taxation of business entities c9-1 chapter 9 corporations: organization, capital structure, and...

C9-C9-11Taxation of Business EntitiesTaxation of Business Entities

Chapter 9Chapter 9

Corporations: Organization, Capital Structure, and Operating Rules

Corporations: Organization, Capital Structure, and Operating Rules

Copyright ©2009 Cengage Learning

Taxation of Business Entities


Various Business FormsVarious Business Forms

• Sole proprietorships

• Partnerships

• Trusts and estates

• S corporations

• Regular corporations (also called C corporations)

• Sole proprietorships

• Partnerships

• Trusts and estates

• S corporations

• Regular corporations (also called C corporations)


Sole ProprietorshipSole Proprietorship

• Not a separate taxable entity

• Income reported on owner’s Sch. C

• Not a separate taxable entity

• Income reported on owner’s Sch. C


PartnershipPartnership

• Separate entity, but does not pay tax

• Allocates partnership income to partners– Partners report partnership income on personal

tax returns

• Files information return (Form 1065)

• Separate entity, but does not pay tax

• Allocates partnership income to partners– Partners report partnership income on personal

tax returns

• Files information return (Form 1065)


S CorporationS Corporation

• Separate entity, only pays special taxes (e.g., built-in gains)

• Allocates entity income to shareholders– Shareholders report entity income on personal

tax return

• Files information return (Form 1120S)

• Separate entity, only pays special taxes (e.g., built-in gains)

• Allocates entity income to shareholders– Shareholders report entity income on personal

tax return

• Files information return (Form 1120S)


C CorporationC Corporation

• Separate tax-paying entity– Reports income and expenses on Form 1120

(or Form 1120-A)

• Income taxed at corporate level and again at owner level when distributed as a dividend

• Separate tax-paying entity– Reports income and expenses on Form 1120

(or Form 1120-A)

• Income taxed at corporate level and again at owner level when distributed as a dividend


DividendsDividends

• Tax Relief Reconciliation Act of 2003 provides partial relief from double taxation of corporate income – Generally, dividends received in taxable years

beginning after 2002 are taxed at same marginal rate applicable to a net capital gain

• Thus, individuals otherwise subject to the 10% or 15% marginal tax rate pay 0% tax on qualified dividends received

• Individuals subject to the 25, 28, 33, or 35 percent marginal tax rate pay a 15% tax on qualified dividends

• Tax Relief Reconciliation Act of 2003 provides partial relief from double taxation of corporate income – Generally, dividends received in taxable years

beginning after 2002 are taxed at same marginal rate applicable to a net capital gain

• Thus, individuals otherwise subject to the 10% or 15% marginal tax rate pay 0% tax on qualified dividends received

• Individuals subject to the 25, 28, 33, or 35 percent marginal tax rate pay a 15% tax on qualified dividends


Corporate Income Tax RatesCorporate Income Tax Rates$50,000 or less 15%

Over $50,000 but not over $75,000 25%

Over $75,000 but not over $100,000 34%

Over $100,000 but not over $335,000 39%

Over $335,000 but not over $10,000,000 34%

Over $10,000,000 but not over $15,000,000 35%

Over $15,000,000 but not over $18,333,333 38%

Over $18,333,333 35%

$50,000 or less 15%

Over $50,000 but not over $75,000 25%

Over $75,000 but not over $100,000 34%

Over $100,000 but not over $335,000 39%

Over $335,000 but not over $10,000,000 34%

Over $10,000,000 but not over $15,000,000 35%

Over $15,000,000 but not over $18,333,333 38%

Over $18,333,333 35%


Nontax Issues in Selecting Entity Form (slide 1 of 3)


• Liability– Sole proprietors and some partners have

unlimited liability for claims against the entity

• Capital-raising– Corporations and partnerships to a lesser extent

can raise large amounts of capital for entity ventures

• Liability– Sole proprietors and some partners have

unlimited liability for claims against the entity

• Capital-raising– Corporations and partnerships to a lesser extent

can raise large amounts of capital for entity ventures




• Transferability– Corporate stock is easily sold, but partners must

approve partnership interest transfer

• Continuity of life– Corporations exist indefinitely

• Transferability– Corporate stock is easily sold, but partners must

approve partnership interest transfer

• Continuity of life– Corporations exist indefinitely




• Centralized management– Corporate actions are governed by a board of

directors– Partnership operations may be conducted by

each partner without approval by other partners

• Centralized management– Corporate actions are governed by a board of

directors– Partnership operations may be conducted by

each partner without approval by other partners


Limited Liability Companies (LLC)

