Question 1 -
Acme Corporation, a calendar year C Corporation, is currently under examination by the Internal Revenue Service for the years 2011 through 2013. The examination began in October of 2014. Since the examination seems to be dragging and not going particularly well, Acme's controller is has recently engaged you to manage the audit.
When preparing for your first meeting with the Agent, you notice that Acme is using the reserve method for bad debts for both book and tax purposes. This is an improper tax accounting method. When reviewing Acme's tax returns, you obtain the following information:
Tax year 2011 - Reserve for bad debts at 12/31/10 is $800,000. Bad debt expense for 2011 is $350,000. Net bad debt charge offs are $300,000. Reserve for bad debts at 12/31/11 is $850,000.
Tax Year 2012- Bad debt expense for 2012 is $400,000. Net bad debt charge offs are $450,000. Reserve for bad debts at 12/31/12 is $800,000
Tax year 2013 - Bad debt expense for 2013 is 600,000. Net bad debt charge offs are $500,000. Reserve for bad debts at 12/31/2013 is $900,000
Tax year 2014 - Bad debt expense for 2014 is $550,000. Net bad debt charge offs are $550,000. Reserve for bad debts at 12/31/2014 is $900,000.
Tax year 2015 - Bad Debt expense for 2015 is $600,000. Net bad debt charge offs are $500,000. Reserve for bad debts at 12/31/2016 is $1,000,000
Tax year 2016 - So far, net bad debt charge offs are $550,000.
How would you advise Acme to proceed in this situation? What important questions would you want to ask Acme's controller?
What are the tax consequences of your advice? The controller wants to understand the impact on taxable income for each year in which there is a change?
Question 2 -
1. In general, is it more or less difficult to take an inventory market writedown for tax purposes compared with book purposes? Give an example.
2. In general, does the application of the UNICAP rules under IRC Section 263A produce higher inventories for tax than for book? Will this result in higher or lower taxable income than book income? Give an example.