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Turbo Tax Filing

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Turbo Tax Filing

Turbo tax filing Publication 538 - Main Content Table of Contents Accounting PeriodsCalendar Year Fiscal Year Short Tax Year Improper Tax Year Change in Tax Year Individuals Partnerships, S Corporations, and Personal Service Corporations (PSCs) Corporations (Other Than S Corporations and PSCs) Accounting MethodsSpecial methods. Turbo tax filing Hybrid method. Turbo tax filing Cash Method Accrual Method Inventories Change in Accounting Method How To Get Tax HelpLow Income Taxpayer Clinics (LITCs). Turbo tax filing Accounting Periods You must use a tax year to figure your taxable income. Turbo tax filing A tax year is an annual accounting period for keeping records and reporting income and expenses. Turbo tax filing An annual accounting period does not include a short tax year (discussed later). Turbo tax filing You can use the following tax years: A calendar year; or A fiscal year (including a 52-53-week tax year). Turbo tax filing Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. Turbo tax filing A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Turbo tax filing You cannot adopt a tax year by merely: Filing an application for an extension of time to file an income tax return; Filing an application for an employer identification number (Form SS-4); or Paying estimated taxes. Turbo tax filing This section discusses: A calendar year. Turbo tax filing A fiscal year (including a period of 52 or 53 weeks). Turbo tax filing A short tax year. Turbo tax filing An improper tax year. Turbo tax filing A change in tax year. Turbo tax filing Special situations that apply to individuals. Turbo tax filing Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation. Turbo tax filing Special situations that apply to corporations. Turbo tax filing Calendar Year A calendar year is 12 consecutive months beginning on January 1st and ending on December 31st. Turbo tax filing If you adopt the calendar year, you must maintain your books and records and report your income and expenses from January 1st through December 31st of each year. Turbo tax filing If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you obtain approval from the IRS to change it, or are otherwise allowed to change it without IRS approval. Turbo tax filing See Change in Tax Year, later. Turbo tax filing Generally, anyone can adopt the calendar year. Turbo tax filing However, you must adopt the calendar year if: You keep no books or records; You have no annual accounting period; Your present tax year does not qualify as a fiscal year; or You are required to use a calendar year by a provision in the Internal Revenue Code or the Income Tax Regulations. Turbo tax filing Fiscal Year A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. Turbo tax filing If you are allowed to adopt a fiscal year, you must consistently maintain your books and records and report your income and expenses using the time period adopted. Turbo tax filing 52-53-Week Tax Year You can elect to use a 52-53-week tax year if you keep your books and records and report your income and expenses on that basis. Turbo tax filing If you make this election, your 52-53-week tax year must always end on the same day of the week. Turbo tax filing Your 52-53-week tax year must always end on: Whatever date this same day of the week last occurs in a calendar month, or Whatever date this same day of the week falls that is nearest to the last day of the calendar month. Turbo tax filing For example, if you elect a tax year that always ends on the last Monday in March, your 2012 tax year will end on March 25, 2013. Turbo tax filing Election. Turbo tax filing   To make the election for the 52-53-week tax year, attach a statement with the following information to your tax return. Turbo tax filing The month in which the new 52-53-week tax year ends. Turbo tax filing The day of the week on which the tax year always ends. Turbo tax filing The date the tax year ends. Turbo tax filing It can be either of the following dates on which the chosen day: Last occurs in the month in (1), above, or Occurs nearest to the last day of the month in (1), above. Turbo tax filing   When you figure depreciation or amortization, a 52-53-week tax year is generally considered a year of 12 calendar months. Turbo tax filing   To determine an effective date (or apply provisions of any law) expressed in terms of tax years beginning, including, or ending on the first or last day of a specified calendar month, a 52-53-week tax year is considered to: Begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week tax year, and End on the last day of the calendar month ending nearest to the last day of the 52-53-week tax year. Turbo tax filing Example. Turbo tax filing Assume a tax provision applies to tax years beginning on or after July 1, 2012, which happens to be a Sunday. Turbo tax filing For this purpose, a 52-53-week tax year that begins on the last Tuesday of June, which falls on June 26, 2012, is treated as beginning on July 1, 2012. Turbo tax filing Short Tax Year A short tax year is a tax year of less than 12 months. Turbo tax filing A short period tax return may be required when you (as a taxable entity): Are not in existence for an entire tax year, or Change your accounting period. Turbo tax filing Tax on a short period tax return is figured differently for each situation. Turbo tax filing Not in Existence Entire Year Even if a taxable entity was not in existence for the entire year, a tax return is required for the time it was in existence. Turbo tax filing Requirements for filing the return and figuring the tax are generally the same as the requirements for a return for a full tax year (12 months) ending on the last day of the short tax year. Turbo tax filing Example 1. Turbo tax filing XYZ Corporation was organized on July 1, 2012. Turbo tax filing It elected the calendar year as its tax year. Turbo tax filing Therefore, its first tax return was due March 15, 2013. Turbo tax filing This short period return will cover the period from July 1, 2012, through December 31, 2012. Turbo tax filing Example 2. Turbo tax filing A calendar year corporation dissolved on July 23, 2012. Turbo tax filing Its final return is due by October 15, 2012. Turbo tax filing It will cover the short period from January 1, 2012, through July 23, 2012. Turbo tax filing Death of individual. Turbo tax filing   When an individual dies, a tax return must be filed for the decedent by the 15th day of the 4th month after the close of the individual's regular tax year. Turbo tax filing The decedent's final return will be a short period tax return that begins on January 1st, and ends on the date of death. Turbo tax filing In the case of a decedent who dies on December 31st, the last day of the regular tax year, a full calendar-year tax return is required. Turbo tax filing Example. Turbo tax filing   Agnes Green was a single, calendar year taxpayer. Turbo tax filing She died on March 6, 2012. Turbo tax filing Her final income tax return must be filed by April 15, 2013. Turbo tax filing It will cover the short period from January 1, 2012, to March 6, 2012. Turbo tax filing Figuring Tax for Short Year If the IRS approves a change in your tax year or you are required to change your tax year, you must figure the tax and file your return for the short tax period. Turbo tax filing The short tax period begins on the first day after the close of your old tax year and ends on the day before the first day of your new tax year. Turbo tax filing Figure tax for a short year under the general rule, explained below. Turbo tax filing You may then be able to use a relief procedure, explained later, and claim a refund of part of the tax you paid. Turbo tax filing General rule. Turbo tax filing   Income tax for a short tax year must be annualized. Turbo tax filing However, self-employment tax is figured on the actual self-employment income for the short period. Turbo tax filing Individuals. Turbo tax filing   An individual must figure income tax for the short tax year as follows. Turbo tax filing Determine your adjusted gross income (AGI) for the short tax year and then subtract your actual itemized deductions for the short tax year. Turbo tax filing You must itemize deductions when you file a short period tax return. Turbo tax filing Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12. Turbo tax filing Subtract the amount in (2) from the amount in (1). Turbo tax filing The result is your modified taxable income. Turbo tax filing Multiply the modified taxable income in (3) by 12, then divide the result by the number of months in the short tax year. Turbo tax filing The result is your annualized income. Turbo tax filing Figure the total tax on your annualized income using the appropriate tax rate schedule. Turbo tax filing Multiply the total tax by the number of months in the short tax year and divide the result by 12. Turbo tax filing The result is your tax for the short tax year. Turbo tax filing Relief procedure. Turbo tax filing   Individuals and corporations can use a relief procedure to figure the tax for the short tax year. Turbo tax filing It may result in less tax. Turbo tax filing Under this procedure, the tax is figured by two separate methods. Turbo tax filing If the tax figured under both methods is less than the tax figured under the general rule, you can file a claim for a refund of part of the tax you paid. Turbo tax filing For more information, see section 443(b)(2) of the Internal Revenue Code. Turbo tax filing Alternative minimum tax. Turbo tax filing   To figure the alternative minimum tax (AMT) due for a short tax year: Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by completing the following steps. Turbo tax filing Multiply the AMTI by 12. Turbo tax filing Divide the result by the number of months in the short tax year. Turbo tax filing Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1) of the Internal Revenue Code. Turbo tax filing The result is the annualized AMT. Turbo tax filing Multiply the annualized AMT by the number of months in the short tax year and divide the result by 12. Turbo tax filing   For information on the AMT for individuals, see the Instructions for Form 6251, Alternative Minimum Tax–Individuals. Turbo tax filing For information on the AMT for corporations, see the Instructions to Form 4626, Alternative Minimum Tax–Corporations. Turbo tax filing Tax withheld from wages. Turbo tax filing   You can claim a credit against your income tax liability for federal income tax withheld from your wages. Turbo tax filing Federal income tax is withheld on a calendar year basis. Turbo tax filing The amount withheld in any calendar year is allowed as a credit for the tax year beginning in the calendar year. Turbo tax filing Improper Tax Year Taxpayers that have adopted an improper tax year must change to a proper tax year. Turbo tax filing For example, if a taxpayer began business on March 15 and adopted a tax year ending on March 14 (a period of exactly 12 months), this would be an improper tax year. Turbo tax filing See Accounting Periods, earlier, for a description of permissible tax years. Turbo tax filing To change to a proper tax year, you must do one of the following. Turbo tax filing If you are requesting a change to a calendar tax year, file an amended income tax return based on a calendar tax year that corrects the most recently filed tax return that was filed on the basis of an improper tax year. Turbo tax filing Attach a completed Form 1128 to the amended tax return. Turbo tax filing Write “FILED UNDER REV. Turbo tax filing PROC. Turbo tax filing 85-15” at the top of Form 1128 and file the forms with the Internal Revenue Service Center where you filed your original return. Turbo tax filing If you are requesting a change to a fiscal tax year, file Form 1128 in accordance with the form instructions to request IRS approval for the change. Turbo tax filing Change in Tax Year Generally, you must