D). Thus, the Section 311(a) loss will reduce the shareholders bases in S corporation stock, and Replacement Page 1/2018 S Corporation Example A comprehensive S corporation example with line-by-line instructions to help in the preparation of Form 1120S Compare with Forms 1065 and This example reflects the same business activity as the examples in Tab B (Partnerships) and Tab C (C Corporations). Compare the differences in tax reporting for each type of business entity. History. Jerry and Bob agreed to go into business together operating a skydiver training facility called Shout and Jump. Organizational costs and start-up costs/amortization. Jerry and Bob met with an accountant and an attorney to discuss which business entity would best fit their needs. After determining they preferred the corporate form of business but wanted flow-through treatment because they expect to generate significant profits that won t be left in the business, these professionals advised them to form an S corporation (see the Entity Comparison Chart on Pages M-2 and M-3). The accountant helped establish a bookkeeping system. The attorney drafted an incorporation agreement. The accountant s fee was $1,200; the attorney s fee was $1,800. Both are considered organizational costs. The corporation paid advertising costs of $2,016 before its grand opening, which is considered a start-up cost. The expenses for the accountant, attorney and advertising are considered capital expenses because the costs were incurred before the start of business operations. Such expenses may be deducted as business expenses in an amount not exceeding $5,000 for start-up costs and $5,000 for organizational costs. Expenditures in excess of $5,000 for each type of cost are amortized over a period of 180 months. Taxpayers are deemed to elect to deduct (and, if applicable, amortize) start-up and organizational costs in the year the business begins. No election statement is required Tax Year Small Business Quickfinder Handbook D-11

10 Instead, deduct/amortize costs in the year business begins (Regs , and ). Shout and Jump, Inc., deducts both the organizational costs of $3,000 and the start-up costs of $2,016. These two expenses are deducted on Form 1120S, page 1, line 19, Other deductions. See the Other Deductions schedule on Page D-21. S corporation election (Form 2553). To elect S corporation status, a corporation must file Form 2553 (Election by a Small Business Corporation). See S Corporation Election (Form 2553) on Page D-3 for more information about making the election. Provisions of the Shout and Jump, Inc., incorporation agreement: Shout and Jump, Inc., elects to be taxed as an S corporation. The corporation authorizes one million shares of stock at par value $100 per share. Jerry makes a capital contribution of $69,000 in exchange for 690 shares of common stock. Bob contributes $46,000 in exchange for 460 shares. The corporation pays for an airplane, hangar rental, office equipment, rental parachutes, inventory and any other expenses directly associated with business operations. The corporation pays group medical insurance premiums for all employees. Employees pay for their own safety equipment, uniforms, trade publications, licenses and professional education. Note: These expenses are deductible as employee business expenses on Schedule A of Forms 1040, subject to the 2%-of-AGI floor. Compare with the same expenses for partners (see Partnership agreement on Page B-12), which reduce SE tax and are not subject to the 2% floor. The corporation adopts a calendar tax year. The corporation uses the cash method of accounting. Note: Under the general rule, a business that holds inventory must use the accrual method of accounting for purchases and sales. However, an exception exists for taxpayers with average annual gross receipts of $1 million or less. Shout and Jump, Inc., is eligible to use the cash method under this exception. Inventory is accounted for in the same manner as nonincidental materials and supplies. See Small Businesses Eligible for Cash Method on Page L-2. Shareholder wages are as follows: Jerry received $36,500 and Bob received $30,800. The corporation also paid group medical insurance premiums of $1,600 for each shareholder-employee. The three other employees received combined wages of $48,182, and $4,800 of combined group medical insurance premiums were paid for them. Note: Jerry and Bob are paid as employees of the corporation. Compare wages paid to shareholder-employees with guaranteed payments to partners in the Partnership Example on Page B-10. Income Statement per Books May 1 December 31, 2017 Income: Jump Fees... $ 242, Merchandise Sales , Training Fees... 41, Interest Earned Gross Income... $ 414, Cost of Goods Sold: Beginning Inventory... $ 0.00 Purchases... 67, Ending Inventory... ( 5, ) Cost of Goods Sold... $ 61, Gross Profit... $ 352, Expenses: Accounting ($4,200 $1,200)... $ 3, Advertising ($13,183 $2,016)... 11, Bank Charges Business Insurance... 3, Depreciation... 