Limited Liability Companies (LLC)

• LLCs have proliferated since 1988 when IRS ruled it would treat qualifying LLCs as partnerships– Major nontax advantage

• Allows entity to avoid unlimited liability

– Major tax advantage• Allows qualifying business to be treated as a

partnership for tax purposes, thereby avoiding double taxation associated with C corporations

• LLCs have proliferated since 1988 when IRS ruled it would treat qualifying LLCs as partnerships– Major nontax advantage

• Allows entity to avoid unlimited liability

– Major tax advantage• Allows qualifying business to be treated as a

partnership for tax purposes, thereby avoiding double taxation associated with C corporations


Entity Classification After 1996 (slide 1 of 2)


• Check-the-box Regulations– Allows taxpayer to choose tax status of entity

without regard to corporate or noncorporate characteristics

– Entities with > 1 owner can elect to be classified as partnership or corporation

– Entities with only 1 owner can elect to be classified as sole proprietorship or as corporation

• Check-the-box Regulations– Allows taxpayer to choose tax status of entity

without regard to corporate or noncorporate characteristics

– Entities with > 1 owner can elect to be classified as partnership or corporation

– Entities with only 1 owner can elect to be classified as sole proprietorship or as corporation




• Check-the-box Regulations (cont’d)– If no election is made, multi-owner entities

treated as partnerships, single person businesses treated as sole proprietorships

– Election is not available to:• Entities incorporated under state law, or

• Entities required to be corporations under federal law (e.g., certain publicly traded partnerships)

• Check-the-box Regulations (cont’d)– If no election is made, multi-owner entities

treated as partnerships, single person businesses treated as sole proprietorships

– Election is not available to:• Entities incorporated under state law, or

• Entities required to be corporations under federal law (e.g., certain publicly traded partnerships)


Consequences of §351(slide 1 of 2)


• In general, no gain or loss to transferors:– On transfer of property to corporation– In exchange for stock– IF immediately after transfer, transferors are in

control of corporation

• In general, no gain or loss to transferors:– On transfer of property to corporation– In exchange for stock– IF immediately after transfer, transferors are in

control of corporation




• If boot (property other than stock) received by transferors– Gain recognized up to lesser of:

• Boot received or

• Realized gain

– No loss is recognized

• If boot (property other than stock) received by transferors– Gain recognized up to lesser of:

• Boot received or

• Realized gain

– No loss is recognized


Formation ExampleFormation Example

Ron will incorporate his donut shop:

Asset Fair Mkt

Tax Basis Value .

Cash $10,000 $ 10,000Furniture & Fixtures 20,000 60,000Building 40,000 100,000Total $70,000 $170,000

• Without §351: gain of $100,000.• With §351: no gain or loss. Ron’s economic status has not

changed.

Ron will incorporate his donut shop:

Asset Fair Mkt

Tax Basis Value .

Cash $10,000 $ 10,000Furniture & Fixtures 20,000 60,000Building 40,000 100,000Total $70,000 $170,000

• Without §351: gain of $100,000.• With §351: no gain or loss. Ron’s economic status has not

changed.


Issues re: Formation(slide 1 of 7)


• Definition of property includes:– Cash– Secret processes and formulas– Unrealized accounts receivable (for cash basis

taxpayer)– Installment obligations

• Code specifically excludes services from definition of property

• Definition of property includes:– Cash– Secret processes and formulas– Unrealized accounts receivable (for cash basis

taxpayer)– Installment obligations

• Code specifically excludes services from definition of property




• Stock transferred– Includes common and most preferred stock

• Does not include nonqualified preferred stock which possesses many attributes of debt

– Does not include stock rights or stock warrants– Does not include corporate debt or securities

(e.g., corporate bonds)• Treated as boot

• Stock transferred– Includes common and most preferred stock

• Does not include nonqualified preferred stock which possesses many attributes of debt

– Does not include stock rights or stock warrants– Does not include corporate debt or securities

(e.g., corporate bonds)• Treated as boot


Issues re: Formation (slide 3 of 7)


• Transferors must be in control immediately after exchange to qualify for nontaxable treatment– To have control, transferors must own:

