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
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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.
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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?
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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%)
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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
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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
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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.
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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
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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
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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?
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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!!
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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
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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
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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
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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
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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
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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?
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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.
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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
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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
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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
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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
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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
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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
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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
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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?
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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
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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
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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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