Pope Phft2015 Corp Pp Stu 03

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Chapter 3: The Corporate Income TaxPrentice Halls Federal Taxation 2015: Corporations, Partnerships, Estates and Trusts

Corporate Tax YearCan use calendar or fiscal year.Tax year must = financial accounting year.Tax year must always end on the last day of a month.Short tax year corporation begins or ends business in the middle of the year.Copyright 2015 Pearson Education, Inc. 3-2

Corporate Tax Year (contd)Must request change in accounting period by filing Form 1128, unless IRS procedures permit automatic change. Will have a short period between end of old period and start of new.Form 1128 due 3 months after close of short period.Change must not create a substantial distortion of income.Copyright 2015 Pearson Education, Inc. 3-3

General Rules for Determining Corporate Tax Liability - Income Tax (Slide 1)

Gross IncomeMinus: Deductions and lossesTaxable Income before special deductionsMinus: Special Deductions Taxable Income Times: Corporate tax rates Regular Tax before credits and other taxesMinus: Foreign tax credit & possessions tax creditRegular Tax Minus: Other tax credits Plus: Recapture of previously claimed tax creditsIncome (regular) Tax LiabilityCopyright 2015 Pearson Education, Inc. See slide 5See slide 63-4

General Rules for Determining Corporate Tax Liability Alternative Minimum Tax (Slide 2)

Taxable Income before NOL Deduction Plus or Minus: Adjustments to taxable incomePlus: Tax preference items Minus: Alternative tax NOL deduction Alternative minimum taxable income Minus: Statutory exemptions Tax Base Times: 20% tax rate and other taxesTentative Minimum Tax before credits Minus: AMT foreign tax creditTentative Minimum Tax Minus: Regular (income) taxAlternative Minimum Tax (if greater than zero)Copyright 2015 Pearson Education, Inc. See slide 4See slide 63-5

General Rules for Determining Corporate Tax Liability (Slide 3)

Income (regular) Tax Liability Plus: Alternative minimum taxSpecial taxes (if applicable)Accumulated earnings taxPersonal holding company tax Total Tax Liability Minus: Estimated tax paymentsNet tax due (or refund) Copyright 2015 Pearson Education, Inc. See slide 5See slide 43-6

Calculating Corporate Tax LiabilityCopyright 2015 Pearson Education, Inc. 3-7

Calculation of Regular Tax

Taxable Incomex rateRegular tax liabilityForeign Tax Credit ( 27)Regular tax General business credits ( 38)Minimum tax credit ( 53)Other allowed credits+ Recapture of previously claimed creditsRegular Income Tax Liability

Copyright 2015 Pearson Education, Inc. 3-8

Sale or Exchanges of PropertyCapital Gains:Must net all capital gains with capital losses.Net capital gains = any net L-T C/G greater than net S-T C/L.No capital gain rate differential for corporations as there is for individuals.


Sales or Exchanges of PropertyCapital Losses (C/L): If there is a net C/L, then cannot deduct currently.Must first carry back 3 years to offset capital gains, then can carry forward to next 5 years. Remaining C/L then expires.C/L carryback and carryforward treated as an S-T C/L. 291 Recapture rules may cause some or all of the gain to be ordinary (e.g., 1250).Copyright 2015 Pearson Education, Inc. 3-10

Business ExpensesSec. 162 tax deduction allowed for ordinary and necessary expenses.No deduction allowed for bribes, kickback fines, penalties, certain key man insurance premiums, or purchase of tax-exempt securities.Organizational expenditures generally must be capitalized and amortized. 248 may deduct the first $5,000 if total org. exp. < $50,000.Copyright 2015 Pearson Education, Inc. 3-11

Start-Up ExpensesStart-up expenses ordinary and necessary business expenses to:-investigate the creation/acquisition of a business-create a new business-engage in for-profit activities

195 capitalize and amortize start-up expenses over 180 months.Copyright 2015 Pearson Education, Inc. 3-12

Accrued Compensation - 2 -Month RuleAccrued compensation must be paid within 2 months of the end of the year, or the taxpayer cannot deduct until the year the amounts were actually paid. Should be considered as an accounting method planning project.Copyright 2015 Pearson Education, Inc. 3-13

Charitable Contributions - Generally 170 a deduction is permitted for a contribution made to a bona fide charity or a state or local government or political subdivision thereof (e.g., public schools).A bona fide charity usually means a charitable organization as defined by 501(c)(3).The taxpayer (TP) must have a charitable intent to make the contribution (e.g., a benevolent and disinterested motivation).Copyright 2015 Pearson Education, Inc. 3-14

Charitable Contributions - GenerallyIf the taxpayer has a different motivation to contribute other than charitable, it may still be possible to deduct the amounts under 162.Generally, a charitable contribution can only be deducted when paid, not when pledged. Exception: Can deduct the year when accrued if: a) BOD authorizes the contribution; AND b) TP pays within 3 months of the EOY.