• 80% of total combined voting power of all classes of stock entitled to vote, and

• 80% of total number of shares of all other classes of stock

• Transferors must be in control immediately after exchange to qualify for nontaxable treatment– To have control, transferors must own:

• 80% of total combined voting power of all classes of stock entitled to vote, and

• 80% of total number of shares of all other classes of stock




• “Immediately after” the transfer– Does not require simultaneous transfers if more

than one transferor– Rights of parties should be outlined before first

transfer– Transfers should occur as close together as

possible

• “Immediately after” the transfer– Does not require simultaneous transfers if more

than one transferor– Rights of parties should be outlined before first

transfer– Transfers should occur as close together as

possible




• After control is achieved, it is not necessarily lost upon the sale or gift of stock received in the transfer to others not party to the initial exchange

• But disposition might violate §351 if prearranged

• After control is achieved, it is not necessarily lost upon the sale or gift of stock received in the transfer to others not party to the initial exchange

• But disposition might violate §351 if prearranged




• Transfers for property and services– May result in service provider being treated as

a member of the 80% control group• Taxed on value of stock issued for services

• Not taxed on value of stock received for property contributions

– Service provider should transfer property having more than “a relatively small value”

• Transfers for property and services– May result in service provider being treated as

a member of the 80% control group• Taxed on value of stock issued for services

• Not taxed on value of stock received for property contributions

– Service provider should transfer property having more than “a relatively small value”




• Subsequent transfers to existing corporation– Tax-free treatment still applies as long as

transferors in subsequent transfer own 80% following exchange

• Subsequent transfers to existing corporation– Tax-free treatment still applies as long as

transferors in subsequent transfer own 80% following exchange


Assumption of Liabilities(slide 1 of 2)


• Assumption of liabilities by corp DOES NOT result in boot to the transferor shareholder for gain recognition purposes – Liabilities ARE treated as boot for determining

basis in acquired stock• Basis of stock received is reduced by amount of

liabilities assumed by the corp

• Assumption of liabilities by corp DOES NOT result in boot to the transferor shareholder for gain recognition purposes – Liabilities ARE treated as boot for determining

basis in acquired stock• Basis of stock received is reduced by amount of

liabilities assumed by the corp




• Liabilities are NOT treated as boot for gain recognition unless:– Liabilities incurred for no business purpose or as

tax avoidance mechanism • Boot = Entire amount of liability

– Liabilities > basis in assets transferred• Gain recognized = Excess amount (liabilities - basis)

• Liabilities are NOT treated as boot for gain recognition unless:– Liabilities incurred for no business purpose or as

tax avoidance mechanism • Boot = Entire amount of liability

– Liabilities > basis in assets transferred• Gain recognized = Excess amount (liabilities - basis)


Formation with Liabilities Example (slide 1 of 2)


Property transferred has:

Fair market value = $150,000Basis = 100,000Realized Gain = $ 50,000

Property transferred has:

Fair market value = $150,000Basis = 100,000Realized Gain = $ 50,000




Liabilities assumed by corp. (independent facts):

Business Business No Business

Purpose Purpose Purpose

Liability: $80,000 $120,000 $120,000

Boot None $ 20,000 $120,000GainRecognized None $20,000 $ 50,000*

*(Gain is lesser of $50,000 realized gain or boot)




Liability: $80,000 $120,000 $120,000

Boot None $ 20,000 $120,000GainRecognized None $20,000 $ 50,000*

*(Gain is lesser of $50,000 realized gain or boot)


Basis Computation for §351 Exchange (slide 1 of 2)


• Shareholder’s basis in stock: Adjusted basis of transferred assets

+ Gain recognized on exchange- Boot received- Liabilities transferred to corporation- Minus: Adjustment for loss property (if elected)= Basis of stock received by shareholder

• Shareholder’s basis in stock: Adjusted basis of transferred assets

+ Gain recognized on exchange- Boot received- Liabilities transferred to corporation- Minus: Adjustment for loss property (if elected)= Basis of stock received by shareholder




• Corporation’s basis in assets:

Adjusted basis of transferred assets

+ Gain recognized by transferor shareholder

- Adjustment for loss property (if required)

= Basis of assets to corporation

• Corporation’s basis in assets:

Adjusted basis of transferred assets

+ Gain recognized by transferor shareholder

- Adjustment for loss property (if required)

