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Chapter 1

Income Taxation of Corporations

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What is a Corporation?• Former Kintner Regulations

An association taxable as a corporation• Associates• Business purpose• Limited liability• Transferability of interests• Continuity of life• Centralized management

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Check the Box Regulations

• Regulation Sec. 301.7701-3 provided an election for illegible entities to check a box on Form 8832 to determine the tax classification of the entity.

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Form 8832

Sham Corporations

• IRS Can pierce the corporate veil.

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A Corporation is Separate Entity

• Publically traded

• Closely held

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

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Corporate Tax Rates• 15% on first $50,000• 25% on the next $25,000• 34% on the next $25,000• 39% on the next $235,000• 34% up to $10,000,000• 35% up to $15,000,000• 38% up to $ 18,333,333• 35% over $ 18,333,333

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Tax Liability on $100,000 of TI

• 15% on first $50,000 = 7,500• 25% on the next $25,000 = 6,250• 34% on the next $25,000 = 8,500

– Tax Liability $22,250

I’ll refer to this as a magic number

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In-class Problem 1

• Compute Tax Liability on TI of $60,000

• 15% on first $50,000 = 7,500• 25% on the next $10,000 = 2,500

– Tax Liability 10,000

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In-class Problem 2

• Compute Tax Liability on TI of $110,000

• 15% on first $50,000 = 7,500• 25% on the next $25,000 = 6,250• 34% on the next $25,000 = 8,500• 39% on the next $10,000 = 3,900

– Tax Liability 26,150

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In-class Problem 2

• Compute Tax Liability on TI of $110,000

• Tax on $100,000 of TI = 22,250• Tax on $10,000 (39%) = 3,900

– Tax Liability 26,150

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Text Problem 20

• Compute Tax Liability on TI of $150,000

• 15% on first $50,000 = 7,500• 25% on the next $25,000 = 6,250• 34% on the next $25,000 = 8,500• 39% on the next $50,000 = 19,500

– Tax Liability 41,750

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Text Problem 20

• Compute Tax Liability on TI of $150,000

• Tax on $100,000 of TI = 22,250• Tax on $50,000 (39%) = 19,500

– Tax Liability 41,750

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Text Problem 21

• Compute Tax Liability on TI of $250,000

• Tax on $100,000 of TI = 22,250• Tax on $150,000 (39%) = 58,500

– Tax Liability 80,750

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Text Problem 21

• If personal service corporation , what is the tax on $250,000 of taxable income?

• 35% times TI

• 35% times $250,000 = $87,500

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Personal Service Corporation

• A PSC is a corporation whose principal activity is the performance of services:– health – law– engineering– architecture– accounting– actuarial services

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

Casualty Losses• Amount of deduction is: For Individual Taxpayers

Smaller of: 1. decline in value2. adjusted basis of property*

Less: insurance reimbursements $100 floor if personal

10% of AGI if personal

Equals: Deductible casualty loss

* Adjusted basis must be used if business property is completely destroyed or stolen.

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Losses for Corporations

• §165 (b)– The basis for determining the amount of

deduction for any loss shall be the adjusted basis in § 1011 for determining the loss from the sale of property

• §165 (c)– Individuals only - See (c)(3)

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

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Corporate Capital Losses

• Net capital losses can not be deductedWhat authority ?§ 1211(a)

• Corporation can:– take the loss back 3 years , or– carry the loss forward 5 years

– Any loss carryback or carryforward will be carried as a short term capital loss

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Do Text Problem 1-12

Net Capital Gain

• No special tax rate for net capital gains.

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

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Special Deductions

• Authority for special corporate deductions?Part VIII of Subchapter B, begins at § 241

• We will cover:

§ 243 Dividends received deduction (DRD)§ 246 Limitations on DRD§ 248 Organizational expenditures

Reason for the rule

• Create a diagram demonstrating the impact

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Two Requirements for DRD

Corporate payor must be:

1. Domestic corporation2. Subject to income tax

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DRD

• General rule: 70% of dividends received

• If Payee owns > 20% of payor: 80%

• Qualifying dividends: 100%

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DRD Limitations

• § 246(b)(1) limits the deduction to 70% of taxable income of the taxpayer computed without regard to:§ 172 (NOL cary-over and NOL carry-back)§ 243(a)§ 1212 (capital loss carry-back)

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Exception to DRD limitation

• § 246(b)(2) says that (b)(1) will not apply if an NOL exists as defined in § 172

• § 172 allows a DRD deduction under § 243

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Summary of DRD Rules

• § 243(a) is the maximum amount of DRD

• § 246(b)(1) limits DRD to 70% of TI computed in a special way

• § 246(b)(2) applies if NOL is created by using the general rule (maximum DRD is allowed)

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In-class Problem

#1 #2 #3Gross Income 400,000 291,000

291,000Operations

Dividends 200,000 200,000 200,000

Expenses ofOperations -350,000 -350,000 -

352,000

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Organizational Expenditures

• Authority?• § 248

• Former rules: Capitalize, or elect to amortize over a period not less than 60 months, beginning in the month in which the business began

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Organizational Expenditures• New Rules: § 248 as amended

• Applicable to expenditures incurred after October 22, 2004

• Deduct up to $5,000 in current year, but the $5,000 is reduced, but not below zero, by expenditures exceeding $50,000

• Remainder of organizational expenditures are amortized over 180 months, beginning in the month in which the business began

In-class Example

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

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Net Operating Loss

• Authority is § 172

Gross income(Deductions)Taxable Income or (Net Operating Loss)

• Carried back 2 years• Carried over 20 years

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Election to Waive the Carryback period

