C Corporation Operation

8/2/2019 C Corporation Operation

1/48

I. C Corporation Formation

A. Corporation Tax Consequences

1. General rule no gain or loss recognized onissuing stock in exchange for property:

a. Formation - Issuance of common stockb. Reacquisition - Purchase of treasury stock.c. Resale - Sale of treasury stock

2. Basis of property (corporation receives) thegreater of :a. Adjusted basis (NBV) + gain recognized bytransferorb. Debt assumed by corporation

B. Shareholder Tax Consequences

1. No Gain or Loss Recognized exchangeproperty (not service) for stock, no gain or loss iffollowing meet:

a. 80% Control after the transaction,transferor own at least 80% of the stock

b. No Boot Involved (received) followingitems are treated as boots:

(1) Cash withdrawn &(2) Receipt of debt securities

c. Boot Excess of debt cancelled over asset

NBV, Gain recognized on it

1


2/48

2. Basis of Common Stock(to shareholder)

a. Cash - Amount contributed

b. Property - Adjusted basis (NBV)(1) Stock = asset NBV debt released(2) Stock = 0, when asset NBV < debtreleased. Gain recognized on excess of debtover NBV

c. Services - Fair Market Value (taxable)II. C. Corporation Operations

A. Book Income vs. Taxable Income(Schedule M-1)

Corporation tax return form 1120. M-1 reconcile

taxable income with net incomeB. Corporate Taxable Income/Loss Items1. Gross Income

a. Cash received in advance ofaccrual GAAPincome is taxed (temporary difference betweenGAAP & Tax):

(1) Interest income received in advance.(2) Rental income received in advance.(Nonrefundable rent deposits and leasecancellation payments are rental incomewhen received.)

(3) Royalty income received in advance.

2


3/48

b. Some GAAP income items are notincludible as income (permanent difference):

(1) Interest income from municipal orstate obligations/bonds.(2) Proceeds from life insurance on thelife of an officer ("key person" policy)where the corporation is the beneficiary.

(so the insurance premium is notdeductible)(3) Federal income tax not deductible ontax return.

2. Trade or Business Deductions (ordinary andnecessary expenses)

a. Domestic Production Deduction

(1) Limitation: The deduction may notexceed 50% of the W-2 wages paid bythe corporation for the year.

(2) Deduction 9% the lesser of:(a). Qualified production activitiesincome (QPAI)(b). Taxable income (disregardingthe QPAI deduction)

(3) D. P. G. R. Defined gross receipts

within the United States from:

3


4/48

(a). Manufactured(b). Produced

(c). Grown(d). Extracted(e). Constructed(f). Engineering services(g). Architectural services

(4) Calculating QPAIDomestic production gross receipts

Qualified production activities income

b. Executive Compensation

(1) Public corp. Deduction for Top 4scompensation maximum =

$1,000,000, unless based uponqualifying commissions or a

performance based plan of thecompany.(2) Entertainment Deduction forofficers, directors, and 10%-or-greater

4


5/48

owners limit to the extent included inthe individual's gross income.

c. Bonus Accruals(non-shareholder/employees)

(1) Incurred(2) Paid within 2&1/2 months

d. Bad Debts - Specific Charge-Off

Method(1) Accrual Basis = Deduct whenspecific A/R written off(2) Cash Basis not allowed deduction

e. Business Interest Expense

(1) Interest incurred & paid or accruedon general business loan deductible.(2) Interest on investment loan deductionLimit to net investment income

(3) Prepaid interest proportionate for

the interest periods only incurredportion can be deducted.

f. Business Losses or Casualty LossesRelated to Business 100% deductible( no100 reduce & no 10%limit)

(1) Partially Destroyed the lesser of:

5


6/48

(a). The decline in value, or(b). NBV before destroyed

(2) Fully Destroyed (NBV) theadjustedbasis of the property.

g. Organizational Expenditures and

Start-up Costs

(1) Deductible Costs

(a). Deduction is allowed for $5,000 oforganizational expenditures & $5,000 ofstart-up costs(b). Each amount is reduced by theamount of each costs exceeds $50,000,respectively.(c). Any excess over $5000 oforganizational expenditures or start-upcosts are amortized over 180 months(beginning with the month in which theactive trade or business begins. Caution:

month business started)(2) Included Costs

(a). Total start-up costs:

Advertising

Travel

Consultant

6


7/48

(b). Organizational costs:

Aattorney fees,

State incorporation fee Accounting fees

(3) Excluded Costs(a). Issuing & selling the stock,(b). Commissions,

(c). Underwriter's fees,(d). Costs incurred in the transfer ofassets to a corporation.

h. Amortization for intangiblesacquired after 08/10/1993 15 years S-L

beginning with the month acquired.i. Depreciation,

j. Depletion

k. Life Insurance Premiums(expense)

(1) Corporation Named as Beneficiary (key

person) not deductible Premiumspaid by the corporation for life insurancepolicies on key employees

(2) Insured Employee Named as Beneficiary(fringe benefit) Premiums are

deductible as an employee benefit.