47, Fuel... 20, Health Insurance... 8, Interest Expense... 6, Meals and Entertainment Miscellaneous Office Supplies Organizational and Start-up... 5, Payroll Taxes... 10, Rent... 14, Repairs and Maintenance... 1, Utilities... 5, Wages , Total Expenses... $ 255, Net Income per Books... $ 97, Balance Sheet as of December 31, 2017 Assets: Cash... $ 172, Inventory... 5, Computer... 6, Office Equipment... 15, Airplane , Accumulated Depreciation... ( 47, ) Total Assets... $ 326, Liabilities: Sales Tax Payable... $ 1, Bank Loan Payable , Total Liabilities... $ 133, Equity: Common Stock... $ 115, Current Earnings... 97, Distributions... ( 20, ) Total Equity... $ 192, Total Liabilities + Equity... $ 326, Depreciation Schedule Asset Placed in Service Cost Section 179 Depreciable Basis Computer... May 1, 2017 $ 6,000 $ 6,000 $ 0 Office Equipment... May 1, ,000 15,000 0 Airplane... May 1, ,000 4, ,000 Totals $ 196,000 $ 25,000 $ 171,000 Airplane: Book and Tax Depreciation MACRS AMT Depreciation 5-year MACRS 5-year AMT Section $ 25,000 Section $ 25,000 Depreciable Basis Regular Depreciation... 22,800 AMT Depreciation... 17,100 $171,000 Total Depreciation... $ 47,800 Total AMT Depreciation... $ 42,100 AMT Adjustment: $47,800 $42,100 = $5,700 Short-Year Depreciation Calculation 2 May 1 December 31 (8 months) Midpoint September 1 Book and Tax: 200% DB $171, % 4 12 = $22,800 1 Amount corporation chose to elect could have elected up to $175,000 for this asset. 2 See Short Tax Year MACRS on Page J-4. D Tax Year Small Business Quickfinder Handbook AMT: 150% DB $171, % 4 12 = $17,100

11 Income and Expense Chart for a Decedent (Continued) Cash Method of Accounting Category Where to Report Explanation Charitable Final Form 1040 Amounts contributed before death. (IRC Sec. 170) Contributions Form 1041, Schedule A Contributions are deductible only if decedent s will requires that contribution be made from gross taxable income [Reg (c)-1]. AGI limitations applicable to individuals do not apply to estates. Form 706, Schedule O Value of property in decedent s estate that was transferred by decedent (via his will) or by qualified disclaimer to a charity described in IRC Sec. 2055(a). Claims Against Estate Form 706, Schedule K Enforceable personal obligations of decedent at time of death plus interest accrued up to time of death. Credit for the Elderly or the Disabled Deductions in Respect of a Decedent (DRD) Earned Income Credit (EIC) Estate Tax Deduction Final Form 1040, Schedule R Form 706 and Form 1041 (or beneficiary s Calculate as though decedent lived full year. Business expenses, income-producing expenses, interest and taxes for which decedent was liable but which are not deductible on final Form Depreciation Final Form 1040 Depreciation for period ending on date of death. Short tax year rules apply; see Tab J. Form 1041, Form 4562 If estate continues to operate decedent s business or rental property, depreciation is allocated between estate and income beneficiaries (assuming estate is claiming an income distribution deduction) on basis of income allocated to each. Estate is not allowed Section 179 deduction. Short tax year rules apply for any tax year of the estate less than 12 months. See Tab J for short tax year rules. Dividend Income Final Form 1040, Schedule B Dividends received through date of death. Form 1041, Schedule B (or beneficiary s Dividends received after date of death. Estates and trusts are subject to same reduced tax rate on qualified dividends as individuals (20% maximum rate for trusts and estates in the 39.6% tax rate bracket). Form 706, Schedule B and Form 1041 (or beneficiary s Dividends declared to shareholders of record before death, but not available or received until after death (IRD). Final Form 1040, Schedule Available even if decedent s return covers only a part year and decedent would not have qualified with a full EIC year s income. A decedent s credit is refundable. If federal estate tax was paid on IRD, a deduction can be claimed on the income tax return that reports the IRD. Form 1040, Schedule A) Exemptions Final Form 1040 Full amount allowed for decedent; no proration required. For decedent to claim exemption of a dependent, decedent must have furnished over one-half of support for entire year. Form 1041 An estate is allowed a $600 exemption even if first return period is less than 12 months. Funeral Expenses Form 706, Schedule J Allowed only on Form 706. State law generally determines which items are deductible funeral expenses. Reg classifies the following as funeral expenses if allowable under local law: tombstone, monument, mausoleum, burial lot for decedent or family (including costs for future care) and transportation of the person bringing body to burial place. Income and Expenses Final Form 1040 Income received and expenses paid before death. Generally Income received and expenses paid after death, including income and expenses in respect of a decedent. Form 706 Income and expenses in respect of decedent (also reported on Form 1041 