Chapter 11 Corporate Income Tax - Accountax Individuals Lecture XI Presentation.pdfChapter 11...

Chapter 11Corporate Income Tax

2012 Cengage Learning

Income Tax Fundamentals 2012

Gerald E. Whittenburg

Martha Altus-Buller

Learning Objectives

This chapter pertains to corporations�Calculate tax liability using tax rates

�Compute basic capital gains/losses

�Ascertain how special deduction may affect taxable income

� Identify components of Schedule M-1

�Outline corporate tax return filing and estimated tax payment requirements

�Understand how S-Corporations operate and are taxed

�Understand basic tax rules when forming entity

�Describe accumulated earnings and personal holding company taxes

�Define elements of alternative minimum tax calculation


Corporate Tax Rates

�Corporate rates are progressive ° Marginal rates are from 15% to 39%, depending on taxable income

° There are eight brackets

° There are a number of ‘tax bubbles’ – these occur when tax rate schedules recapture savings from prior brackets

�For corporations with large income (more than $18.33 million) the rate is a flat 35%

�Qualified personal service corps taxed at flat 35%◦ Architects, CPAs, consultants, etc.


Example Corporate Tax Rates

Example

Johnson & Kelby Inc. (a dental products wholesaler) has taxable income of $300,000 for the current year. What is the corporation’s tax liability? How would the answer change if it was an architectural firm, and Johnson & Kelby were principals who provided personal services to their clients?


Solution

Example

Johnson & Kelby Inc. (a dental products wholesaler) has taxable

income of $300,000 for the current year. What is the

corporation’s tax liability? How would the answer change if it

was an architectural firm, and Johnson & Kelby were

principals who provided personal services to their clients?

Solution

Corporate tax = $100,250

$22,250 + (39%)($300,000 – 100,000)

If Johnson & Kelby is a qualified personal service corporation,

corporate tax = $105,000 ($300,000 x 35%)


Corporate Capital Gains

�A corporation can choose from two alternative tax treatments on capital gains◦ Taxed at ordinary rates

or

◦ Elect to pay an alternative tax (35%) on net long-term capital gain (LTCG)

�Essentially equivalent to maximum regular corporate tax (no tax benefit to LTCG)

�Bottom line: there is no difference in tax on ordinary vs. capital income


Dividends Received Deduction

�Corporations are allowed a deduction for a percentage of the dividends received from other corporations ◦ Attempt to alleviate triple taxation

�Dividends received deduction is allowed based upon ownership


Percentage Ownership Dividends Received % Deduction

< 20% 70%

20% or more, less than 80% 80%

> 80% 100%

Dividends received deduction is limited by %

of corporate taxable income shown above

(calculated before certain deductions)

Organizational Expenditures & Start Up Costs

� Organizational expenditures pertain to LLCs, corporations and partnerships

� Start up costs can be incurred by any organization, including a sole proprietorship and entities mentioned above

◦ Examples of these type of costs include◦ Investigatory costs to look at a business before deciding whether or not to pursue it

◦ Legal/accounting services incidental to organization, costs of a temporary board of directors and state incorporation fees

◦ Preopening costs such as advertising expenses, employee training costs, etc.


Amortization of Organizational Expenditures &

Start Up Costs

�Organizational expenditures and start up costs are capitalized and then amortized over 180 months

� However, can make election to deduct up to $5,000 of organization costs in the year corporation begins business◦ $5,000 amount is reduced $1 for each $1 that organizational expenses exceed $50,000


Charitable Contributions

�Corporations are allowed a deduction for charitable contributions◦ Cash basis taxpayers can deduct when paid◦ Accrual basis taxpayers have until the 15th day of the third month following year-end to contribute, as long as pledge is made by year-end

�Charitable contributions limited to 10% of taxable income*◦ Carry forward unused deduction for five years

*Calculated before any loss carry backs, net operating

losses (NOLs) or the dividend received deduction


Example Charitable Contributions

Example

Ferndale Corp. had net operating income of $400,000 for the current year and made charitable contributions of $60,000. A dividends received deduction of $80,000 is included in the net operating income calculation. What is Ferndale’s charitable contribution deduction; what is the charitable contribution carry forward?


Solution

Example

Ferndale Corp. had net operating income of $400,000 for the current year and made charitable contributions of $60,000. A dividends received deduction (DRD) of $80,000 is included in the net operating income calculation. What is Ferndale’s charitable contribution deduction; what is the carry forward?

Solution

The charitable contribution deduction is $48,000

($400,000 + 80,000) x 10% = $48,000 limit*

Therefore, carry forward is $32,000 ($80,000 – 48,000)

*Note: had to add back DRD first!!