file Form 1128 to request IRS approval to change your tax year. Turbo tax filing See the Instructions for Form 1128 for exceptions. Turbo tax filing If you qualify for an automatic approval request, a user fee is not required. Turbo tax filing Individuals Generally, individuals must adopt the calendar year as their tax year. Turbo tax filing An individual can adopt a fiscal year provided that the individual maintains his or her books and records on the basis of the adopted fiscal year. Turbo tax filing Partnerships, S Corporations, and Personal Service Corporations (PSCs) Generally, partnerships, S corporations (including electing S corporations), and PSCs must use a required tax year. Turbo tax filing A required tax year is a tax year that is required under the Internal Revenue Code and Income Tax Regulations. Turbo tax filing The entity does not have to use the required tax year if it receives IRS approval to use another permitted tax year or makes an election under section 444 of the Internal Revenue Code (discussed later). Turbo tax filing The following discussions provide the rules for partnerships, S corporations, and PSCs. Turbo tax filing Partnership A partnership must conform its tax year to its partners' tax years unless any of the following apply. Turbo tax filing The partnership makes an election under section 444 of the Internal Revenue Code to have a tax year other than a required tax year by filing Form 8716. Turbo tax filing The partnership elects to use a 52-53-week tax year that ends with reference to either its required tax year or a tax year elected under section 444. Turbo tax filing The partnership can establish a business purpose for a different tax year. Turbo tax filing The rules for the required tax year for partnerships are as follows. Turbo tax filing If one or more partners having the same tax year own a majority interest (more than 50%) in partnership profits and capital, the partnership must use the tax year of those partners. Turbo tax filing If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. Turbo tax filing A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. Turbo tax filing If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally must use a tax year that results in the least aggregate deferral of income to the partners. Turbo tax filing If a partnership changes to a required tax year because of these rules, it can get automatic approval by filing Form 1128. Turbo tax filing Least aggregate deferral of income. Turbo tax filing   The tax year that results in the least aggregate deferral of income is determined as follows. Turbo tax filing Figure the number of months of deferral for each partner using one partner's tax year. Turbo tax filing Find the months of deferral by counting the months from the end of that tax year forward to the end of each other partner's tax year. Turbo tax filing Multiply each partner's months of deferral figured in step (1) by that partner's share of interest in the partnership profits for the year used in step (1). Turbo tax filing Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1). Turbo tax filing Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years. Turbo tax filing   The partner's tax year that results in the lowest aggregate (total) number is the tax year that must be used by the partnership. Turbo tax filing If the calculation results in more than one tax year qualifying as the tax year with the least aggregate deferral, the partnership can choose any one of those tax years as its tax year. Turbo tax filing However, if one of the tax years that qualifies is the partnership's existing tax year, the partnership must retain that tax year. Turbo tax filing Example. Turbo tax filing A and B each have a 50% interest in partnership P, which uses a fiscal year ending June 30. Turbo tax filing A uses the calendar year and B uses a fiscal year ending November 30. Turbo tax filing P must change its tax year to a fiscal year ending November 30 because this results in the least aggregate deferral of income to the partners, as shown in the following table. Turbo tax filing Year End 12/31: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Turbo tax filing 5 -0- -0- B 11/30 0. Turbo tax filing 5 11 5. Turbo tax filing 5 Total Deferral 5. Turbo tax filing 5 Year End 11/30: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Turbo tax filing 5 1 0. Turbo tax filing 5 B 11/30 0. Turbo tax filing 5 -0- -0- Total Deferral 0. Turbo tax filing 5 When determination is made. Turbo tax filing   The determination of the tax year under the least aggregate deferral rules must generally be made at the beginning of the partnership's current tax year. Turbo tax filing However, the IRS can require the partnership to use another day or period that will more accurately reflect the ownership of the partnership. Turbo tax filing This could occur, for example, if a partnership interest was transferred for the purpose of qualifying for a particular tax year. Turbo tax filing Short period return. Turbo tax filing   When a partnership changes its tax year, a short period return must be filed. Turbo tax filing The short period return covers the months between the end of the partnership's prior tax year and the beginning of its new tax year. Turbo tax filing   If a partnership changes to the tax year resulting in the least aggregate deferral, it must file a Form 1128 with the short period return showing the computations used to determine that tax year. Turbo tax filing The short period return must indicate at the top of page 1, “FILED UNDER SECTION 1. Turbo tax filing 706-1. Turbo tax filing ” More information. Turbo tax filing   For more information about changing a partnership's tax year, and information about ruling requests, see the Instructions for Form 1128. Turbo tax filing S Corporation All S corporations, regardless of when they became an S corporation, must use a permitted tax year. Turbo tax filing A permitted tax year is any of the following. Turbo tax filing The calendar year. Turbo tax filing A tax year elected under section 444 of the Internal Revenue Code. Turbo tax filing See Section 444 Election, below for details. Turbo tax filing A 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Turbo tax filing Any other tax year for which the corporation establishes a business purpose. Turbo tax filing If an electing S corporation wishes to adopt a tax year other than a calendar year, it must request IRS approval using Form 2553, instead of filing Form 1128. Turbo tax filing For information about changing an S corporation's tax year and information about ruling requests, see the Instructions for Form 1128. Turbo tax filing Personal Service Corporation (PSC) A PSC must use a calendar tax year unless any of the following apply. Turbo tax filing The corporation makes an election under section 444 of the Internal Revenue Code. Turbo tax filing See Section 444 Election, below for details. Turbo tax filing The corporation elects to use a 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Turbo tax filing The corporation establishes a business purpose for a fiscal year. Turbo tax filing See the Instructions for Form 1120 for general information about PSCs. Turbo tax filing For information on adopting or changing tax years for PSCs and information about ruling requests, see the Instructions for Form 1128. Turbo tax filing Section 444 Election A partnership, S corporation, electing S corporation, or PSC can elect under section 444 of the Internal Revenue Code to use a tax year other than its required tax year. Turbo tax filing Certain restrictions apply to the election. Turbo tax filing A partnership or an S corporation that makes a section 444 election must make certain required payments and a PSC must make certain distributions (discussed later). Turbo tax filing The section 444 election does not apply to any partnership, S corporation, or PSC that establishes a business purpose for a different period, explained later. Turbo tax filing A partnership, S corporation, or PSC can make a section 444 election if it meets all the following requirements. Turbo tax filing It is not a member of a tiered structure (defined in section 1. Turbo tax filing 444-2T of the regulations). Turbo tax filing It has not previously had a section 444 election in effect. Turbo tax filing It elects a year that meets the deferral period requirement. Turbo tax filing Deferral period. Turbo tax filing   The determination of the deferral period depends on whether the partnership, S corporation, or PSC is retaining its tax year or adopting or changing its tax year with a section 444 election. Turbo tax filing Retaining tax year. Turbo tax filing   Generally, a partnership, S corporation, or PSC can make a section 444 election to retain its tax year only if the deferral period of the new tax year is 3 months or less. Turbo tax filing This deferral period is the number of months between the beginning of the retained year and the close of the first required tax year. Turbo tax filing Adopting or changing tax year. Turbo tax filing   If the partnership, S corporation, or PSC is adopting or changing to a tax year other than its required year, the deferral period is the number of months from the end of the new tax year to the end of the required tax year. Turbo tax filing The IRS will allow a section 444 election only if the deferral period of the new tax year is less than the shorter of: Three months, or The deferral period of the tax year being changed. Turbo tax filing This is the tax year immediately preceding the year for which the partnership, S corporation, or PSC wishes to make the section 444 election. Turbo tax filing If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero. Turbo tax filing Example 1. Turbo tax filing BD Partnership uses a calendar year, which is also its required tax year. Turbo tax filing BD cannot make a section 444 election because the deferral period is zero. Turbo tax filing Example 2. Turbo tax filing E, a newly formed partnership, began operations on December 1. Turbo tax filing E is owned by calendar year partners. Turbo tax filing E wants to make a section 444 election to adopt a September 30 tax year. Turbo tax filing E's deferral period for the tax year beginning December 1 is 3 months, the number of months between September 30 and December 31. Turbo tax filing Making the election. Turbo tax filing   Make a section 444 election by filing Form 8716 with the Internal Revenue Service Center where the entity will file its tax return. Turbo tax filing Form 8716 must be filed by the earlier of: The due date (not including extensions) of the income tax return for the tax year resulting from the section 444 election, or The 15th day of the 6th month of the tax year for which the election will be effective. Turbo tax filing For this purpose, count the month in which the tax year begins, even if it begins after the first day of that month. Turbo tax filing Note. Turbo tax filing If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. Turbo tax filing   Attach a copy of Form 8716 to Form 1065, Form 1120S, or Form 1120 for the first tax year for which the election is made. Turbo tax filing Example 1. Turbo tax filing AB, a partnership, begins operations on September 13, 2012, and is qualified to make a section 444 election to use a September 30 tax year for its tax year beginning September 13, 2012. Turbo tax filing AB must file Form 8716 by January 15, 2013, which is the due date of the partnership's tax return for the period from September 13, 2012, to September 30, 2012. Turbo tax filing Example 2. Turbo tax filing The facts are the same as in Example 1 except that AB begins operations on October 21, 2012. Turbo tax filing AB must file Form 8716 by March 17, 2013. Turbo tax filing Example 3. Turbo tax filing B is a corporation that first becomes a PSC for its tax year beginning September 1, 2012. Turbo tax filing B qualifies to make a section 444 election to use a September 30 tax year for its tax year beginning September 1, 2012. Turbo tax filing B must file