or beneficiary s. Income in Respect of a Form 706 and Form 1041 (or All gross income that the decedent had the right to receive and is not includable on final Form If estate tax Decedent (IRD) beneficiary s is paid on this income, a deduction for estate tax paid can be claimed on the income tax return that reports income. Income Tax Due on Final Form 1040 Form 706, Schedule K Federal and state income taxes unpaid at date of death, including tax due on final Form 1040 prepared and filed after death. Installment Sale Final Form 1040, Form 6252 Payments received through date of death. Contracts Held by Decedent Form 706 and Form 1041 (or beneficiary s If note cancels at death under decedent s will, date-of-death value is reported on Form 706 and unrecognized gain on Form 1041 (as IRD). If decedent and obligor are related, FMV of installment note cannot be less than its face value. If note is self-canceling at death (referred to as a self-canceling installment note or SCIN), unrecognized gain is included on Form 1041 (as IRD). Form 706 and Form 1041 (or beneficiary s (attach Form 6252) If contract is not canceled at death, difference between face amount of obligation and decedent s basis is reported on Form 706 and is considered IRD [IRC Sec. 691(a)(4)]. As payments are collected, recipient reports income using decedent s gross profit percentage. Interest Earned Final Form 1040, Schedule B Interest received through date of death plus original issue discount (OID) earned through date of death. Form 706, Schedule B and Interest accrued but unpaid at date of death is IRD. Interest Expense Final Form 1040 Deductible interest paid before death. IRA, SEP, SIMPLE, Keogh, 401(k), etc. Form 706 and Form 1041 (or beneficiary s Form 706, Schedule I Final Form 1040 Interest earned and received after date of death. Deductible interest expense accrued before death but paid after death (DRD). Nondeductible personal interest accrued before death but paid after death is allowed as a debt of estate on Form 706, Schedule K. Interest paid after death. Use Form 4952 for investment interest expense. Interest expense on decedent s personal residence is qualified residential interest only if a beneficiary uses it as a residence during estate administration [IRC Sec. 163(h)(4)]. Otherwise, the interest is either investment interest (subject to limitations on Form 4952), rental interest expense or nondeductible personal interest. Investment interest expense attributable to tax-exempt income is not deductible. The account balance of all tax-deferred benefits at the time of death. Benefits are taxable to the beneficiary when distributed (IRD). Beneficiaries can roll over IRA funds. Amounts actually received before death. Distributions made after death (IRD). These distributions are not subject to the 10% early withdrawal penalty. [IRC Sec. 72(t)(2)(A)(ii)] Table continued on the next page 2017 Tax Year Small Business Quickfinder Handbook H-3

12 Income and Expense Chart for a Decedent (Continued) Cash Method of Accounting Category Where to Report Explanation Medical Expenses Final Form 1040, Schedule A Medical expenses paid before death. Can elect to deduct medical expenses incurred before death but paid from the estate within one year of the day following death [Reg (d)]. Election does not apply to medical expenses for a decedent s dependents. To elect, attach a statement to Form 1040 stating the estate has waived the right to claim medical expense for estate tax. With the election, deduction is taken on Form 1040, Schedule A in year costs were incurred (a Form 1040X may be needed). Amounts not allowed due to 10%-of-AGI Miscellaneous Itemized Deductions Net Investment Income Tax Partnership Income (Loss) Form 706, Schedule K threshold cannot be claimed on Form 706. Unpaid medical expenses at death are reported on Form 706 as a claim against the estate, unless an election is made to report on decedent s final Form Amounts deducted on Form 706 are not subject to the 10% of AGI deduction threshold. If deduction taken on Form 1040, amount not allowed due to 10% of AGI threshold cannot be claimed on Form 706. Form 1041 Any insurance reimbursements after death of amounts previously deducted on Form Report as IRD. Final Form 1040, Schedule A Miscellaneous itemized deductions paid before death. Form 706, Schedule J or Form Unpaid miscellaneous itemized deductions at date of death are reported on Form 706. When paid, deduct on 1041 Form 1041 as DRD. Form 1041 Incurred and paid after death: may be subject to 2% AGI limit. See Deductions on Page G-5. Form 8960 Estates are subject to the 3.8% net investment income tax. See Tab G for additional discussion. Final Form 1040, Schedule E Income (or loss) up to date of death using any reasonable method of allocating income (loss). Allocation is often based on pro rata amount for year or interim closing of books. Income (or loss) after death not included on final Form Passive Losses Final Form 1040 Losses are allowed to extent of passive income, plus