= Basis of assets to corporation


Basis in Stock in Last ExampleBasis in Stock in Last Example

Adjusted Basis of transferred assets: $100,000Liabilities assumed by corp. (independent facts):

Business Business No Business Purpose Purpose Purpose .Liability: $ 80,000 $120,000 $120,000Basis in assetsTransferred $100,000 $ 100,000 $100,000+ Gain recognized None 20,000 50,000- Liab. Transferred (80,000) (120,000) (120,000)Basis in stock $ 20,000 -0- $ 30,000

Adjusted Basis of transferred assets: $100,000Liabilities assumed by corp. (independent facts):

Business Business No Business Purpose Purpose Purpose .Liability: $ 80,000 $120,000 $120,000Basis in assetsTransferred $100,000 $ 100,000 $100,000+ Gain recognized None 20,000 50,000- Liab. Transferred (80,000) (120,000) (120,000)Basis in stock $ 20,000 -0- $ 30,000


Corporation’s Basis in Assets Received in Last Example

Corporation’s Basis in Assets Received in Last Example




Liability: $ 80,000 $120,000 $120,000

Basis of trans-

ferred assets: $100,000 $100,000 $100,000

Gain recognized

by shareholder None 20,000 50,000

Basis to Corp. $100,000 $120,000 $150,000




Liability: $ 80,000 $120,000 $120,000

Basis of trans-

ferred assets: $100,000 $100,000 $100,000

Gain recognized

by shareholder None 20,000 50,000

Basis to Corp. $100,000 $120,000 $150,000


Basis Adjustment for Loss Property (slide 1 of 2)


• When built-in loss property is contributed to a corporation– Aggregate basis in property may have to

be stepped down so basis does not exceed the F.M.V. of property transferred• Necessary to prevent parties from obtaining

double benefit from losses involved

• When built-in loss property is contributed to a corporation– Aggregate basis in property may have to

be stepped down so basis does not exceed the F.M.V. of property transferred• Necessary to prevent parties from obtaining

double benefit from losses involved




• Step-down in basis is allocated among assets with built-in loss– Alternatively, if shareholder and corporation

both elect, the basis reduction can be made to the shareholder’s stock

• Built-in loss adjustment places loss with either the shareholder or the corporation but not both

• Step-down in basis is allocated among assets with built-in loss– Alternatively, if shareholder and corporation

both elect, the basis reduction can be made to the shareholder’s stock

• Built-in loss adjustment places loss with either the shareholder or the corporation but not both


Stock Issued for Services RenderedStock Issued for

Services Rendered

• Corporation may be able to deduct the fair market value of stock issued in exchange for services as a business expense – e.g., Performance of management services– May claim a compensation expense deduction under

§ 162• If the services are such that the payment is

characterized as a capital expenditure (e.g., legal services in organizing the corporation)– Must capitalize the amount as an organizational

expenditure

• Corporation may be able to deduct the fair market value of stock issued in exchange for services as a business expense – e.g., Performance of management services– May claim a compensation expense deduction under

§ 162• If the services are such that the payment is

characterized as a capital expenditure (e.g., legal services in organizing the corporation)– Must capitalize the amount as an organizational

expenditure


Holding PeriodHolding Period

• Holding period of stock received – For capital assets or §1231 property, includes

holding period of property transferred to corporation

– For other property, begins on day after exchange

• Corp’s holding period for property acquired in the transfer is holding period of transferor

• Holding period of stock received – For capital assets or §1231 property, includes

holding period of property transferred to corporation

– For other property, begins on day after exchange

• Corp’s holding period for property acquired in the transfer is holding period of transferor


Recapture ConsiderationsRecapture Considerations

• In a § 351 transfer where no gain is recognized, the depreciation recapture rules do not apply– Recapture potential associated with the

property carries over to the corporation

• In a § 351 transfer where no gain is recognized, the depreciation recapture rules do not apply– Recapture potential associated with the

property carries over to the corporation


Capital Contributions (slide 1 of 3)Capital Contributions (slide 1 of 3)

• No gain or loss is recognized by corp on receipt of money or property in exchange for its stock– Also applies to additional voluntary pro rata

contributions of money or property to a corp even though no additional shares are issued

• No gain or loss is recognized by corp on receipt of money or property in exchange for its stock– Also applies to additional voluntary pro rata

contributions of money or property to a corp even though no additional shares are issued



