On November 1 of year 0, Jaxon borrowed $50,000 from Bucksnort Savings and Loan for use in his business. In December, Jaxon paid interest of $4,500 relating to the 12-month period from November of year 0 through October of year 1. a. How much interest, if any, can Jaxon deduct in year 0 if his business uses the cash method of accounting for tax purposes? b. How much interest, if any, can Jaxon deduct in year 0 if his business uses the accrual method of accounting for tax purposes?

Question

Business

Steve Dorsey

18 February, 17:29

On November 1 of year 0, Jaxon borrowed $50,000 from Bucksnort Savings and Loan for use in his business. In December, Jaxon paid interest of $4,500 relating to the 12-month period from November of year 0 through October of year 1. a. How much interest, if any, can Jaxon deduct in year 0 if his business uses the cash method of accounting for tax purposes? b. How much interest, if any, can Jaxon deduct in year 0 if his business uses the accrual method of accounting for tax purposes?

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Answers (1)

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Mina Beltran · Answer 1

a. $750

b. $750

Explanation:

The first thing to do is calculate the monthly interest as follows:

Monthly interest = Total interest : 12 = $4,500 : 12 = $375

The rent for two months in year 0 (November and December) = $375 * 2 = $750.

Prepaid expenses (January to October of year 1) = $4,500 - $750 = $3,750.

Decision:

Prepaid expenses is not deductible under either cash accounting method or accrual accounting method for tax purposes.

Therefore, Jaxon can deduct only $750 two months (November and December) relevant for year 0 under both cash accounting method and accrual accounting method.

The prepaid expenses of $3,750 is not deductible in year 0 but can only be deducted in year 1.