7


8/48

l. Business Gifts deductionmaximum up to $25 per recipient per year.

m. Business Meals and Entertainment deductible 50%

n. Penalties and Illegal Activities NotDeductible

o. Taxes deductible:

(1) State Tax(2) Local Tax(3) Payroll Tax

(4) Federal income not deductiblep. Lobbying and Political

Expenditures(1) Lobbying for Federal & State legislation

not deductible

(2) Political contributions are not deductible(3) Direct-type lobbying expenses in

connection with local governmentallobbying are deductible.

q. Capital Gains and Losses

(1) No $3,000 Capital Losses Deductionallowed differ from individual tax.

8


9/48

Capital losses deduction only allowedup to Capital Gains.

(2) Capital Loss Carryover 3 back 5forward, but only as short-term capitallosses and are applied only againstcapital gains.(differ from individualwhich no carry back, forward forever)

(3) Capital Gains Tax Calculation Same rateas ordinary income, differ fromindividual which special Capital gainsrates apply

r. Net Operating Losses

NOL Carry back 2, forward 20 same asindividual(1) NOL Carry back claiming form 1120X

(Amended Corporate Income TaxReturn) must be filed within three yearsof the due date (including extensions) of

the return for the loss year.(2) An election to forgo carry back must be

made on the tax return for the year ofloss without special form to file.

(3) NOL calculation points:

9


10/48

(a).No charitable contributiondeduction is allowed in calculating the

NOL.(b).The dividends received deduction(DRD) is allowed to be deducted beforecalculating the NOL.

s. Inventory Valuation Methods

(2) Requirement:(a). Accrual basis of accounting forpurchases and sales with inventory is amust.(b). A change in inventory method isconsidered a change in accountingmethod and must be approved by theIRS.(c). Valuation method must be consistent

same method used on valuing openingand closing inventory.

(3) Basic Valuation Methods(a). Cost Method: = DL + DM + OH Disc + Frt-in, no prime cost (no OH)&no direct cost (no fixed OH).

(b).Lower of Cost or Market Method

Inventories are valued at the lower of

10


11/48

cost (per above) or market, which, fornormal goods is generally the current bid

price at the date of inventory(c).Rolling-Average Method: Not beallowed when inventories are held forlong periods of time in somecircumstances or when costs tend to

fluctuate significantly (unless thetaxpayer regularly re-computes costs andmakes certain adjustments)

(d).Retail Method: approximate the costor the market of items in inventory bysubtracting the mark-up percentage toretail from the retail price

(3) Common Inventory IdentificationMethods (Cost-Flow Assumptions)

(a).FIFO (First-in, First-out) Method most commonly used method.

(b).LIFO (Last-in, First-out) Method:LIFO must be elected by the taxpayer inthe first year it is used, and must be usedfor its financial statement purposes too.Significant adjustments to inventory

valuations may be required to use LIFO.

11


12/48

(c). Specific Identification Method

(4) Uniform Capitalization Rules

(DL+DM+MOH) if subject to theuniform capitalization rules, othermethods may not allowed to be used.

(5) Unsalable or Unusable Goods deemedas unsalable or unusable, expected

selling price ("bona fide selling price")within 30 days minus the costs to disposeof them.

t. General Business Credit

(1) Included Credits:(a). Investment credit;(b). Work opportunity credit;(c). Alcohol fuels credit;(d). Increased research credit (generally20% of the increase in qualified researchexpenditures over the base amount for

the year);(e). Low-income housing credit;(f). Small employer pension plan start-upcosts credit;(g). Alternate motor vehicle credit;

12


13/48

(h). Worker retention credit (allowedfor each qualified worker for the first

year of eligibility - lesser of $1 ,000 or6.2% of qualified wages per qualifiedworker in 2011); and(i). Other infrequent credits.

(2) Formula: total credit limit = "net income

tax" the greater of:(a) 25% (regular tax -$25,000), or(b) "Tentative minimum tax" for theyear.

(3) Unused Credit Carryover carried backone year and forward twenty years

u. Special deduction:

Charitable Contributions

(1) Deduction limitation 10% adjustedtaxable income

(2) Carry over not deducted contribution

carried forward 5 years.(3) Time limit Accrual must be paid within

2&1/2 months after the tax year end

(4) Adjusted taxable income = Gross income business deductions, but not including:

13


14/48

(a). Any charitable contributiondeduction;

(b). The dividends received deduction;(c). Any net operating loss carry back;(d).Any capital loss carry back; or(e). U.S. production activities deduction.