Form 8716 by December 17, 2012, the due date of the income tax return for the short period from September 1, 2012, to September 30, 2012. Turbo tax filing Note. Turbo tax filing The due dates in Examples 2 and 3 are adjusted because the dates fall on a Saturday, Sunday or legal holiday. Turbo tax filing Extension of time for filing. Turbo tax filing   There is an automatic extension of 12 months to make this election. Turbo tax filing See the Form 8716 instructions for more information. Turbo tax filing Terminating the election. Turbo tax filing   The section 444 election remains in effect until it is terminated. Turbo tax filing If the election is terminated, another section 444 election cannot be made for any tax year. Turbo tax filing   The election ends when any of the following applies to the partnership, S corporation, or PSC. Turbo tax filing The entity changes to its required tax year. Turbo tax filing The entity liquidates. Turbo tax filing The entity becomes a member of a tiered structure. Turbo tax filing The IRS determines that the entity willfully failed to comply with the required payments or distributions. Turbo tax filing   The election will also end if either of the following events occur. Turbo tax filing An S corporation's S election is terminated. Turbo tax filing However, if the S corporation immediately becomes a PSC, the PSC can continue the section 444 election of the S corporation. Turbo tax filing A PSC ceases to be a PSC. Turbo tax filing If the PSC elects to be an S corporation, the S corporation can continue the election of the PSC. Turbo tax filing Required payment for partnership or S corporation. Turbo tax filing   A partnership or an S corporation must make a required payment for any tax year: The section 444 election is in effect. Turbo tax filing The required payment for that year (or any preceding tax year) is more than $500. Turbo tax filing    This payment represents the value of the tax deferral the owners receive by using a tax year different from the required tax year. Turbo tax filing   Form 8752, Required Payment or Refund Under Section 7519, must be filed each year the section 444 election is in effect, even if no payment is due. Turbo tax filing If the required payment is more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is filed. Turbo tax filing If the required payment is $500 or less and no payment was required in a prior year, Form 8752 must be filed showing a zero amount. Turbo tax filing Applicable election year. Turbo tax filing   Any tax year a section 444 election is in effect, including the first year, is called an applicable election year. Turbo tax filing Form 8752 must be filed and the required payment made (or zero amount reported) by May 15th of the calendar year following the calendar year in which the applicable election year begins. Turbo tax filing Required distribution for PSC. Turbo tax filing   A PSC with a section 444 election in effect must distribute certain amounts to employee-owners by December 31 of each applicable year. Turbo tax filing If it fails to make these distributions, it may be required to defer certain deductions for amounts paid to owner-employees. Turbo tax filing The amount deferred is treated as paid or incurred in the following tax year. Turbo tax filing   For information on the minimum distribution, see the instructions for Part I of Schedule H (Form 1120), Section 280H Limitations for a Personal Service Corporation (PSC). Turbo tax filing Back-up election. Turbo tax filing   A partnership, S corporation, or PSC can file a back-up section 444 election if it requests (or plans to request) permission to use a business purpose tax year, discussed later. Turbo tax filing If the request is denied, the back-up section 444 election must be activated (if the partnership, S corporation, or PSC otherwise qualifies). Turbo tax filing Making back-up election. Turbo tax filing   The general rules for making a section 444 election, as discussed earlier, apply. Turbo tax filing When filing Form 8716, type or print “BACK-UP ELECTION” at the top of the form. Turbo tax filing However, if Form 8716 is filed on or after the date Form 1128 (or Form 2553) is filed, type or print “FORM 1128 (or FORM 2553) BACK-UP ELECTION” at the top of Form 8716. Turbo tax filing Activating election. Turbo tax filing   A partnership or S corporation activates its back-up election by filing the return required and making the required payment with Form 8752. Turbo tax filing The due date for filing Form 8752 and making the payment is the later of the following dates. Turbo tax filing May 15 of the calendar year following the calendar year in which the applicable election year begins. Turbo tax filing 60 days after the partnership or S corporation has been notified by the IRS that the business year request has been denied. Turbo tax filing   A PSC activates its back-up election by filing Form 8716 with its original or amended income tax return for the tax year in which the election is first effective and printing on the top of the income tax return, “ACTIVATING BACK-UP ELECTION. Turbo tax filing ” 52-53-Week Tax Year A partnership, S corporation, or PSC can use a tax year other than its required tax year if it elects a 52-53-week tax year (discussed earlier) that ends with reference to either its required tax year or a tax year elected under section 444 (discussed earlier). Turbo tax filing A newly formed partnership, S corporation, or PSC can adopt a 52-53-week tax year ending with reference to either its required tax year or a tax year elected under section 444 without IRS approval. Turbo tax filing However, if the entity wishes to change to a 52-53-week tax year or change from a 52-53-week tax year that references a particular month to a non-52-53-week tax year that ends on the last day of that month, it must request IRS approval by filing Form 1128. Turbo tax filing Business Purpose Tax Year A partnership, S corporation, or PSC establishes the business purpose for a tax year by filing Form 1128. Turbo tax filing See the Instructions for Form 1128 for details. Turbo tax filing Corporations (Other Than S Corporations and PSCs) A new corporation establishes its tax year when it files its first tax return. Turbo tax filing A newly reactivated corporation that has been inactive for a number of years is treated as a new taxpayer for the purpose of adopting a tax year. Turbo tax filing An S corporation or a PSC must use the required tax year rules, discussed earlier, to establish a tax year. Turbo tax filing Generally, a corporation that wants to change its tax year must obtain approval from the IRS under either the: (a) automatic approval procedures; or (b) ruling request procedures. Turbo tax filing See the Instructions for Form 1128 for details. Turbo tax filing Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on your tax return. Turbo tax filing Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. Turbo tax filing You choose an accounting method when you file your first tax return. Turbo tax filing If you later want to change your accounting method, you must get IRS approval. Turbo tax filing See Change in Accounting Method, later. Turbo tax filing No single accounting method is required of all taxpayers. Turbo tax filing You must use a system that clearly reflects your income and expenses and you must maintain records that will enable you to file a correct return. Turbo tax filing In addition to your permanent accounting books, you must keep any other records necessary to support the entries on your books and tax returns. Turbo tax filing You must use the same accounting method from year to year. Turbo tax filing An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. Turbo tax filing If you do not regularly use an accounting method that clearly reflects your income, your income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. Turbo tax filing Methods you can use. Turbo tax filing   In general, you can compute your taxable income under any of the following accounting methods. Turbo tax filing Cash method. Turbo tax filing Accrual method. Turbo tax filing Special methods of accounting for certain items of income and expenses. Turbo tax filing A hybrid method which combines elements of two or more of the above accounting methods. Turbo tax filing The cash and accrual methods of accounting are explained later. Turbo tax filing Special methods. Turbo tax filing   This publication does not discuss special methods of accounting for certain items of income or expenses. Turbo tax filing For information on reporting income using one of the long-term contract methods, see section 460 of the Internal Revenue Code and the related regulations. Turbo tax filing The following publications also discuss special methods of reporting income or expenses. Turbo tax filing Publication 225, Farmer's Tax Guide. Turbo tax filing Publication 535, Business Expenses. Turbo tax filing Publication 537, Installment Sales. Turbo tax filing Publication 946, How To Depreciate Property. Turbo tax filing Hybrid method. Turbo tax filing   Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. Turbo tax filing However, the following restrictions apply. Turbo tax filing If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. Turbo tax filing See Exceptions under Inventories, later. Turbo tax filing Generally, you can use the cash method for all other items of income and expenses. Turbo tax filing See Inventories, later. Turbo tax filing If you use the cash method for reporting your income, you must use the cash method for reporting your expenses. Turbo tax filing If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Turbo tax filing Any combination that includes the cash method is treated as the cash method for purposes of section 448 of the Internal Revenue Code. Turbo tax filing Business and personal items. Turbo tax filing   You can account for business and personal items using different accounting methods. Turbo tax filing For example, you can determine your business income and expenses under an accrual method, even if you use the cash method to figure personal items. Turbo tax filing Two or more businesses. Turbo tax filing   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Turbo tax filing No business is separate and distinct, unless a complete and separate set of books and records is maintained for each business. Turbo tax filing Note. Turbo tax filing If you use different accounting methods to create or shift profits or losses between businesses (for example, through inventory adjustments, sales, purchases, or expenses) so that income is not clearly reflected, the businesses will not be considered separate and distinct. Turbo tax filing Cash Method Most individuals and many small businesses use the cash method of accounting. Turbo tax filing Generally, if you produce, purchase, or sell merchandise, you must keep an inventory and use an accrual method for sales and purchases of merchandise. Turbo tax filing See Inventories, later, for exceptions to this rule. Turbo tax filing Income Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. Turbo tax filing If you receive property and services, you must include their fair market value (FMV) in income. Turbo tax filing Constructive receipt. Turbo tax filing   Income is constructively received when an amount is credited to your account or made available to you without restriction. Turbo tax filing You need not have possession of it. Turbo tax filing If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Turbo tax filing Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. Turbo tax filing Example. Turbo tax filing You are a calendar year taxpayer. Turbo tax filing Your bank credited, and made available, interest to your bank account in December 2012. Turbo tax filing You did not withdraw it or enter it into your books until 2013. Turbo tax filing You must include the amount in gross income for 2012, the year you constructively received it. Turbo tax filing You cannot hold checks or postpone taking possession of similar property