accumulated unused losses to extent they exceed any increase in basis allocated to the activity. For example, if a passive activity s basis is increased $6,000 upon taxpayer s death, and unused passive activity losses as of date of death are $8,000, decedent s deduction is $2,000 ($8,000 $6,000). Form 1041 Estates are subject to the same passive loss limitation rules as individuals. The fiduciary s level of participation determines the classification. If decedent actively participated in a rental real estate activity before death, the estate will be allowed the special $25,000 rental real estate exemption for up to two years after decedent s death. Personal Residence Form 1041 The Section 121 exclusion of gain from sale of personal residence does not apply to estates. If personal residence is a capital asset to the estate (either held for investment or rental purposes), estate can deduct loss on sale. If property is used by estate beneficiaries for personal purposes, loss on sale is not deductible. If home was not subject to probate and passed directly to heirs, sale of home is reported on beneficiaries Form Real Estate, State and Local Income Taxes Rental Income and Expenses S Corporation Income (Loss) Savings Bond Interest (Decedent did not elect to report interest annually) Savings Bond Interest (Decedent elected to report interest annually) Final Form 1040, Schedule A Form 706, Schedule K and Paid before death. General sales taxes deductible if state and local income taxes not deducted. [IRC Sec. 164(b)(5)] Real estate taxes accrued before death but paid after death. Accrued and paid after death. Final Form 1040, Schedule E Income and expenses received or paid before death. Form 706 and Form 1041 (or Income and expenses accrued before death but not actually received or paid until after death (IRD and DRD). beneficiary s Passive activity loss rules apply to estates (for Form 1041 reporting). Form 1041 (use Schedule E of Income and expenses accrued and received or paid after death. Passive loss rules apply to estates. Form 1040) Final Form 1040, Schedule E Pro rata share of income (or loss) up to death. Generally, amount of income (or loss) is computed as follows: S corporation income or loss for the year, divided by number of days in S corporation s year, multiplied by number of days shareholder was alive. Can elect under Section 1377(a)(2) to close S corporation books on day of death. Income (or loss) after date of death and not included on final Form Final Form 1040 or Form 1041 Two options: (Rev. Rul ) 1) Executor elects to report interest accrued before death on final Form Interest accrued after death is reported on in year bond is redeemed or matures. 2) All interest (both before and after death) is reported on in year bond is redeemed, matures or an election is made to report income. Interest accrued before death is IRD. Alternatively, recipient of an inherited bond can elect to report interest annually. (Rev. Rul ) Form 706, Schedule B Final Form 1040 FMV of bonds, including interest accrued up to date of death, which may be IRD. Interest accrued up to date of death. Interest accrued after death. Note that the last Series E bonds matured in 2010 and the last Series H bonds matured in These bonds stopped paying interest at that time and any deferred interest should have been recognized on the 1040 in the year the bond matured. Form 706, Schedule B FMV of bonds as of date of death. No IRD. Social Security Final Form 1040 Payments cease at death; therefore, subject to reporting on final Form Standard Deduction Final Form 1040 Full amount allowed. No proration required. Wages Final Form 1040 Wages received before death. Form 706, Schedule F and Wages earned before death but received after death (IRD). 7.5% H Tax Year Small Business Quickfinder Handbook Replacement Page 1/2018

13 Determining the Midpoint of Each Quarter in a Short Tax Year Years consisting of anything other than four or eight months 1) Number of days in the short tax year... 1) 2) Number of days in each quarter (line 1 divided by four)... 2) 3) Number of days to midpoint (line 2 divided by two)... 3) 4) Starting on the first day of the year, add the number of days in each quarter (line 2) to determine the beginning and ending dates of each quarter. Then, find the midpoint of each quarter. If a midpoint of a quarter is on a day other than the first day or midpoint of a month, treat the property as placed in service or disposed of on the nearest preceding first day or midpoint of that month... 