ExampleABC corporation, as part of a marketing campaign, promises to contribute $1 for every unit sold to a local charity. They cannot deduct the contribution under 170 since their motive for making the donation is to promote a product rather than disinterested generosity. However, they may be able to deduct the contribution as a marketing expense under 162.


Contributions of PropertyGR: Amount of deduction = FMVExceptions:Ordinary income property Capital gain propertyCopyright 2015 Pearson Education, Inc. 3-17

Contributions of Ordinary Income (OI) Property

OI Property = inventory, investment property held < 1 yr, and property with depreciation recapture.Deduction = FMV less short-term C/G or OI amounts.


Exceptions on Valuation for Inventory

Exception for certain inventory taxpayers can deduct cost + markup (ltd to cost) for inventory donations as long as:donation used for the care of the ill, needy, or infantsnot transferred to charity in exchange for money/property/servicesdonor receives statement from charityCopyright 2015 Pearson Education, Inc. 3-19

Contributions of Capital Gain Property

Capital Gain Property property that has a built-in gain but is not subject to depreciation recapture (e.g., raw land).Deduction = FMV of the property.Exception the charity does not use donated tangible personal property in a way that is related to their tax-exempt purpose.Copyright 2015 Pearson Education, Inc. 3-20

Example Donation of EquipmentTP contributes a forklift to the Salvation Army for use in their warehouse. The forklift has an original cost of $10,000 and $4,000 of depreciation has been taken. The FMV of the equipment is $ 9,000.

Answer?Copyright 2015 Pearson Education, Inc. 3-21

Example Donation of InventoryTP is a retailer and donates 1,000 blankets to the Red Cross for use in a disaster relief area. The blankets retail for $20 each but have a cost of $5 each. What is the amount of the charitable deduction?Copyright 2015 Pearson Education, Inc. 3-22

Example Donation of Capital Gain Property

ABC Corporation has a tract of land that it had acquired many years ago with the intention of building a warehouse on it. Now, the TP has no use for the land in the near future. ABC contributes the land to the YMCA for the site of their new location. The original cost of the land was $50,000 and its fair market value is $125,000.

What is the charitable deduction?Copyright 2015 Pearson Education, Inc. 3-23

Substantiating Charitable Deductions Contrib. > $500 TP must attach description of the property to the tax return.Contrib. > $5,000 TP must obtain a qualified appraisal and attach description and an appraisal summary to tax return.Contrib. > $500,000 TP must attach qualified appraisal to tax return.Copyright 2015 Pearson Education, Inc. 3-24

Limitations on DeductionsMaximum total deduction permitted in any given year is 10% of adjusted taxable income (ATI)ATI = taxable income WITHOUT the effects of:Charitable contribution deductionNOL carrybackC/L carrybackDividends Received Deduction (DRD)US Production Activities Deduction (USPAD)Note that ATI does include any NOL carryforwards.Copyright 2015 Pearson Education, Inc. 3-25

Limitations on Deductions (contd)The taxpayer can deduct up to 10% of ATI.Contributions >10% can be carried forward to the next 5 years. If carryforward is not used up at the end of the 5 years, it expires and is permanently non-deductible. Must first deduct current year contributions and then can use carryovers.


Special DeductionsUS Production Activities Deduction (USPAD)Dividends-Received Deduction (DRD)Net Operating Losses (NOLs)Sequencing of the DeductionsCopyright 2015 Pearson Education, Inc. 3-27

US Production Activities Deduction (USPAD) - 199

Calculation: 9% times lessor of: a) Qualified Prod. Activities Income ORb) taxable income before USPAD

Limitation: USPAD cant exceed 50% of W-2 wages allocable to qualifying USPA


Qualified Production Activities Income (QPAI)QPAI = Domestic Production Gross ReceiptsCOGS allocable to DPGRDirect deductions, expenses, and losses allocable to DPGRIndirect deductions, expenses, and losses ratably allocated to DPGR= QPAICopyright 2015 Pearson Education, Inc. 3-29

Domestic Prod. Gross Receipts (DPGR)

Consists of the following:Lease, rental, sale of a) qualified production property mfg in the US; b) qualified film production; c) electricity, natural gas, or water produced in the US.Construction in US.Engineering/architectural svcs performed in the US for US projects.Copyright 2015 Pearson Education, Inc. 3-30

Dividends Received Deduction (DRD)DRD permits a TP to exclude some or all of dividends received on stock it owns in another company. Without DRD, there could be up to three layers of tax on the same dollar of dividends (investment company, TP, and then TPs shareholder).