from one tax year to another to postpone paying tax on the income. Turbo tax filing You must report the income in the year the property is received or made available to you without restriction. Turbo tax filing Expenses Under the cash method, generally, you deduct expenses in the tax year in which you actually pay them. Turbo tax filing This includes business expenses for which you contest liability. Turbo tax filing However, you may not be able to deduct an expense paid in advance. Turbo tax filing Instead, you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. Turbo tax filing Expense paid in advance. Turbo tax filing   An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Turbo tax filing   Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Turbo tax filing 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Turbo tax filing   If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must obtain approval from the IRS before using the general rule and/or the 12-month rule. Turbo tax filing See Change in Accounting Method, later. Turbo tax filing Example 1. Turbo tax filing You are a calendar year taxpayer and pay $3,000 in 2012 for a business insurance policy that is effective for three years (36 months), beginning on July 1, 2012. Turbo tax filing The general rule that an expense paid in advance is deductible only in the year to which it applies is applicable to this payment because the payment does not qualify for the 12-month rule. Turbo tax filing Therefore, only $500 (6/36 x $3,000) is deductible in 2012, $1,000 (12/36 x $3,000) is deductible in 2013, $1,000 (12/36 x $3,000) is deductible in 2014, and the remaining $500 is deductible in 2015. Turbo tax filing Example 2. Turbo tax filing You are a calendar year taxpayer and pay $10,000 on July 1, 2012, for a business insurance policy that is effective for only one year beginning on July 1, 2012. Turbo tax filing The 12-month rule applies. Turbo tax filing Therefore, the full $10,000 is deductible in 2012. Turbo tax filing Excluded Entities The following entities cannot use the cash method, including any combination of methods that includes the cash method. Turbo tax filing (See Special rules for farming businesses, later. Turbo tax filing ) A corporation (other than an S corporation) with average annual gross receipts exceeding $5 million. Turbo tax filing See Gross receipts test, below. Turbo tax filing A partnership with a corporation (other than an S corporation) as a partner, and with the partnership having average annual gross receipts exceeding $5 million. Turbo tax filing See Gross receipts test, below. Turbo tax filing A tax shelter. Turbo tax filing Exceptions The following entities are not prohibited from using the cash method of accounting. Turbo tax filing Any corporation or partnership, other than a tax shelter, that meets the gross receipts test for all tax years after 1985. Turbo tax filing A qualified personal service corporation (PSC). Turbo tax filing Gross receipts test. Turbo tax filing   A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method. Turbo tax filing A corporation or a partnership meets the test if, for each prior tax year beginning after 1985, its average annual gross receipts are $5 million or less. Turbo tax filing    An entity's average annual gross receipts for a prior tax year is determined by: Adding the gross receipts for that tax year and the 2 preceding tax years; and Dividing the total by 3. Turbo tax filing See Gross receipts test for qualifying taxpayers, for more information. Turbo tax filing Generally, a partnership applies the test at the partnership level. Turbo tax filing Gross receipts for a short tax year are annualized. Turbo tax filing Aggregation rules. Turbo tax filing   Organizations that are members of an affiliated service group or a controlled group of corporations treated as a single employer for tax purposes are required to aggregate their gross receipts to determine whether the gross receipts test is met. Turbo tax filing Change to accrual method. Turbo tax filing   A corporation or partnership that fails to meet the gross receipts test for any tax year is prohibited from using the cash method and must change to an accrual method of accounting, effective for the tax year in which the entity fails to meet this test. Turbo tax filing Special rules for farming businesses. Turbo tax filing   Generally, a taxpayer engaged in the trade or business of farming is allowed to use the cash method for its farming business. Turbo tax filing However, certain corporations (other than S corporations) and partnerships that have a partner that is a corporation must use an accrual method for their farming business. Turbo tax filing For this purpose, farming does not include the operation of a nursery or sod farm or the raising or harvesting of trees (other than fruit and nut trees). Turbo tax filing   There is an exception to the requirement to use an accrual method for corporations with gross receipts of $1 million or less for each prior tax year after 1975. Turbo tax filing For family corporations engaged in farming, the exception applies if gross receipts were $25 million or less for each prior tax year after 1985. Turbo tax filing See chapter 2 of Publication 225, Farmer's Tax Guide, for more information. Turbo tax filing Qualified PSC. Turbo tax filing   A PSC that meets the following function and ownership tests can use the cash method. Turbo tax filing Function test. Turbo tax filing   A corporation meets the function test if at least 95% of its activities are in the performance of services in the fields of health, veterinary services, law, engineering (including surveying and mapping), architecture, accounting, actuarial science, performing arts, or consulting. Turbo tax filing Ownership test. Turbo tax filing   A corporation meets the ownership test if at least 95% of its stock is owned, directly or indirectly, at all times during the year by one or more of the following. Turbo tax filing Employees performing services for the corporation in a field qualifying under the function test. Turbo tax filing Retired employees who had performed services in those fields. Turbo tax filing The estate of an employee described in (1) or (2). Turbo tax filing Any other person who acquired the stock by reason of the death of an employee referred to in (1) or (2), but only for the 2-year period beginning on the date of death. Turbo tax filing   Indirect ownership is generally taken into account if the stock is owned indirectly through one or more partnerships, S corporations, or qualified PSCs. Turbo tax filing Stock owned by one of these entities is considered owned by the entity's owners in proportion to their ownership interest in that entity. Turbo tax filing Other forms of indirect stock ownership, such as stock owned by family members, are generally not considered when determining if the ownership test is met. Turbo tax filing   For purposes of the ownership test, a person is not considered an employee of a corporation unless that person performs more than minimal services for the corporation. Turbo tax filing Change to accrual method. Turbo tax filing   A corporation that fails to meet the function test for any tax year; or fails to meet the ownership test at any time during any tax year must change to an accrual method of accounting, effective for the year in which the corporation fails to meet either test. Turbo tax filing A corporation that fails to meet the function test or the ownership test is not treated as a qualified PSC for any part of that tax year. Turbo tax filing Accrual Method Under the accrual method of accounting, generally you report income in the year it is earned and deduct or capitalize expenses in the year incurred. Turbo tax filing The purpose of an accrual method of accounting is to match income and expenses in the correct year. Turbo tax filing Income Generally, you include an amount in gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. Turbo tax filing Under this rule, you report an amount in your gross income on the earliest of the following dates. Turbo tax filing When you receive payment. Turbo tax filing When the income amount is due to you. Turbo tax filing When you earn the income. Turbo tax filing When title has passed. Turbo tax filing Estimated income. Turbo tax filing   If you include a reasonably estimated amount in gross income and later determine the exact amount is different, take the difference into account in the tax year you make that determination. Turbo tax filing Change in payment schedule. Turbo tax filing   If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive payments at a reduced rate. Turbo tax filing Continue this procedure until you complete the services, then account for the difference. Turbo tax filing Advance Payment for Services Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. Turbo tax filing However, if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance payment in income until the next tax year. Turbo tax filing However, you cannot postpone including any payment beyond that tax year. Turbo tax filing Service agreement. Turbo tax filing   You can postpone reporting income from an advance payment you receive for a service agreement on property you sell, lease, build, install, or construct. Turbo tax filing This includes an agreement providing for incidental replacement of parts or materials. Turbo tax filing However, this applies only if you offer the property without a service agreement in the normal course of business. Turbo tax filing Postponement not allowed. Turbo tax filing   Generally, one cannot postpone including an advance payment in income for services if either of the following applies. Turbo tax filing You are to perform any part of the service after the end of the tax year immediately following the year you receive the advance payment. Turbo tax filing You are to perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year you receive the advance payment. Turbo tax filing Examples. Turbo tax filing   In each of the following examples, assume the tax year is a calendar year and that the accrual method of accounting is used. Turbo tax filing Example 1. Turbo tax filing You manufacture, sell, and service computers. Turbo tax filing You received payment in 2012 for a one-year contingent service contract on a computer you sold. Turbo tax filing You can postpone including in income the part of the payment you did not earn in 2012 if, in the normal course of your business, you offer computers for sale without a contingent service contract. Turbo tax filing Example 2. Turbo tax filing You are in the television repair business. Turbo tax filing You received payments in 2012 for one-year contracts under which you agree to repair or replace certain parts that fail to function properly in television sets manufactured and sold by unrelated parties. Turbo tax filing You include the payments in gross income as you earn them. Turbo tax filing Example 3. Turbo tax filing You own a dance studio. Turbo tax filing On October 1, 2012, you receive payment for a one-year contract for 48 one-hour lessons beginning on that date. Turbo tax filing You give eight lessons in 2012. Turbo tax filing Under this method of including advance payments, you must include one-sixth (8/48) of the payment in income for 2012, and five-sixths (40/48) of the payment in 2013, even if you do not give all the lessons by the end of 2013. Turbo tax filing Example 4. Turbo tax filing Assume the same facts as in Example 3, except the payment is for a two-year contract for 96 lessons. Turbo tax filing You must include the entire payment in income in 2012 since part of the services may be performed after the following year. Turbo tax filing Guarantee or warranty. Turbo tax filing   Generally, you cannot postpone reporting income you receive under a guarantee or warranty contract. Turbo tax filing Prepaid rent. Turbo tax filing   You cannot postpone reporting income from prepaid rent. Turbo tax filing Prepaid rent does not include payment for the use of a room