ExamworthyExamworthy
Open the appStart free

SEE-2 - Business Tax Preparation - Section 2.1

Determine business gross income, cost of goods sold, and the proper treatment of cash versus accrual accounting methods and constructive receipt.

Determine business gross income from gross receipts less cost of goods sold (COGS), applying the appropriate inventory valuation method and the uniform capitalisation rules where they apply. Distinguish the cash method - income when constructively received, deductions when paid - from the accrual method that uses the all-events test, and recognise when a taxpayer must use accrual because inventory is a material income-producing factor.

Gross receiptsCost of goods soldAccrual methodCash methodConstructive receipt

Practice question for this objective

Free sampleBusiness Tax Preparationmedium

Calderwood Distributors Inc, a calendar-year C corporation that is not a tax shelter, sells merchandise and currently uses the accrual method. For 2024 it wants to know whether it qualifies as a small business taxpayer that may use the cash method and be exempt from the uniform capitalisation rules. Its average annual gross receipts for the three prior tax years (2021, 2022 and 2023) are 26,000,000 dollars. Applying the inflation-adjusted gross receipts test for the 2024 tax year, may the corporation use the cash method?

  • ANo, because any C corporation that holds inventory is barred from the cash method and must use the accrual method regardless of the size of its gross receipts.
  • BNo, because its average annual gross receipts of 26,000,000 dollars exceed the 25,000,000 dollar small business taxpayer threshold and so it fails the gross receipts test.
  • CNo, because a C corporation may use the cash method only if its average annual gross receipts are below 5,000,000 dollars, a limit the corporation clearly exceeds.
  • DYes, because its average annual gross receipts of 26,000,000 dollars are at or below the inflation-adjusted 30,000,000 dollar gross receipts threshold for the 2024 tax year. Correct
A small business taxpayer that meets the inflation-adjusted gross receipts test for 2024 may use the cash method even as a C corporation holding inventory. Under the small business taxpayer rules, a taxpayer that is not a tax shelter and meets the gross receipts test may use the cash method, is exempt from the uniform capitalisation rules, and may treat inventory under a simplified method. The gross receipts test is met if average annual gross receipts for the three prior tax years do not exceed an inflation-adjusted threshold, which for tax years beginning in 2024 is 30,000,000 dollars. Calderwood's 26,000,000 dollar average is below that figure, so it qualifies. The answer is not driven by the old per se inventory bar, the unindexed 25,000,000 dollar base amount, or the historic 5,000,000 dollar C corporation limit, all of which are superseded by the current small business taxpayer exception.

Why A is wrong: The old rule that inventory forces the accrual method was relaxed for small business taxpayers; a C corporation under the gross receipts threshold may use the cash method even with inventory, so this overstates the restriction.

Why B is wrong: The 25,000,000 dollar figure is the unindexed base amount; the threshold is adjusted for inflation and is higher for 2024, so comparing against the base rather than the indexed figure wrongly disqualifies the corporation.

Why C is wrong: The 5,000,000 dollar C corporation limit is a separate, older rule that the small business taxpayer exception supersedes; applying that low threshold here misidentifies the governing test and gives the wrong conclusion.

Why D is correct: For tax years beginning in 2024 the inflation-adjusted gross receipts threshold is 30,000,000 dollars, and the corporation's 26,000,000 dollar average is below it, so it is a small business taxpayer eligible for the cash method.

See more SEE-2 practice questions, answers explained.

More in this domain

Back to all Business Tax Preparation objectives, or the SEE-2 cert hub.

Examworthy is not affiliated with or endorsed by IRS / Prometric. Original, blueprint-aligned practice material only.