DRD - GenerallyTP may deduct dividends received from stock it owns in another company as follows:

Ownership %DRD< 20% 70%Btw 20% and 80%80%>80% (affiliated group)100%Copyright 2015 Pearson Education, Inc. 3-32

Limitations on the DRDIf 20% owned, then DRD is limited to lessor of:80% of dividends received; OR 80% of TI excluding NOLSsC/L carrybacksDRDUSPAD


Limitations on the DRD (contd)NOTE: If eligible for both the 70% and 80% limitation, then first calculate the 80% limitation and reduce taxable income before computing the 70% limitation.Copyright 2015 Pearson Education, Inc. 3-35

Exception to DRD limitationNo taxable income limitation on the DRD if the DRD creates or increases an NOL for the year. Note that low TI could cause the TP to permanently lose DRD deductions (TP may be better off finding a way of pushing itself into an NOL).


Affiliated GroupsA group of corporations are affiliated if a parent company owns at least 80% stock (voting and value) of one or more subsidiaries, and that any other corporation is owned at least 80% by other group members.The DRD = 100% and is not subject to a taxable income limitation. The 100% DRD is taken before the 80%/70% DRD.Copyright 2015 Pearson Education, Inc. 3-37

Other DRD IssuesNo DRD for dividends received from foreign corporations since it is not taxable by the US to begin with.No DRD for debt-financed stock. Prevents TP from taking an interest deduction but avoiding recognition of dividend income.Copyright 2015 Pearson Education, Inc. 3-38

Other DRD Issues (contd)No DRD for stock held for 45 days or less. Testing period begins 45 days before a stock becomes ex-dividend and runs 91 days. Prevents TP from taking a DRD and then getting a capital loss if selling ex-dividend.Ex-dividend means purchaser is not entitled to a previously declared dividend.


Net Operating Losses (NOL)Deductions > Income = NOLDo not include any NOL carryforward or carrybacks in calculating CY NOL.Do include DRDs in calculating CY NOL.No USPAD if there is a CY NOL because no TI.Copyright 2015 Pearson Education, Inc. 3-40

Carrybacks and CarryforwardsNOL carries back 2 years and carries forward 20 years.Any unused NOLs expire after 20 years and expired amounts become permanently non-deductible. TP can elect to forgo carryback and just carryforward. May want to do this to avoid having to amend state and local returns, losing credits or higher future marginal rates than in the past.


Obtaining a Quick RefundFile an extension.Put together a quickie return based on estimates.File the quickie return with the IRS. TPs often use specialty firms to get their returns processed more quickly. Prepare the real return and file. The real return automatically supersedes the quickie return so no need to amend S&L returns. Copyright 2015 Pearson Education, Inc. 3-42

Sequencing Deduction Calculations There is an order by which the TP takes categories of deductions:All deductions other than charitable, DRD, NOL, and USPAD.Charitable contributions.DRD.NOL.USPAD.Copyright 2015 Pearson Education, Inc. 3-43

Controlled Groups - GenerallyGenerally, there are rules to prevent controlled groups from artificially allocating revenue and expenses among group members in order to minimize regular taxes and maximize credits.Whether a corporation is part of a controlled group is tested on December 31. Corporation also has to have been a group member for at least the year.Copyright 2015 Pearson Education, Inc. 3-44

Controlled Groups Generally (contd)Losses on sales between members of a controlled group are deferred until the asset is sold outside the group.Copyright 2015 Pearson Education, Inc. 3-45

Parent-Subsidiary Controlled GroupParent must own at least 80% voting or value of stock of at least one other corporation. A corporation is part of a controlled group if the parent, subsidiary, or other members of the controlled group own 80% (voting or value) of it.Very similar to the definition of affiliated group (DRD).


Example: Parent-Subsidiary Controlled Group


Brother-Sister Controlled Group50%-80% definition of B-S controlled group: Needs to have 2 or more corporations5 or fewer individuals, trust, or estates must meet BOTH conditions:Have in common more than 50% of stock (voting or value) of each corporation.Own at least 80% of the stock (voting or value) of each corporation.