or other space when significant service is also provided for the occupant. Turbo tax filing You provide significant service when you supply space in a hotel, boarding house, tourist home, motor court, motel, or apartment house that furnishes hotel services. Turbo tax filing Books and records. Turbo tax filing   Any advance payment you include in gross receipts on your tax return for the year you receive payment must not be less than the payment you include in income for financial reports under the method of accounting used for those reports. Turbo tax filing Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Turbo tax filing IRS approval. Turbo tax filing   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payment for services. Turbo tax filing Advance Payment for Sales Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods held primarily for sale to customers in the ordinary course of your trade or business. Turbo tax filing However, the rules do not apply to a payment (or part of a payment) for services that are not an integral part of the main activities covered under the agreement. Turbo tax filing An agreement includes a gift certificate that can be redeemed for goods. Turbo tax filing Amounts due and payable are considered received. Turbo tax filing How to report payments. Turbo tax filing   Generally, include an advance payment in income in the year in which you receive it. Turbo tax filing However, you can use the alternative method, discussed next. Turbo tax filing Alternative method of reporting. Turbo tax filing   Under the alternative method, generally include an advance payment in income in the earlier tax year in which you: Include advance payments in gross receipts under the method of accounting you use for tax purposes, or Include any part of advance payments in income for financial reports under the method of accounting used for those reports. Turbo tax filing Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Turbo tax filing Example 1. Turbo tax filing You are a retailer. Turbo tax filing You use an accrual method of accounting and account for the sale of goods when you ship the goods. Turbo tax filing You use this method for both tax and financial reporting purposes. Turbo tax filing You can include advance payments in gross receipts for tax purposes in either: (a) the tax year in which you receive the payments; or (b) the tax year in which you ship the goods. Turbo tax filing However, see Exception for inventory goods, later. Turbo tax filing Example 2. Turbo tax filing You are a calendar year taxpayer. Turbo tax filing You manufacture household furniture and use an accrual method of accounting. Turbo tax filing Under this method, you accrue income for your financial reports when you ship the furniture. Turbo tax filing For tax purposes, you do not accrue income until the furniture has been delivered and accepted. Turbo tax filing In 2012, you received an advance payment of $8,000 for an order of furniture to be manufactured for a total price of $20,000. Turbo tax filing You shipped the furniture to the customer in December 2012, but it was not delivered and accepted until January 2013. Turbo tax filing For tax purposes, you include the $8,000 advance payment in gross income for 2012; and include the remaining $12,000 of the contract price in gross income for 2013. Turbo tax filing Information schedule. Turbo tax filing   If you use the alternative method of reporting advance payments, you must attach a statement with the following information to your tax return each year. Turbo tax filing Total advance payments received in the current tax year. Turbo tax filing Total advance payments received in earlier tax years and not included in income before the current tax year. Turbo tax filing Total payments received in earlier tax years included in income for the current tax year. Turbo tax filing Exception for inventory goods. Turbo tax filing   If you have an agreement to sell goods properly included in inventory, you can postpone including the advance payment in income until the end of the second tax year following the year you receive an advance payment if, on the last day of the tax year, you meet the following requirements. Turbo tax filing You account for the advance payment under the alternative method (discussed earlier). Turbo tax filing You have received a substantial advance payment on the agreement (discussed next). Turbo tax filing You have enough substantially similar goods on hand, or available through your normal source of supply, to satisfy the agreement. Turbo tax filing These rules also apply to an agreement, such as a gift certificate, that can be satisfied with goods that cannot be identified in the tax year you receive an advance payment. Turbo tax filing   If you meet these conditions, all advance payments you receive by the end of the second tax year, including payments received in prior years but not reported, must be included in income by the second tax year following the tax year of receipt of substantial advance payments. Turbo tax filing You must also deduct in that second year all actual or estimated costs for the goods required to satisfy the agreement. Turbo tax filing If you estimated the cost, you must take into account any difference between the estimate and the actual cost when the goods are delivered. Turbo tax filing Note. Turbo tax filing You must report any advance payments you receive after the second year in the year received. Turbo tax filing No further deferral is allowed. Turbo tax filing Substantial advance payments. Turbo tax filing   Under an agreement for a future sale, you have substantial advance payments if, by the end of the tax year, the total advance payments received during that year and preceding tax years are equal to or more than the total costs reasonably estimated to be includible in inventory because of the agreement. Turbo tax filing Example. Turbo tax filing You are a calendar year, accrual method taxpayer who accounts for advance payments under the alternative method. Turbo tax filing In 2008, you entered into a contract for the sale of goods properly includible in your inventory. Turbo tax filing The total contract price is $50,000 and you estimate that your total inventoriable costs for the goods will be $25,000. Turbo tax filing You receive the following advance payments under the contract. Turbo tax filing 2009 $17,500 2010 10,000 2011 7,500 2012 5,000 2013 5,000 2014 5,000 Total contract price $50,000   Your customer asked you to deliver the goods in 2015. Turbo tax filing In your 2010 closing inventory, you had on hand enough of the type of goods specified in the contract to satisfy the contract. Turbo tax filing Since the advance payments you had received by the end of 2010 were more than the costs you estimated, the payments are substantial advance payments. Turbo tax filing   For 2012, include in income all payments you received by the end of 2012, the second tax year following the tax year in which you received substantial advance payments. Turbo tax filing You must include $40,000 in sales for 2012 (the total amounts received from 2009 through 2012) and include in inventory the cost of the goods (or similar goods) on hand. Turbo tax filing If no such goods are on hand, then estimate the cost necessary to satisfy the contract. Turbo tax filing   No further deferral is allowed. Turbo tax filing You must include in gross income the advance payment you receive each remaining year of the contract. Turbo tax filing Take into account the difference between any estimated cost of goods sold and the actual cost when you deliver the goods in 2015. Turbo tax filing IRS approval. Turbo tax filing   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payments for sales. Turbo tax filing Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. Turbo tax filing The all-events test has been met. Turbo tax filing The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Turbo tax filing Economic performance has occurred. Turbo tax filing Economic Performance Generally, you cannot deduct or capitalize a business expense until economic performance occurs. Turbo tax filing If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. Turbo tax filing If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Turbo tax filing Example. Turbo tax filing You are a calendar year taxpayer. Turbo tax filing You buy office supplies in December 2012. Turbo tax filing You receive the supplies and the bill in December, but you pay the bill in January 2013. Turbo tax filing You can deduct the expense in 2012 because all events have occurred to fix the liability, the amount of the liability can be determined, and economic performance occurred in 2012. Turbo tax filing Your office supplies may qualify as a recurring item, discussed later. Turbo tax filing If so, you can deduct them in 2012, even if the supplies are not delivered until 2013 (when economic performance occurs). Turbo tax filing Workers' compensation and tort liability. Turbo tax filing   If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. Turbo tax filing If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments. Turbo tax filing Taxes. Turbo tax filing   Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. Turbo tax filing are paid. Turbo tax filing However, you can elect to treat taxes as a recurring item, discussed later. Turbo tax filing You can also elect to ratably accrue real estate taxes. Turbo tax filing See chapter 5 of Publication 535 for information about real estate taxes. Turbo tax filing Other liabilities. Turbo tax filing   Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts. Turbo tax filing Interest. Turbo tax filing   Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made. Turbo tax filing Compensation for services. Turbo tax filing   Generally, economic performance occurs as an employee renders service to the employer. Turbo tax filing However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. Turbo tax filing For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. Turbo tax filing Vacation pay. Turbo tax filing   You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2½ months after the end of the year. Turbo tax filing If you pay it later than this, you must deduct it in the year actually paid. Turbo tax filing An amount is vested if your right to it cannot be nullified or cancelled. Turbo tax filing Exception for recurring items. Turbo tax filing   An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. Turbo tax filing The exception applies if all the following requirements are met. Turbo tax filing The all-events test, discussed earlier, is met. Turbo tax filing Economic performance occurs by the earlier of the following dates. Turbo tax filing 8½ months after the close of the year. Turbo tax filing The date you file a timely return (including extensions) for the year. Turbo tax filing The item is recurring in nature and you consistently treat similar items as incurred in the tax year in which the all-events test is met. Turbo tax filing Either: The item is not material, or Accruing the item in the year in which the all-events test is met results in a better match against income than accruing the item in the year of economic performance. Turbo tax filing This exception does not apply to workers' compensation or tort liabilities. Turbo tax filing Amended return. Turbo tax filing   You may be able to file an amended return and treat a liability as incurred under the recurring item exception. Turbo tax filing You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8½ months after the close of the tax year. Turbo tax filing Recurrence and consistency. Turbo tax filing   To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. Turbo tax filing A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future. Turbo tax filing Materiality. Turbo tax filing   Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements. Turbo tax filing   An item considered material for financial statement purposes is also considered material for tax purposes. Turbo tax filing