4) Example #1: Bismarck Inc., a calendar-year taxpayer, was incorporated on March 15. It has a short tax year of 91/2 months, ending on December 31. During December of its first year, it placed property in service for which it must use the mid-quarter convention. Because this is a short tax year of other than four or eight full calendar months, the tax year consists of 292 days (including 17 days in March). Each quarter is 73 days (292 days 4) and the midpoint of each quarter is the 37th day (73 2). The table below shows the quarters of the short year, the midpoint and the date that property is treated as placed in service in each quarter. Quarter Midpoint Date Placed in Service March 15 May 26 April 20 April 15 May 27 August 7 July 2 July 1 August 8 October 19 September 13 September 1 October 20 December 31 November 25 November 15 The last quarter of the short year begins on October 20, which is 73 days from December 31, the end of the tax year. Day 37 of the quarter is November 25. Since the midpoint of the quarter is not the first or the midpoint of November, the property is treated as placed in service in the middle of November. Computing Depreciation for Short Tax Year MACRS percentage tables cannot be used to determine depreciation for a short tax year. Depreciation for the first recovery year in the recovery period is computed by multiplying the taxpayer s basis in the property by the applicable depreciation rate. Depreciation for the first tax year is computed by multiplying the depreciation for a full first year by a fraction (that is, pro-rated). The numerator is the number of months (including parts of a month) the property is treated as in service during the tax year (applying the applicable convention), and the denominator is 12. When the half-year convention is used: 200% DB formula: 1 Midpoint Adjusted Basis 2 Life % DB formula for AMT purposes: Adjusted Basis 1 Midpoint 1.5 Life 12 Example #2: Bismarck Inc., with a short tax year beginning March 15 and ending on December 31, placed in service on March 16 an item of five-year property with a basis of $100. This is the only property the corporation placed in service during the short tax year. The depreciation method for the property is the 200% DB method. The property is treated as placed in service on August 1. Bismarck Inc. is entitled to five months of depreciation for the short tax year that consists of 10 months. Short tax year depreciation is: $ = $17 For AMT Purposes. AMT depreciation allowed is: $ = $13 Example #3: Bismarck Inc., with a short tax year beginning March 15 and ending on December 31, placed in service on October 16 an item of five-year property with a basis of $100. This is the only property the corporation placed in service during the short tax year. The depreciation method for this property is the 200% DB method. The mid-quarter convention is used because the property was placed in service in the last three months of the tax year. The property is treated as placed in service on September 1. (See chart in Example #1.) Bismarck Inc. is entitled to four months of depreciation for the short tax year that consists of 10 months. Short tax year depreciation is: $ = $13 Computing Depreciation After Short Tax Year For the tax years after the first short year, depreciation may be computed using either the simplified method or the allocation method. The method chosen must be consistently used until the tax year that a switch to the MACRS SL method is required because it produces a larger depreciation deduction. Usually, both methods produce the same depreciation allowance. Simplified method. Depreciation for subsequent tax years is figured by multiplying the unrecovered basis of the property at the beginning of the tax year by the applicable depreciation rate. Example #4: The ABC Corporation had a short tax year starting August 1, 20X1 and ending December 31, 20X1. On August 9, 20X1, it placed in service seven-year property with a basis of $2, X1: First-year depreciation using the 200% DB method with the half-year convention calculation: $2, = $119 Depreciation for 20X2 (a full 12 months) calculation: 20X2: ($2,000 $ 119) = $ 1,881 $1,881 (1 7 2) = $ 537 Depreciation for 20X3 through 20X5 calculation: 20X3: ($2,000 $ 656) (1 7 2) = $384 20X4: ($2,000 $ 1,040) (1 7 2) = $274 20X5: ($2,000 $ 1,314) (1 7 2) = $196 Starting in the year 20X6, the method switches to SL depreciation. SL Depreciation = Adjusted Basis/Remaining Life. 20X6: ($2,000 $ 1,510) 33.5 months 12 = $176 20X7: ($2,000 $ 1,686) 21.5 months 12 = $175 In 20X8, the remaining depreciation equals the remaining basis. 20X8: $2,000 $1,861 = $139 Allocation method. Depreciation for each recovery year, or portion thereof, that falls within a tax year, whether the tax year is a 12-month year or a short tax year, is allocated to such tax year. For each recovery year included, depreciation attributable to such recovery year is multiplied by a fraction, the numerator of which is the number of months (including parts of months) of the recovery year that falls within the tax year and the denominator of which is 12. The allowable depreciation for the tax year is the sum of the depreciation figured for each recovery year. Straight-Line Method To avoid complex calculations in figuring depreciation for years after a short tax year, the taxpayer may elect under IRC Sec. 168(g)(7) to depreciate all assets placed in service during the short year under the SL method Tax Year Small Business Quickfinder Handbook J-5