Use this definition specifically for 179 expenses and general business tax credits.


B-S Controlled Group (contd)50% only definition of B-S controlled groupNeeds to have 2 or more corporations5 or fewer individuals, trust, or estates must have in common more than 50% of stock (voting or value) of each corporation.

50% only and 50%-80% test used in determining whether low bracket tax rates, AMT exemptions, and minimum accumulated earnings tax credits should be allocated.


Example: Brother-Sister Controlled Group


Combined Controlled GroupsDefined as three or more corporations meeting the following criteria:Each corporation is a member of a P-S or B-S controlled group.At least one of the corporations is both the parent of the P-S group and a member of the B-S group.


Example: Combined Controlled Group


Consolidated ReturnsAffiliated groups can file one combined (consolidated) return. Criteria:Common parent must own 80% stock (voting AND value) of at least one other corporation.The group must own 80% stock (voting AND value) of any of the other affiliated corporations.Copyright 2015 Pearson Education, Inc. 3-53

Consolidated Returns (contd)Do not include foreign corporations, insurance companies, tax-exempt organizations, and S corporations even if they are part of the affiliated group. Partnerships are not part of an affiliated group and therefore cannot be part of a consolidated return.TP can elect to file a consolidated return by filing Form 1120.


Advantages to Filing a Consolidated ReturnLosses of one member can offset profits of another (subject to certain 382 limits).Capital gains and losses can be combined across the group.Intercompany profits and gains can be deferred until triggered.Copyright 2015 Pearson Education, Inc. 3-55

Limitations on Utilizing NOLs - 382

One corporation cannot acquire another corporation and utilize the acquirees outstanding NOLs to offset the purchasers income.Chapters 7 and 8 have a more in-depth discussion of 382.Copyright 2015 Pearson Education, Inc. 3-56

Disadvantages of Filing a Consolidated ReturnElection to file a consolidated return is binding upon subsequent years unless granted permission to discontinue by IRS.Intercompany losses are deferred until triggered.Losses from one member may affect the deductions and credits of another member.Copyright 2015 Pearson Education, Inc. 3-57

Compliance IssuesEstimated PaymentsRequirements for Filing and Paying TaxesTax Return Schedules


Estimated TaxesMust pay in quarterly installments 25% of the required amount due. For large corporations, must pay 100% of this years liability although 1st Q may be based on prior year. Take into account AMT and regular tax in determining liability.Payments due 4/15, 6/15, 9/15, 12/15.


Penalties for Underpayment of ES Tax 6621 imposes penalties on the deficient amount that was underpaid each quarter.The penalty charges run from the time the amounts should have been paid until they are actually paid.Rate is the short-term federal rate + 5%.Use Form 2220 to calculate underpayments and penalties.


Computational Methods for Estimated PaymentsAnnualized Income Method:1st and 2nd Q based on annualized income for the first 3 months of the year.3rd Q based on first 6 months of the year.4th Q based on first 9 months of the year.

Most helpful for TP who have income that increases toward the end of the year.Can only use this method if less than normal required installment. Will have to recapture if greater than normal installment.


Computing Estimated Payments (contd)Adjusted seasonal income methodTP can base installments assuming CY income will be earned in same pattern as PY.Can only use this method if less than normal required installment. Will have to recapture if greater than normal installment.Copyright 2015 Pearson Education, Inc. 3-62

Estimated Payments - MiscellaneousAny remaining amounts must be paid with the filing of the return or the extension, whichever comes first.If the TP does not pay the liability in full, then penalties and interest can apply. Copyright 2015 Pearson Education, Inc. 3-63

Filing Form 1120Corporate TP must file a Form 1120 even if there is no taxable income for the year. Due date is March 15 assuming calendar year end and 3/15 does not fall on a weekend or holiday.Can file automatic 6-month extension to 9/15 by filing Form 7004.Copyright 2015 Pearson Education, Inc. 3-64

Tax Return SchedulesSchedule L balance sheet.Schedule M-3 for large corporations with total assets > $10m reconciles book and tax.Shows permanent and temporary differences.

Schedule M-2 analysis of unappropriated R/E (like a retained earnings statement).Copyright 2015 Pearson Education, Inc. 3-65

Book-Tax DifferencesArises when financial accounting records an item differently than what is reported for tax.

