Related Party Transactions. Sally is an attorney who computes her taxable income
ID: 2548160 • Letter: R
Question
Related Party Transactions. Sally is an attorney who computes her taxable income using the cash method of accounting. Sage Corporation, owned 40% by Sally's brother, 40% by her cousin, and 20% by her grandmother, uses the accrual method of accounting. Sally is a calendar-year taxpayer, whereas Sage Corporation's fiscal year ends on January 31. Dur- g 2016, Sally does some consulting work for Sage Corporation for a fee of $10,000. The work is completed on December 15 and Sage receives Sally's invoice on that date. For each of the following assumptions, answer the following questions: During which tax year Sally report the income? During which tax year must Sage Corporation deduct the expense? a. The payment to Sally is made on December 27, 2016. b. The payment to Sally is made on January 12, 2017. c. The payment to Sally is made on February 3, 2017. -49
Explanation / Answer
Sally compute her taxable income on cash method and Sage corporation uses the accrual method of accounting.
Under cash method, income is reported when cash is received.
Under accrual mehod, expenses are booked when occured even if it is not paid.
a. The payment to Sally is made on December 27, 2016
Sally must report this income in year 2016 as she received the payment in 2016
Sage corporation must deduct the expenses in year 2016 as the service is taken and paid in 2016.
b. The payment to Sally is made on January 12, 2017
Sally uses the cash method of accounting and a calender year taxpayer,so She must report this income in year 2017 as the payment is received in year 2017.
Sage corporation's fiscal year ends on January 31, so it must deduct the expense in fiscal year 2016-2017, when it is occured and paid.
c. The payment to Sally is made on February 3, 2017.
Sally must report this income in year 2017 as she will receive the payment in year 2017.
Sage corporation uses the accrual method of accounting and in this method expenses is reported when occured, even if it is not paid. Sage's fiscal year ends on January 31, 2017 and they paid the expenses after that. Sage corporation must report it in year 2016 even if it paid in year 2017 after fiscal year ends.