• Capital contributions of property by nonshareholders– Not taxable to corporation– Basis of property received from nonshareholder

is -0-

• Capital contributions of property by nonshareholders– Not taxable to corporation– Basis of property received from nonshareholder

is -0-



• Capital contributions of cash by nonshareholder– Must reduce basis of assets acquired during 12

month period following contribution– Any remaining amount reduces basis of other

property owned by the corp• Applied in the following order to depreciable

property, amortizable property, assets subject to depletion, and other remaining assets

• Capital contributions of cash by nonshareholder– Must reduce basis of assets acquired during 12

month period following contribution– Any remaining amount reduces basis of other

property owned by the corp• Applied in the following order to depreciable

property, amortizable property, assets subject to depletion, and other remaining assets


Debt vs. Equity(slide 1 of 2)


• Debt– Corporation pays interest to debt holder which

is deductible by corporation– Interest paid is taxable as ordinary income to

individual or corporate recipient– Loan repayments are not taxable to investors

unless repayments exceed basis

• Debt– Corporation pays interest to debt holder which

is deductible by corporation– Interest paid is taxable as ordinary income to

individual or corporate recipient– Loan repayments are not taxable to investors

unless repayments exceed basis




• Equity:– Corporation pays dividends which are not

deductible• Taxable to individuals at low capital gain rates to

extent corp has E & P

• Corporate shareholder may receive dividends received deduction

• Equity:– Corporation pays dividends which are not

deductible• Taxable to individuals at low capital gain rates to

extent corp has E & P

• Corporate shareholder may receive dividends received deduction


Reclassification of Debt as Equity

Reclassification of Debt as Equity

• If corp is “thinly capitalized,” i.e., has too much debt and too little equity– IRS may argue that debt is really equity and

deny tax advantages of debt financing– If debt has too many features of stock, principal

and interest payments may be treated as dividends

• If corp is “thinly capitalized,” i.e., has too much debt and too little equity– IRS may argue that debt is really equity and

deny tax advantages of debt financing– If debt has too many features of stock, principal

and interest payments may be treated as dividends


Thin Capitalization Factors(slide 1 of 2)


• Debt instrument documentation

• Debt terms (e.g., reasonable rate of interest and definite maturity date)

• Timeliness of repayment of debt

• Whether payments are contingent on earnings

• Debt instrument documentation

• Debt terms (e.g., reasonable rate of interest and definite maturity date)

• Timeliness of repayment of debt

• Whether payments are contingent on earnings




• Subordination of debt to other liabilities

• Whether debt and stock holdings are proportionate

• Use of funds (if used to finance initial operations or to acquire capital assets, looks like equity)

• Debt to equity ratio

• Subordination of debt to other liabilities

• Whether debt and stock holdings are proportionate

• Use of funds (if used to finance initial operations or to acquire capital assets, looks like equity)

• Debt to equity ratio

Taxation of Business EntitiesTaxation of Business Entities

Dividends Received Deduction(slide 1 of 3)


– If corporation owns stock in another corporation and receives dividends, a portion of dividends may be deducted from income:

% owned Deduction Percent

Less than 20% 70%

20% but < 80% 80%

80% or more, and affiliated 100%

– If corporation owns stock in another corporation and receives dividends, a portion of dividends may be deducted from income:

% owned Deduction Percent

Less than 20% 70%

20% but < 80% 80%

80% or more, and affiliated 100%




• The dividends received deduction is limited to a percentage of the taxable income of a corporation– For this purpose, taxable income is computed without

regard to• The NOL• The domestic production activities deduction• The dividends received deduction, and • Any capital loss carryback to the current tax year

– The percentage of taxable income limitation corresponds to the deduction percentage

• The dividends received deduction is limited to a percentage of the taxable income of a corporation– For this purpose, taxable income is computed without

regard to• The NOL• The domestic production activities deduction• The dividends received deduction, and • Any capital loss carryback to the current tax year

– The percentage of taxable income limitation corresponds to the deduction percentage




The following steps are useful in calculating the dividends received deduction

1. Multiply dividends received by deduction percentage

2. Multiply taxable income by deduction percentage

3. Subtract 1. from taxable income - If entity has income before DRD, but DRD creates NOL, amount in 1. is DRD

-If DRD does not create NOL, deduction is limited to lesser of 1. or 2.