Reconciliation of Income (Loss) per Books with Income Per Return

� Schedule M-1 of Form 1120 reconciles accounting (book) income to taxable income

� Amounts added to book income (left column)◦ Federal tax expense

◦ Capital losses

◦ Income recorded on tax return but not on books

◦ Expenses recorded on books but not on tax return

� Amounts deducted from book income (right column) ◦ Income recorded on books but not on tax return

◦ Expenses recorded on tax return but not on books

See chapter for other items included on Schedule M-1


Schedule UTP Now Required

�Schedule UTP (Uncertain Tax Position) is required

beginning in 2010 for large corporations

� It requires that the corporation disclose any tax

positions taken on prior year’s returns that are

uncertain

o Allows the IRS to engage in more pointed and directed

audit

o Intended to generate additional revenue


Filing Requirements & Estimated Tax

�Form 1120 filed for regular corporation

�Form 1120S filed for S Corporation◦ Returns are due by the 15th day of the third month after year-end

◦ Can file Form 7004 and receive automatic 6-month extension

�Corporations must make estimated tax payments in similar manner as self-employed taxpayers, in four installments


S Corporations

�Certain qualified small business corporations may elect to be taxed in a manner similar to partnerships

�Qualified small business corporation may elect S Corporation status if several criteria apply◦ Operates as a domestic corporation

◦ Has 100 or fewer shareholders

� Shareholders may not be corporations or partnerships

◦ Has only one class of stock

◦ Has only shareholders that are U.S. citizens or resident aliens


S Corporations

� Corporation must make election of S status in a prior

year ◦ Or within 2-1/2 months of the current tax year

� S Corp status stays in effect until revocation*◦ Status can be voluntarily revoked by consent of shareholders

or

◦ Involuntarily revoked� If corporation ceases to be a small business corporation

or

� If corporate passive income is 25% or more for three consecutive

years and corporation has accumulated earnings and profits at the

end of each of those years

*Election is terminated on the date status is revoked


Example S Corporation Election

Example

Swannak Thermography Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2011. In which year may the corporation first be treated as an S Corporation?


Solution

Example

Swannak Thermography Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2011. In which year may the corporation first be treated as an S Corporation?

Solution

Since Swannak did not make the S Corporation election within the first 2-1/2 months of the tax year, it will be treated as a regular corporation for 2011. It will become an S Corporation for tax year 2012.


Income Reporting

�Must report all elements of income and expense separately on Form 1120S

�Then each shareholder reports his/her share of these items of corporate income/expense on personal return◦ K-1 takes total shareholder income/expenses and

allocates each item to each shareholder based upon

his/her ownership percentage

If shareholder dies, his/her portion of S Corp items

will be included in shareholder’s final return


Loss Reporting

�Each shareholder of an S Corp may also report his/her respective share of loss◦ Individual taxpayer cannot take a loss in excess of adjusted basis in stock

◦ If loss exceeds adjusted basis in stock plus loans, shareholder can carry it forward

� If shareholder entered/departed S Corp mid-year, must allocate losses on a daily basis


S Corporation Pass Through Items

�Many items retain tax character when passing through to the S Corporation’s shareholders on individual K-1

�Examples of such items include◦ Capital gains/losses

◦ §1231 gains/losses

◦ Dividend Income

◦ Charitable contributions

◦ Tax-exempt interest

◦ Most credits


Special Taxes

�S Corporations, in general, do not pay corporate taxes on their taxable income

�Certain exceptions exist such as:◦ Built-in gains tax (paid on appreciated assets that were held by corporation prior to S Corp election)

◦ Certain tax imposed if corporation has large amount of passive income, such as dividends and income

These rules are complex and will not be covered in this text


Corporate Formation

� Shareholders often transfer high-value low-basis assets

to a corporation in exchange for stock in company

�No tax is due on gain from transfer of appreciated

assets if following conditions met

◦ Shareholder transferred cash or property

and

◦ Shareholder made transfer solely in exchange for stock*

� Shareholder is not providing a service and all taxpayers together

own at least 80% of stock after transaction

*If shareholder receives boot in addition to stock,

transaction may qualify for partial nonrecognition of gain


Shareholder Basis in Stock

� A shareholder’s initial basis in his/her stock is calculated as follows

Basis of property transferred

Less Boot received*

Plus Gain recognized

Less Liabilities transferred

Equals Basis in stock

� The corporation has a carry-over basis in the property contributed equal to the basis in the hands of the shareholder, increased by any gain recognized by shareholder on the transfer

*Boot is any property other than stock


Note: generally, corporate assumption of shareholder liabilities that are attached to property are not

considered boot received

Accumulated Earnings Tax (AET)

�Penalty tax designed to prevent a corporation from avoiding tax by retaining earnings

� 15% AET imposed on “unreasonable” accumulation of earnings; this is in addition to corporate income taxo Corporation may accumulate up to $250,000 a year that is exempt from AET tax or $150,000 for a service corporation

o May accumulate more if can prove a valid business purpose


Example Accumulated Earnings Tax

Example

Xinix Corporation (a medical device manufacturing firm) has accumulated earnings of $800,000. The corporation can establish reasonable needs for $500,000 of the accumulation. What would Xinix’ accumulated earnings tax be?


Solution

ExampleXinix Corporation (a medical device manufacturing firm) has accumulated earnings of $800,000. The corporation can establish reasonable needs for $500,000 of the accumulation. What would Xinix’ accumulated earnings tax be?

SolutionXinix’ AET = $45,000($800,000 – 500,000) x 15%Note: this is paid in addition to regular tax


Personal Holding Company Tax

�Penalty tax designed to encourage Personal Holding Companies to distribute earnings to shareholders◦ Tax is 15% on undistributed earnings

�Corporation is not liable for both the personal holding company tax and the AET in the same year


Corporate AMT

� Corporate AMT - calculated similar to the individual AMT� AMT is 20% of Alternative Minimum Taxable Income (defined below)

Taxable Income +/- Adjustments + Preferences - Exemption*

Alternative Minimum Taxable Income (AMTI)

� Small corporations are not subject to the AMT◦ Defined as having average annual gross receipts < $7.5 million over a three-year period

*Exemption is $40,000, but is phased out when AMTI > $150,000


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