Karen, an accrual basis taxpayer, sold goods in December 2017 for $20,000. The customer was unable to pay cash. So the customer gave Karen a note for $20,000 that was payable in April 2018. The note bore interest at the Federal rate. The fair market value of the note at the end of 2017 was $18,000. Karen collected $20,500 from the customer in April 2018, $20,000 principal plus $500 interest. Under the accrual method, Karen must recognize income of:

Question

Quizplus · Accepted Answer

As an accrual basis taxpayer, Karen recognizes income in the year it is earned. Since she made the sale in December 2017, she must recognize the income in 2017, even though she did not receive the cash payment until 2018. The fair market value of the note at the end of 2017 is also considered income in 2017. Therefore, Karen must recognize income of $20,000 (principal amount of note) + $18,000 (fair market value of note at end of 2017) = $38,000 for 2017. When Karen collected $20,500 in April 2018, she recognized the $500 in interest income for 2018. So, the answer is $20,000 in 2017 and $500 in 2018.

Karen, an Accrual Basis Taxpayer, Sold Goods in December 2017