However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance. Turbo tax filing Matching expenses with income. Turbo tax filing   Costs directly associated with the revenue of a period are properly allocable to that period. Turbo tax filing To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles (GAAP; visit www. Turbo tax filing fasab. Turbo tax filing gov/accepted. Turbo tax filing html) are an important factor. Turbo tax filing   For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. Turbo tax filing Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. Turbo tax filing However, the matching requirement is considered met for certain types of expenses. Turbo tax filing These expenses include taxes, payments under insurance, warranty, and service contracts, rebates, refunds, awards, prizes, and jackpots. Turbo tax filing Expenses Paid in Advance An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Turbo tax filing Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Turbo tax filing 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Turbo tax filing If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. Turbo tax filing See Change in Accounting Method, later, for information on how to get IRS approval. Turbo tax filing See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules. Turbo tax filing Related Persons Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Turbo tax filing Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. Turbo tax filing See section 267 of the Internal Revenue Code and Publication 542, Corporations, for the definition of related person. Turbo tax filing Inventories An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Turbo tax filing If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales. Turbo tax filing However, see Exceptions, next. Turbo tax filing See also Accrual Method, earlier. Turbo tax filing To figure taxable income, you must value your inventory at the beginning and end of each tax year. Turbo tax filing To determine the value, you need a method for identifying the items in your inventory and a method for valuing these items. Turbo tax filing See Identifying Cost and Valuing Inventory, later. Turbo tax filing The rules for valuing inventory are not the same for all businesses. Turbo tax filing The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Turbo tax filing Your inventory practices must be consistent from year to year. Turbo tax filing The rules discussed here apply only if they do not conflict with the uniform capitalization rules of section 263A and the mark-to-market rules of section 475. Turbo tax filing Exceptions The following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. Turbo tax filing These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). Turbo tax filing A qualifying taxpayer under Revenue Procedure 2001-10 on page 272 of Internal Revenue Bulletin 2001-2, available at www. Turbo tax filing irs. Turbo tax filing gov/pub/irs-irbs/irb01–02. Turbo tax filing pdf. Turbo tax filing A qualifying small business taxpayer under Revenue Procedure 2002-28, on page 815 of Internal Revenue Bulletin 2002-18, available at www. Turbo tax filing irs. Turbo tax filing gov/pub/irs-irbs/irb02–18. Turbo tax filing pdf. Turbo tax filing In addition to the information provided in this publication, you should see the revenue procedures referenced in the list, above, and the instructions for Form 3115 for information you will need to adopt or change to these accounting methods (see Changing methods, later). Turbo tax filing Qualifying taxpayer. Turbo tax filing   You are a qualifying taxpayer under Revenue Procedure 2001-10 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 17, 1998 (see Gross receipts test for qualifying taxpayers, next). Turbo tax filing Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $1 million or less. Turbo tax filing You are not a tax shelter as defined under section 448(d)(3) of the Internal Revenue Code. Turbo tax filing Gross receipts test for qualifying taxpayers. Turbo tax filing   To determine if you meet the gross receipts test for qualifying taxpayers, use the following steps: Step 1. Turbo tax filing List each of the test years. Turbo tax filing For qualifying taxpayers under Revenue Procedure 2001-10, the test years are each prior tax year ending on or after December 17, 1998. Turbo tax filing Step 2. Turbo tax filing Determine your average annual gross receipts for each test year listed in Step 1. Turbo tax filing Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Turbo tax filing Step 3. Turbo tax filing You meet the gross receipts test for qualifying taxpayers if your average annual gross receipts for each test year listed in Step 1 is $1 million or less. Turbo tax filing Qualifying small business taxpayer. Turbo tax filing   You are a qualifying small business taxpayer under Revenue Procedure 2002-28 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 31, 2000 (see Gross receipts test for qualifying small business taxpayers, next). Turbo tax filing Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $10 million or less. Turbo tax filing You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. Turbo tax filing Your principle business activity is an eligible business. Turbo tax filing See Eligible business, later. Turbo tax filing You have not changed (or have not been required to change) from the cash method because you became ineligible to use the cash method under Revenue Procedure 2002-28. Turbo tax filing Note. Turbo tax filing Revenue Procedure 2002-28 does not apply to a farming business of a qualifying small business taxpayer. Turbo tax filing A taxpayer engaged in the trade or business of farming generally is allowed to use the cash method for any farming business. Turbo tax filing See Special rules for farming businesses under Cash Method, earlier. Turbo tax filing Gross receipts test for qualifying small business taxpayers. Turbo tax filing   To determine if you meet the gross receipts test for qualifying small business taxpayers, use the following steps: Step 1. Turbo tax filing List each of the test years. Turbo tax filing For qualifying small business taxpayers under Revenue Procedure 2002-28, the test years are each prior tax year ending on or after December 31, 2000. Turbo tax filing Step 2. Turbo tax filing Determine your average annual gross receipts for each test year listed in Step 1. Turbo tax filing Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Turbo tax filing Step 3. Turbo tax filing You meet the gross receipts test for qualifying small business taxpayers if your average annual gross receipts for each test year listed in Step 1 is $10 million or less. Turbo tax filing Eligible business. Turbo tax filing   An eligible business is any business for which a qualified small business taxpayer can use the cash method and choose to not keep an inventory. Turbo tax filing You have an eligible business if you meet any of the following requirements. Turbo tax filing Your principal business activity is described in a North American Industry Classification System (NAICS) code other than any of the following NAICS subsector codes: NAICS codes 211 and 212 (mining activities). Turbo tax filing NAICS codes 31-33 (manufacturing). Turbo tax filing NAICS code 42 (wholesale trade). Turbo tax filing NAICS codes 44-45 (retail trade). Turbo tax filing NAICS codes 5111 and 5122 (information industries). Turbo tax filing Your principal business activity is the provision of services, including the provision of property incident to those services. Turbo tax filing Your principal business activity is the fabrication or modification of tangible personal property upon demand in accordance with customer design or specifications. Turbo tax filing   Information about the NAICS codes can be found at http://www. Turbo tax filing census. Turbo tax filing gov/naics or in the instructions for your federal income tax return. Turbo tax filing Gross receipts. Turbo tax filing   In general, gross receipts must include all receipts from all your trades or businesses that must be recognized under the method of accounting you used for that tax year for federal income tax purposes. Turbo tax filing See the definit
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The Turbo Tax Filing

Turbo tax filing 2. Turbo tax filing   Possession Source Income Table of Contents Types of IncomeCompensation for Labor or Personal Services Investment Income Sales or Other Dispositions of Property Scholarships, Fellowships, Grants, Prizes, and Awards Effectively Connected Income In order to determine where to file your return and which form(s) you need to complete, you must determine the source of each item of income you received during the tax year. Turbo tax filing Income you received from sources within, or that was effectively connected with the conduct of a trade or business within, the relevant possession must be identified separately from U. Turbo tax filing S. Turbo tax filing or foreign source income. Turbo tax filing This chapter discusses the rules for determining if the source of your income is from: American Samoa, The Commonwealth of the Northern Mariana Islands (CNMI), The Commonwealth of Puerto Rico (Puerto Rico), Guam, or The U. Turbo tax filing S. Turbo tax filing Virgin Islands (USVI). Turbo tax filing Generally, the same rules that apply for determining U. Turbo tax filing S. Turbo tax filing source income also apply for determining possession source income. Turbo tax filing However, there are some important exceptions to these rules. Turbo tax filing Both the general rules and the exceptions are discussed in this chapter. Turbo tax filing U. Turbo tax filing S. Turbo tax filing income rule. Turbo tax filing   This rule states that income is not possession source income if, under the rules of Internal Revenue Code sections 861–865, it is treated as income: From sources within the United States, or Effectively connected with the conduct of a trade or business within the United States. Turbo tax filing Table 2-1 shows the general rules for determining whether income is from sources within the United States. Turbo tax filing Table 2-1. Turbo tax filing General Rules for Determining U. Turbo tax filing S. Turbo tax filing Source of Income Item of Income Factor Determining Source Salaries, wages, and other compensation for labor or personal services Where labor or services performed Pensions Contributions: Where services were performed that earned the pension Investment earnings: Where pension trust is located Interest Residence of payer Dividends Where corporation created or organized Rents Location of property Royalties:   Natural resources Location of property Patents, copyrights, etc. Turbo tax filing Where property is used Sale of business inventory—purchased Where sold Sale of business inventory—produced Allocation if produced and sold in different locations Sale of real property Location of property Sale of personal property Seller's tax home (but see Special Rules for Gains From Dispositions of Certain Property , later, for exceptions) Sale of natural resources Allocation based on fair market value of product at export terminal. Turbo tax filing For more information, see Regulations section 1. Turbo tax filing 863-1(b). Turbo tax filing Types of Income This section looks at the most common types of income received by individuals, and the rules for determining the source of the income. Turbo tax filing Generally, the same rules shown in Table 2-1 are used to determine if you have possession source income. Turbo tax filing Compensation for Labor or Personal Services Income from labor or personal services includes wages, salaries, commissions, fees, per diem allowances, employee allowances and bonuses, and fringe benefits. Turbo tax filing It also includes income earned by sole proprietors and general partners from providing personal services in the course of their trade or business. Turbo tax filing Services performed wholly within a relevant possession. Turbo tax filing   Generally, all pay you receive