Permanent differences income never recognized or deductions never taken. Examples:Meals and entertainmentTax-exempt interest


Book-Tax Differences (contd)Temporary differencesIncome will eventually be recognized or deductions taken, but at a different time than the other system.Example tax depreciation that is accelerated.Copyright 2015 Pearson Education, Inc. 3-67

Tax ProvisionAlso known as Federal Income Tax Expense (FITE or Provision) on the financial statements.Financial Accounting may calculate tax expense differently than the amount that is actually due to the IRS.Differences are associated with book-tax temporary differences.


Tax Provision (contd)Broken down into current and deferred components.Current ties into what is actually due to the IRS that year.Deferred is associated with book-tax temporary differences and a state and local component.The Deferred component can further be broken down into Deferred Tax Assets (DTAs) or Deferred Tax Liabilities (DTLs) which are part of the balance sheet.Copyright 2015 Pearson Education, Inc. 3-69

Tax Provision (contd)Rules of the Provision are dictated by ASC 740 issued by FASB.Major components:Current tax liability (due to IRS) or asset (refund from IRS)DTA or DTL associated with temporary differences and carryforwardsReduce DTA by amount TP does not expect to get based on research and valuationLiability for Uncertain Tax Positions (UTP)Copyright 2015 Pearson Education, Inc. 3-70

Temporary Differences Book v. TaxAcceleration or delays in revenue recognitionExpenses deductible earlier or later for tax purposes rather than for book.Differences in tax v. book basisTax carryforwardsCopyright 2015 Pearson Education, Inc. 3-71

Deferred Tax AssetsTP will realize the tax benefit of an event some time in the future.If there is a possibility that the TP wont get the full benefit, the DTA must be reduced by a valuation allowance.This reduction is only required if there is a greater than 50% chance (more likely than not MLTN) the TP will NOT sustain its tax position.Copyright 2015 Pearson Education, Inc. 3-72

DTA ExampleTP has tax credit carryforward of $1m. However, the TP is running losses and may not be able to use all of the credits before they expire. There is a 48% chance that some or all of the credits will expire. The TP needs to reflect the DTA at $750K based on its analysis.

DTA1,000,000Valuation allowance250,000Federal income tax exp750,000


Uncertain Tax Positions (UTP)The TP may take certain positions in its tax return which may or may not pass IRS scrutiny. FASB may require the TP to reduce or eliminate the tax benefit.The TP cannot recognize the tax benefit for financial accounting purposes unless it is more likely than not the position will be sustained.Copyright 2015 Pearson Education, Inc. 3-74

UTP (contd)If MLTN threshold is not met, the tax benefit can later be recognized for financial accounting purposes if:The position later meets the MLTN threshold.Position is settled with the IRS/court.Statute of Limitations runs.MLTN is a cliff. If below 50%, then no tax benefit is recognized. If above, then some or all of the tax benefit can be recognized.Copyright 2015 Pearson Education, Inc. 3-75

Journal Entries for UTPFed. Inc. Tax Exp. (book)1,000,000Liab. for unrecog. tax benefits150,000Fed. Inc. Taxes Payable (tax)850,000To record liability for UTP below MLTN

Liab. For unrecog. tax benefits 150,000Cash(disallowed) 50,000Fed. Tax Exp.100,000 To record settlement with IRSCopyright 2015 Pearson Education, Inc. 3-76

Balance Sheet ClassificationDTAs and DTLs must be classified as current or noncurrent.Classification depends on underlying asset, then expected reversal date.Current assets and liabilities are netted to one amount. Non-current assets and liabilities are netted to another amount.Copyright 2015 Pearson Education, Inc. 3-77

Tax Provision ProcessID temporary differences.Prepare roll forward schedules of temporary differences that tabulate cumulative differences and CY changes.Apply statutory rates to schedules to determine ending balances of DTAs and DTLs.Adjust DTAs by valuation allowance.Adjust income tax expense for UTPs.Copyright 2015 Pearson Education, Inc. 3-78

Tax Provision Process (contd)Determine Federal Tax Payable.Determine Federal Tax Expense.Prepare journal entries.Prepare tax provision reconciliation (walking book numbers to tax).Prepare tax rate reconciliation (book to tax).Prepare financial statements.Copyright 2015 Pearson Education, Inc. 3-79

Accounting MethodsVery important way of implementing tax planning ideas. Taxpayer requests permission to change the way it treats certain expense or revenue items. Copyright 2015 Pearson Education, Inc. 3-80

ENDChapter 3Copyright 2015 Pearson Education, Inc. This work is protected by U.S. copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials.3-81All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.

Pope Phft2015 Corp Pp Stu 03

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