The following steps are useful in calculating the dividends received deduction

1. Multiply dividends received by deduction percentage

2. Multiply taxable income by deduction percentage

3. Subtract 1. from taxable income - If entity has income before DRD, but DRD creates NOL, amount in 1. is DRD

-If DRD does not create NOL, deduction is limited to lesser of 1. or 2.


DRD Examples DRD ExamplesZ Corp owns 60% of X Corp’s stock in years 1, 2 & 3. Dividend of $200 is received each year. Limit (Step 1) is 80% × $200 = $160.

1 2 3_ Income 400 301 299Dividend rec’d 200 200 200Expenses (340) (340) (340)Income before DRD 260 161 15980% of income 208 129 127

Year #1 $208 > $160, so $160 DRDYear #2 $129 < $160, so $129 DRDYear #3 DRD causes NOL ($159-$160), so $160 DRD is used.

$2 less income results in $31 more DRD.

Z Corp owns 60% of X Corp’s stock in years 1, 2 & 3. Dividend of $200 is received each year. Limit (Step 1) is 80% × $200 = $160.

1 2 3_ Income 400 301 299Dividend rec’d 200 200 200Expenses (340) (340) (340)Income before DRD 260 161 15980% of income 208 129 127

Year #1 $208 > $160, so $160 DRDYear #2 $129 < $160, so $129 DRDYear #3 DRD causes NOL ($159-$160), so $160 DRD is used.

$2 less income results in $31 more DRD.


Organizational Expenditures (slide 1 of 2)


• A corporation may elect to amortize organizational expenses over a period of 15 years or more– A special exception allows the corporation to

immediately expense the first $5,000 of these costs

• Phased out on a dollar-for-dollar basis when these expenses exceed $50,000

• A corporation may elect to amortize organizational expenses over a period of 15 years or more– A special exception allows the corporation to

immediately expense the first $5,000 of these costs

• Phased out on a dollar-for-dollar basis when these expenses exceed $50,000




• Organizational expenditures include the following:– Legal services incident to organization – Necessary accounting services– Expenses of temporary directors and of organizational

meetings of directors and shareholders– Fees paid to the state of incorporation

• Expenditures connected with issuing or selling shares of stock or other securities or with the transfer of assets to a corporation do not qualify– Such expenditures reduce the amount of capital

raised and are not deductible at all

• Organizational expenditures include the following:– Legal services incident to organization – Necessary accounting services– Expenses of temporary directors and of organizational

meetings of directors and shareholders– Fees paid to the state of incorporation

• Expenditures connected with issuing or selling shares of stock or other securities or with the transfer of assets to a corporation do not qualify– Such expenditures reduce the amount of capital

raised and are not deductible at all


Start-up Expenditures(slide 1 of 2)


• Start-up expenditures include:– Various investigation expenses involved in

entering a new business• e.g., Travel, market surveys, financial audits, legal

fees

– Also includes operating expenses, such as rent and payroll, that are incurred by a corporation before it actually begins to produce any gross income

• Start-up expenditures include:– Various investigation expenses involved in

entering a new business• e.g., Travel, market surveys, financial audits, legal

fees

– Also includes operating expenses, such as rent and payroll, that are incurred by a corporation before it actually begins to produce any gross income




• At the election of the taxpayer, such expenditures can be treated in the same manner as organizational expenditures– Up to $5,000 can be immediately expensed

(subject to the dollar cap and excess-of-$50,000 phaseout)

– Any remaining amounts are amortized over a period of 180 months or longer

• At the election of the taxpayer, such expenditures can be treated in the same manner as organizational expenditures– Up to $5,000 can be immediately expensed

(subject to the dollar cap and excess-of-$50,000 phaseout)

– Any remaining amounts are amortized over a period of 180 months or longer


Corporate Tax FormulaCorporate Tax Formula

Gross income

Less: Deductions (except charitable, Div. Rec’d, NOL

carryback, STCL carryback)

Taxable income for charitable limitation

Less: Charitable contributions (< = 10% of above)

Taxable income for div. rec’d deduction

Less: Dividends received deduction

Taxable income before carrybacks

Less: NOL carryback and STCL carryback

TAXABLE INCOME

Gross income

Less: Deductions (except charitable, Div. Rec’d, NOL

carryback, STCL carryback)