for services performed in a relevant possession is considered to be from sources within that possession. Turbo tax filing However, there is an exception for income earned as a member of the U. Turbo tax filing S. Turbo tax filing Armed Forces or a civilian spouse. Turbo tax filing U. Turbo tax filing S. Turbo tax filing Armed Forces. Turbo tax filing   If you are a bona fide resident of a relevant possession, your military service pay will be sourced in that possession even if you perform the services in the United States or another possession. Turbo tax filing However, if you are not a bona fide resident of a possession, your military service pay will be income from the  United States even if you perform services in a possession. Turbo tax filing Civilian spouse of active duty member of the U. Turbo tax filing S. Turbo tax filing Armed Forces. Turbo tax filing   If you are a bona fide resident of a U. Turbo tax filing S. Turbo tax filing possession and choose to keep that possession as your tax residence under MSRRA when relocating with your servicemember spouse under military orders, the source of income for your labor or personal services is considered to be that possession. Turbo tax filing Likewise, if your tax residence is in one of the 50 states or the District of Columbia before relocating and you choose to keep it as your tax residence, the source of income for services performed in any of the U. Turbo tax filing S. Turbo tax filing possessions is considered to be the United States and, specifically, your state of residence or the District of Columbia. Turbo tax filing Services performed partly inside and partly outside a relevant possession. Turbo tax filing   If you are an employee and receive compensation for labor or personal services performed both inside and outside the relevant possession, special rules apply in determining the source of the compensation. Turbo tax filing Compensation (other than certain fringe benefits) is sourced on a time basis. Turbo tax filing Certain fringe benefits (such as housing and education) are sourced on a geographical basis. Turbo tax filing   Or, you may be permitted to use an alternative basis to determine the source of compensation. Turbo tax filing See Alternative basis , later. Turbo tax filing   If you are self-employed, determine the source of your income for labor or personal services from self-employment on the basis that most correctly reflects the proper source of that income under the facts and circumstances of your particular case. Turbo tax filing In many cases, the facts and circumstances will call for an apportionment on a time basis as explained next. Turbo tax filing Time basis. Turbo tax filing   Use a time basis to figure your compensation for labor or personal services from the relevant possession (other than the fringe benefits discussed later). Turbo tax filing Do this by multiplying your total compensation (other than the fringe benefits discussed later) by the following fraction:   Number of days you performed  services in the relevant  possession during the year     Total number of days you  performed services during the year           You can use a unit of time less than a day in the above fraction, if appropriate. Turbo tax filing The time period for which the income is made does not have to be a year. Turbo tax filing Instead, you can use another distinct, separate, and continuous time period if you can establish to the satisfaction of the IRS that this other period is more appropriate. Turbo tax filing Example. Turbo tax filing In 2013, you worked in your employer's office in the United States for 60 days and in the Puerto Rico office for 180 days, earning a total of $80,000 for the year. Turbo tax filing Your Puerto Rico source income is $60,000, figured as follows. Turbo tax filing       180 days 240 days × $80,000 = $60,000                 Multi-year compensation. Turbo tax filing   The source of multi-year compensation is generally determined on a time basis over the period to which the compensation is attributable. Turbo tax filing Multi-year compensation is compensation that is included in your income in 1 tax year but is attributable to a period that includes 2 or more tax years. Turbo tax filing You determine the period to which the income is attributable based on the facts and circumstances of your case. Turbo tax filing For more information on multi-year compensation, see Treasury Decision (T. Turbo tax filing D. Turbo tax filing ) 9212 and Regulations section 1. Turbo tax filing 861-4, 2005-35 I. Turbo tax filing R. Turbo tax filing B. Turbo tax filing 429, available at www. Turbo tax filing irs. Turbo tax filing gov/irb/2005-35_IRB/ar14. Turbo tax filing html. Turbo tax filing Certain fringe benefits sourced on a geographical basis. Turbo tax filing   If you received any of the following fringe benefits as compensation for labor or services performed as an employee partly inside and partly outside a relevant possession, you must source that income on a geographical basis. Turbo tax filing Housing. Turbo tax filing Education. Turbo tax filing Local transportation. Turbo tax filing Tax reimbursement. Turbo tax filing Hazardous or hardship duty pay. Turbo tax filing Moving expense reimbursement. Turbo tax filing For information on determining the source of the fringe benefits listed above, see Regulations section 1. Turbo tax filing 861-4. Turbo tax filing Alternative basis. Turbo tax filing   You can determine the source of your compensation under an alternative basis if you establish to the satisfaction of the IRS that, under the facts and circumstances of your case, the alternative basis more properly determines the source of your income than the time or geographical basis. Turbo tax filing If you use an alternative basis, you must keep (and have available for inspection) records to document why the alternative basis more properly determines the source of your income. Turbo tax filing De minimis exception. Turbo tax filing   There is an exception to the rule for determining the source of income earned in a possession. Turbo tax filing Generally, you will not have income from a possession if during a tax year you: Are a U. Turbo tax filing S. Turbo tax filing citizen or resident, Are not a bona fide resident of that possession, Are not employed by or under contract with an individual, partnership, or corporation that is engaged in a trade or business in that possession, Temporarily perform services in that possession for 90 days or less, and Earned $3,000 or less from such services. Turbo tax filing This exception began with income earned during your 2008 tax year. Turbo tax filing Pensions. Turbo tax filing   Generally, pension income has two components: contributions to the pension plan and the earnings accrued from investing those contributions. Turbo tax filing The contribution portion is sourced according to where services were performed that earned the pension. Turbo tax filing The investment earnings portion is sourced according to the location of the pension trust. Turbo tax filing Example. Turbo tax filing You are a U. Turbo tax filing S. Turbo tax filing citizen who worked in Puerto Rico for a U. Turbo tax filing S. Turbo tax filing company. Turbo tax filing All services were performed in Puerto Rico. Turbo tax filing Upon retirement you remained in Puerto Rico and began receiving your pension from the U. Turbo tax filing S. Turbo tax filing pension trust of your employer. Turbo tax filing Distributions from the U. Turbo tax filing S. Turbo tax filing pension trust must be allocated between (1) contributions, which are Puerto Rico source income, and (2) investment earnings, which are U. Turbo tax filing S. Turbo tax filing source income. Turbo tax filing Investment Income This category includes such income as interest, dividends, rents, and royalties. Turbo tax filing Interest income. Turbo tax filing   The source of interest income is generally determined by the residence of the payer. Turbo tax filing Interest paid by corporations created or organized in a relevant possession (possession corporation) or by individuals who are bona fide residents of a relevant possession is considered income from sources within that possession. Turbo tax filing   However, there is an exception to this rule if you are a bona fide resident of a relevant possession, receive interest from a corporation created or organized in that possession, and are a shareholder of that corporation who owns, directly or indirectly, at least 10% of the total voting stock of the corporation. Turbo tax filing See Regulations section 1. Turbo tax filing 937-2(i) for more information. Turbo tax filing Dividends. Turbo tax filing   Generally, dividends paid by a corporation created or organized in a relevant possession will be considered income from sources within that possession. Turbo tax filing There are additional rules for bona fide residents of a relevant possession who receive dividend income from possession corporations, and who own, directly or indirectly, at least 10% of the voting stock of the corporation. Turbo tax filing For more information, see Regulations section 1. Turbo tax filing 937-2(g). Turbo tax filing Rental income. Turbo tax filing   Rents from property located in a relevant possession are treated as income from sources within that possession. Turbo tax filing Royalties. Turbo tax filing   Royalties from natural resources located in a relevant possession are considered income from sources within that possession. Turbo tax filing   Also considered possession source income are royalties received for the use of, or for the privilege of using, in a relevant possession, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property. Turbo tax filing Sales or Other Dispositions of Property The source rules for sales or other dispositions of property are varied. Turbo tax filing The most common situations are discussed below. Turbo tax filing Real property. Turbo tax filing   Real property includes land and buildings, and generally anything built on, growing on, or attached to land. Turbo tax filing The location of the property generally determines the source of income from the sale. Turbo tax filing For example, if you are a bona fide resident of Guam and sell your home that is located in Guam, the gain on the sale is sourced in Guam. Turbo tax filing If, however, the home you sold was located in the United States, the gain is U. Turbo tax filing S. Turbo tax filing source income. Turbo tax filing Personal property. Turbo tax filing   The term “personal property” refers to property (such as machinery, equipment, or furniture) that is not real property. Turbo tax filing Generally, gain (or loss) from the sale or other disposition is sourced according to the seller's tax home. Turbo tax filing If personal property is sold by a bona fide resident of a relevant possession, the gain (or loss) from the sale is treated as sourced within that possession. Turbo tax filing   This rule does not apply to the sale of inventory, intangible property, depreciable personal property, or property sold through a foreign office or fixed place of business. Turbo tax filing The rules applying to sales of inventory are discussed below. Turbo tax filing For information on sales of the other types of property mentioned, see Internal Revenue Code section 865. Turbo tax filing Inventory. Turbo tax filing   Your inventory is personal property that is stock in trade or that is held primarily for sale to customers in the ordinary course of your trade or business. Turbo tax filing The source of income from the sale of inventory depends on whether the inventory was purchased or produced. Turbo tax filing Purchased. Turbo tax filing   Income from the sale of inventory that you purchased is sourced where you sell the property. Turbo tax filing Generally, this is where title to the property passes to the buyer. Turbo tax filing Produced. Turbo tax filing   Income from the sale of inventory that you produced in a relevant possession and sold outside that possession (or