• Authority is? § 172(b)(3)

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

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Charitable Contributions• Authority is

§ 170(a)

• Must be made to a qualifying organization

• Deduction when payment is made

• Exception for accrual basis corporations– Board must authorize the contribution in year 1– Payment must be made before 2½ months of year 2

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Percentage Limitation

• Authority is § 170(b)(2)

• Limited to 10% of taxable income computed w/o/ regard to:

(1) this section [§ 170](2) Part VIII, except for § 248 [DRD](3) NOL carryback(4) Capital loss carryback

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In-class Problem

Operating Income $200,000Dividend income 10,000Expenses 120,000(included in expenseswas $15,000 of CC)NOL Carryover (3,000)

Requirement: Compute taxable income

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Solution Step 1

• First determine the § 170(b)(2) taxable income

Taxable income computed w/o/ regard to:

(1) this section [§ 170](2) Part VIII, except for § 248 [DRD](3) NOL carryback(4) Capital loss carryback

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Solution to In-class ProblemOperating Income $ 200,000Dividend income 10,000Gross income 210,000Expenses (105,000)NOL Carryover (3,000)§ 170(b)(2) TI 102,000CC (10,200)Are we done yet?DRD (7,000)Taxable Income $ 84,800

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Testing Understanding!

• What is the § 246(b)(1) taxable income?$ 94,800

Taxable income computed w/o regard to:§ 172 § 243(a)§ 1212 (capital loss carry-back

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Differences BetweenIndividuals & Corporations

• Tax Rates• Casualty Losses• Capital Gains and Losses• Special Deductions• NOL• Charitable Contributions• Depreciation Recapture

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Depreciation Recapture

• Section 291– Applies only to corporations– Applies only to real property

• Section 291applies in addition to § 1250

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Section 291 Formula

“as if” § 1245 recapture- § 1250 recapture

DifferenceX 20%= § 291 recapture

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Corporate Tax Reporting Requirements

• Form 1120• Due 15th day of the third month after the

close of the taxable year• Automatic 6 month extension (Form 7004)

– Any tax due must be paid at this time• Additional 3 month extension is available

with the permission of the IRS

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Schedule M-1 [M-3]

Start with Book Income net of FIT+ income tax per books+ capital losses+ nondeductible expenses [CREEP]+ income subject to tax but not reported on books

[prepaid rental income]- nontaxable Income [muni interest]- special tax deductions not allowed for booksTaxable income

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BOOK/TAX DIFFERENCES

• Books use GAAP

• Tax use IRC

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GAAP ORIENTATION

• Generally conservative in nature– Defer income– Accelerate expenses

• Written to prevent managers from arbitrarily increasing the net income from the firm

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IRC ORIENTATION

• Generally seeks to impose taxes on income in the earliest possible year

• Written to prevent managers from arbitrarily decreasing the taxable income of the firm

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PERMANENT DIFFERENCES• A permanent difference occurs when:

• Income or gain is realized for book purposes but is never recognized for tax purposes [§ 103]

• Expense or loss is realized for book purposes but is never deducted for tax purposes[§ 162(f)]

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PERMANENT DIFFERENCES (cont.)

• Income or gain is recognized for tax purposes but is never realized for book purposes [§ 7872]

• A tax deduction is allowed that never corresponds to an expense or loss for book purposes[§ 243]

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PERMANENT BOOK/TAX DIFFERENCE

• Firms never have to repay the tax savings attributable to a permanent book/tax difference (the good news)

• But, firms never recover the tax cost attributable to a permanent book/tax difference (the bad news)

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PERMANENT DIFFERENCES

• Muni interest income• Fines and bribes• Dividend received deduction• Federal income taxes• Key man life insurance premiums and proceeds• Meals & entertainment expenses• Charitable contributions (Property where A/B ≠

FMV)

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TEMPORARY DIFFERENCES

• The same item of income, gain, expense or loss is taken into account in a different year for book purposes than for tax purposes

• Temporary differences turn around

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Temporary Differences• Depreciation• Unearned income items (receipt of cash)• Bad debts• Unicap adjustments• NOLs• Installment sales• Organizational expenses• Capital losses• Charitable Contributions (subject to the tax

limitation)

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Do Text Problem 1-25

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Corporate Tax Returns

• All corporations must file a corporate tax return, generally a Form 1120

• Due date is 15th day of the 3rd month after the close of the taxable year

• If the tax liability is more than $ 500 quarterly estimated payments must be made

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Corporate Estimated Tax Issues

• No withholding on corporations so corporations must make quarterly estimated tax payments.

• Due dates are: 4/15 6/15 9/1512/15

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Safe Harbor Estimated Tax Payments

General Rule: Each payment should be 25% of this years tax liability

Exception 1: Each payment should be 25% of last year’s tax liability {Special rule for large corporations}

Exception 2: Pay the tax due for each quarter based on the annualized taxable income

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Example of Quarterly Estimated Tax Payments using the Annualized Method

Q1 Q2 Q3 Q4

Taxable Income 100,000 100,000 100,000 700,000

Gross up to annual 100,000 200,000 300,000 1,000,000taxable income 4 2 1.33 1

400,000 400,000 400,000 1,000,000

Tax on annual TI 136,000 136,000 136,000 340,000

Annual tax 136,000 136,000 136,000 340,000attributable through 25% 50% 75% 100%the quarter 34,000 68,000 102,000 340,000

Prevous Payments 34,000 68,000 102,000

Payment due 34,000 34,000 34,000 238,000

Payments Due under the General Rule 85,000 85,000 85,000 85,000

AMT Issues

• The AMT counts as an income tax for purposes of making estimated tax payments.

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