Taxable income for charitable limitation

Less: Charitable contributions (< = 10% of above)

Taxable income for div. rec’d deduction

Less: Dividends received deduction

Taxable income before carrybacks

Less: NOL carryback and STCL carryback

TAXABLE INCOME


Tax Liability of Related Corporations

Tax Liability of Related Corporations

• Subject to special rules for computing income tax – Limits controlled group’s taxable income in tax

brackets below 35% to amount corporations in group would have if they were one corporation

• Controlled group includes:– Parent-subsidiary groups

– Brother-sister groups

– Combined groups

• Subject to special rules for computing income tax – Limits controlled group’s taxable income in tax

brackets below 35% to amount corporations in group would have if they were one corporation

• Controlled group includes:– Parent-subsidiary groups

– Brother-sister groups

– Combined groups


Parent-Subsidiary Controlled Group


• Consists of one or more chains of corporations connected through stock ownership with a common parent– Ownership is established through either:

• Voting power test: requires ownership of stock with at least 80% of total voting power of all classes of stock entitled to vote

• Value test: requires ownership of at least 80% of total value of all classes of stock

• Consists of one or more chains of corporations connected through stock ownership with a common parent– Ownership is established through either:

• Voting power test: requires ownership of stock with at least 80% of total voting power of all classes of stock entitled to vote

• Value test: requires ownership of at least 80% of total value of all classes of stock


Application of §482Application of §482

• §482 permits IRS to reallocate income, deductions, and credits between two or more businesses owned or controlled by the same interests

• Used to prevent avoidance of taxes or to reflect income properly– Controlled groups of corps are especially

vulnerable to §482

• §482 permits IRS to reallocate income, deductions, and credits between two or more businesses owned or controlled by the same interests

• Used to prevent avoidance of taxes or to reflect income properly– Controlled groups of corps are especially

vulnerable to §482


Corporate Filing Requirements(slide 1 of 2)


• Must file Form 1120 on or before the 15th day of 3rd month following close of tax year even if it has no taxable income– Automatic 6 month extensions are available by

filing Form 7004

• Must file Form 1120 on or before the 15th day of 3rd month following close of tax year even if it has no taxable income– Automatic 6 month extensions are available by

filing Form 7004




• Must make estimated tax payments equal to lesser of:– 100% of corporation’s final tax, or– 100% of tax for preceding year– No estimated tax payments required if tax

liability expected to be less than $500

• Must make estimated tax payments equal to lesser of:– 100% of corporation’s final tax, or– 100% of tax for preceding year– No estimated tax payments required if tax

liability expected to be less than $500


Schedule M-1Schedule M-1

• Corporations must reconcile financial accounting income with taxable income on Sch M-1, Form 1120– Common reconciling items include:

• Federal tax liability

• Net capital losses

• Income reported for tax but not book income (e.g., prepaid income) and vice versa

• Expenses deducted for book income but not tax (e.g., excess charitable contributions) and vice versa

• Corporations must reconcile financial accounting income with taxable income on Sch M-1, Form 1120– Common reconciling items include:

• Federal tax liability

• Net capital losses

• Income reported for tax but not book income (e.g., prepaid income) and vice versa

• Expenses deducted for book income but not tax (e.g., excess charitable contributions) and vice versa



• Corporations must reconcile retained earnings at beginning of year with retained earnings at end of year using Sch M-2, Form 1120

• Corporations must reconcile retained earnings at beginning of year with retained earnings at end of year using Sch M-2, Form 1120



• Corporate taxpayers with total assets of $10 million or more are now required to report much greater detail regarding differences in financial accounting income (loss) and taxable income (loss) – Reported on Schedule M–3

• Schedule M–3 should– Create greater transparency between corporate financial

statements and tax returns– Help the IRS identify corporations that engage in

aggressive tax practices

• Corporate taxpayers with total assets of $10 million or more are now required to report much greater detail regarding differences in financial accounting income (loss) and taxable income (loss) – Reported on Schedule M–3

• Schedule M–3 should– Create greater transparency between corporate financial

statements and tax returns– Help the IRS identify corporations that engage in

aggressive tax practices


If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:

Dr. Donald R. Trippeer, CPA [email protected]

SUNY Oneonta

If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:

Dr. Donald R. Trippeer, CPA [email protected]

SUNY Oneonta

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