vice versa) is sourced based on an allocation. Turbo tax filing For information on making the allocation, see Regulations section 1. Turbo tax filing 863-3(f). Turbo tax filing Special Rules for Gains From Dispositions of Certain Property There are special rules for gains from dispositions of certain investment property (for example, stocks, bonds, debt instruments, diamonds, and gold) owned by a U. Turbo tax filing S. Turbo tax filing citizen or resident alien prior to becoming a bona fide resident of a possession. Turbo tax filing You are subject to these special rules if you meet both of the following conditions. Turbo tax filing For the tax year for which the source of the gain must be determined, you are a bona fide resident of the relevant possession. Turbo tax filing For any of the 10 years preceding that year, you were a citizen or resident alien of the United States (other than a bona fide resident of the relevant possession). Turbo tax filing If you meet these conditions, gains from the disposition of this property will not be treated as income from sources within the relevant possession for purposes of the Internal Revenue Code. Turbo tax filing Accordingly, bona fide residents of American Samoa and Puerto Rico, for example, may not exclude the gain on their U. Turbo tax filing S. Turbo tax filing tax return. Turbo tax filing (See chapter 3 for additional filing information. Turbo tax filing ) With respect to the CNMI, Guam, and the USVI, the gain from the disposition of this property will not meet the requirements for certain tax rules that may allow bona fide residents of those possessions to reduce or obtain a rebate of taxes on income from sources within the relevant possessions. Turbo tax filing These rules apply to dispositions after April 11, 2005. Turbo tax filing For details, see Regulations section 1. Turbo tax filing 937-2(f)(1) and Examples 1 and 2 of section 1. Turbo tax filing 937-2(k). Turbo tax filing Example 1. Turbo tax filing In 2007, Cheryl Jones, a U. Turbo tax filing S. Turbo tax filing citizen, lived in the United States and paid $1,000 for 100 shares of stock in the Rose Corporation, a U. Turbo tax filing S. Turbo tax filing corporation listed on the New York Stock Exchange. Turbo tax filing On March 1, 2010, she moved to Puerto Rico and changed her tax home to Puerto Rico on the same date. Turbo tax filing Cheryl satisfied the presence test in 2010 and, under the year-of-move exception, she was considered a bona fide resident of Puerto Rico for the rest of 2010. Turbo tax filing On March 1, 2010, the closing value of Cheryl's stock in the Rose Corporation was $2,000. Turbo tax filing On January 5, 2013, while still a bona fide resident of Puerto Rico, Cheryl sold all her Rose Corporation stock for $7,000. Turbo tax filing Under the earlier rules, none of Cheryl's $6,000 gain will be treated as income from sources within Puerto Rico. Turbo tax filing The source rules discussed in the preceding paragraphs supplement, and may apply in conjunction with, an existing special rule. Turbo tax filing This existing special rule applies if you are a U. Turbo tax filing S. Turbo tax filing citizen or resident alien who becomes a bona fide resident of American Samoa, the CNMI, or Guam, and who has gain from the disposition of certain U. Turbo tax filing S. Turbo tax filing assets during the 10-year period beginning when you became a bona fide resident. Turbo tax filing The gain is U. Turbo tax filing S. Turbo tax filing source income that generally is subject to U. Turbo tax filing S. Turbo tax filing tax if the property is either (1) located in the United States; (2) stock issued by a U. Turbo tax filing S. Turbo tax filing corporation or a debt obligation of a U. Turbo tax filing S. Turbo tax filing person or of the United States, a state (or political subdivision), or the District of Columbia; or (3) property that has a basis in whole or in part by reference to property described in (1) or (2). Turbo tax filing See chapter 3 for filing information. Turbo tax filing Special election. Turbo tax filing   For dispositions after April 11, 2005, you can choose to treat the part of gain (or loss) attributable to the time you held the property while a bona fide resident of the relevant possession (the possession holding period) as gain (or loss) from sources within that possession. Turbo tax filing Make the election by reporting the gain attributable to the possession holding period on your income tax return for the year of disposition. Turbo tax filing This election overrides both of the special rules discussed earlier. Turbo tax filing   There are two methods for figuring the gain for the possession holding period, one for marketable securities and another for other types of investment property. Turbo tax filing Marketable securities. Turbo tax filing   Marketable securities are those actively traded on an established financial market, such as stock in a publicly held corporation. Turbo tax filing Under the special election, allocate the gain (or loss) by figuring the appreciation separately for your possession and U. Turbo tax filing S. Turbo tax filing holding periods. Turbo tax filing   Your possession holding period begins on the first day you do not have a tax home outside the relevant possession. Turbo tax filing The gain (or loss) attributable to the possession holding period is the difference in fair market value of the security at the close of the market on the first and last days of this holding period. Turbo tax filing This is your gain (or loss) that is treated as being from sources within the relevant possession. Turbo tax filing If you were a bona fide resident of the relevant possession for more than one continuous period, combine the gains (or losses) from each possession holding period. Turbo tax filing Example 2. Turbo tax filing Assume the same facts as in Example 1, except that Cheryl makes the special election to allocate the gain between her U. Turbo tax filing S. Turbo tax filing and possession holding periods. Turbo tax filing Cheryl's possession holding period began March 1, 2010, the date her tax home changed to Puerto Rico. Turbo tax filing Therefore, the portion of gain attributable to her possession holding period is $5,000 ($7,000 sale price – $2,000 closing value on first day of the possession holding period). Turbo tax filing By reporting $5,000 of her $6,000 gain as Puerto Rico source income on her 2013 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income. Turbo tax filing Other personal property. Turbo tax filing   For personal property other than marketable securities, use a time-based allocation. Turbo tax filing Figure the gain (or loss) attributable to the possession holding period by multiplying your total gain (or loss) by the following fraction. Turbo tax filing      Number of days in the  possession holding period     Total number of days  in your holding period         The result is your gain (or loss) that is treated as being from sources within the relevant possession. Turbo tax filing Example 3. Turbo tax filing In addition to the stock in Rose Corporation, Cheryl acquired a 5% interest in the Alder Partnership on January 1, 2009. Turbo tax filing On March 1, 2010, when she established bona fide residency in Puerto Rico, her partnership interest was not considered a marketable security. Turbo tax filing On September 16, 2013, while still a bona fide resident of Puerto Rico, Cheryl sold her interest in Alder Partnership for a $100,000 gain. Turbo tax filing She had owned the interest for a total of 1,720 days. Turbo tax filing Cheryl's possession holding period (from March 1, 2010, through September 16, 2013) is 1,296 days. Turbo tax filing The portion of her gain attributable to Puerto Rico is $75,349 ($100,000 x (1,296 Puerto Rico days ÷ 1,720 total days)). Turbo tax filing By reporting $75,349 of her $100,000 gain as Puerto Rico source income on her 2013 Puerto Rico tax return (and the remainder as non-Puerto Rico source income), Cheryl elects to treat that amount as Puerto Rico source income. Turbo tax filing Scholarships, Fellowships, Grants, Prizes, and Awards The source of these types of income is generally the residence of the payer, regardless of who actually disburses the funds. Turbo tax filing Therefore, in order to be possession source income, the payer must be a resident of the relevant possession, such as an individual who is a bona fide resident or a corporation created or organized in that possession. Turbo tax filing These rules do not apply to amounts paid as salary or other compensation for services. Turbo tax filing See Compensation for Labor or Personal Services, earlier in this chapter, for the source rules that apply. Turbo tax filing Effectively Connected Income In limited circumstances, some kinds of income from sources outside the relevant possession must be treated as effectively connected with a trade or business in that possession. Turbo tax filing These circumstances are listed below. Turbo tax filing You have an office or other fixed place of business in the relevant possession to which the income can be attributed. Turbo tax filing That office or place of business is a material factor in producing the income. Turbo tax filing The income is produced in the ordinary course of the trade or business carried on through that office or other fixed place of business. Turbo tax filing An office or other fixed place of business is a material factor if it significantly contributes to, and is an essential economic element in, the earning of the income. Turbo tax filing The three kinds of income from sources outside the relevant possession to which these rules apply are the following. Turbo tax filing Rents and royalties for the use of, or for the privilege of using, intangible personal property located outside the relevant possession or from any interest in such property. Turbo tax filing Included are rents or royalties for the use of, or for the privilege of using, outside the relevant possession, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and similar properties if the rents or royalties are from the active conduct of a trade or business in the relevant possession. Turbo tax filing Dividends or interest from the active conduct of a banking, financing, or similar business in the relevant possession. Turbo tax filing Income, gain, or loss from the sale or exchange outside the relevant possession, through the office or other fixed place of business in the relevant possession, of: Stock in trade, Property that would be included in inventory if on hand at the end of the tax year, or Property held primarily for sale to customers in the ordinary course of business. Turbo tax filing Item (3) will not apply if you sold the property for use, consumption, or disposition outside the relevant possession and an office or other fixed place of business in a foreign country was a material factor in the sale. Turbo tax filing Example. Turbo tax filing Marcy Jackson is a bona fide resident of American Samoa. Turbo tax filing Her business, which she conducts from an office in American Samoa, is developing and selling specialized computer software. Turbo tax filing A software purchaser will frequently pay Marcy an additional amount to install the software on the purchaser's operating system and to ensure that the software is functioning properly. Turbo tax filing Marcy installs the software at the purchaser's place of business, which may be in American Samoa, in the United States, or in another country. Turbo tax filing The income from selling the software is effectively connected with the conduct of Marcy's business in American Samoa, even though the product's destination may be outside the possession. Turbo tax filing However, the compensation she receives for installing the software (personal services) outside of American Samoa is not effectively connected with the conduct of her business in the possession—the income is sourced where she performs the services. Turbo tax filing Prev  Up  Next   Home   More Online Publications