Dividends received deduction

(1) Percentage of Dividends ReceivedDeduction is based on the stock ownership ;

(a). 70% for < 20% ownership (unrelated)(b). 80% for 20% to < 80% (large

investment)(c). 100% for 80% or more (consolidate)

(2) Amount = percentage x QualifiedDividend

(a). Maximum Deduction limit to the

percentage x Taxable income beforeDRD, When No NOL exist or becreated.

(b).When NOL exist or be created,Deduction will not limit

14


15/48

(3) Owned at least 45days before or afterthe dividend income.

III. Depreciation The Modified Accelerated CostRecovery System (MACRS) is used for the majorityof depreciation expense for taxation.A. MACRS - Property Other than Real Estate

1. Types of Property ADR (Asset

Depreciation Range)Class ADR midpoint Description

3-y200%

4 years No automobiles

5-y

200%

4 < ADR < 10 Automobiles, light

trucks, computers,typewriters,copiers, &duplicatingequipment.

7-y200%

10 ADR < 16 Office furniture &fixtures, equipment,

property with noADR midpoint notclassifiedelsewhere, &

railroad track.

15


16/48

10-y200%

16 ADR < 20

15-y150%

20 ADR < 25 Sewage treatmentplants, telephonedistribution plants,and comparableequipment use for

the two-wayexchange of voice&datacommunications.

20-y150%

25 years Other than realproperty with anADR midpoint of27.5 years andmore, includingsewer pipes.

2. MACRS Depreciation Rules (1987 andbeyond)

a. MACRS Modified Accelerated CostRecovery System. For 3-,5-,7-, and 10-yearMACRS property (other than real property)

placed in service afterJanuary 1, 1987

16


17/48

b. Calculation MACRS: depreciation =declining balance 1 / years of class 200% (or

150%)3. Salvage Value No salvage value under the

method.

4. Half-year Convention In general,depreciation for the year the proper was

placed in use or disposed is treated as it isplaced or disposed at midpoint of the year.

5. Mid-quarter Convention If more than40% of depreciable property is placed inservice in the last quarter of the year, the

mid-quarter convention must be used.B. MACRS - Real Estate (salvage valueignored/ subtract land cost)

1. Residential Rental Property (27.5-year straight-line) include apartments and duplex rental homes.

2. Non-residential Real Property (39-yearstraight-line) include office buildings andwarehouses. Tenant improvements to the interiorqualify for depreciation over 15years.

3. Mid-month Convention Straight-linedepreciation & One half for first and last month.

17


18/48

C. Expense Deduction in Lieu of

Depreciation (179)

1. Depreciable property allowed to expense in theyear acquired

2. Expense deduction limit $250,000.00(139,000.00 for 2012)

3. Limit reduced dollar for dollar when property

exceeds $800,000(560,000.00 for 2012)4. No deduction if it could have net loss.

5. Vehicles Qualify for the full Section 179Deduction

a. Section 179 limits the cost of a sport utility

vehicle (SUV) that may be expensed to $25,000.b. Nature of vehicle for the purpose: not likelyto be used for personal purposes, including thefollowing vehicles:

(1) Heavy non-SUV vehicles with a cargo

area at least six feet in interior length (thisarea must not be easily accessible from thepassenger area.) To give an example, manypickups with full-sized cargo beds willqualify (although some "extended cab"

pickups may have beds that are too small toqualify).

18


19/48

(2) Vehicles that can seat nine-pluspassengers behind the driver's seat (i.e.:

Hotel / Airport shuttle vans, etc.).(3) Vehicles with: (1) a fully-encloseddriver's compartment / cargo area, (2) noseating at all behind the driver's seat, and (3)no body section protruding more than 30

inches ahead of the leading edge of thewindshield. In other words, a classic cargovan.

D. Straight-line in Lieu of AcceleratedDepreciation Election S-L regular or longer

period available for election.IV. Depletion Exhaustible natural resources:timber, oil, gas or mineral. The two methods ofdepletion are (i) cost depletion and (ii) percentagedepletion.A. Cost Depletion(GAAP)

Under cost depletion, the remaining basis of theproperty is divided by the remaining numberof recoverable units (tons of ore, barrels of oil) toarrive at the unit depletion rate. Thededuction for depletion is the depletion unit rate

multiplied by the number of units sold for the

19


20/48

year.B. Percentage Depletion(non-GAAP)

1. Depletion deduction = Percentage GrossIncome from the property2. Percentage range from 5% to 22%3. Mines and other natural deposits Thefollowing is a list of the percentage depletion rates

for the more common minerals.

DEPOSITS RATE

Sulphur, uranium, and, if from deposits in the

United States, asbestos, lead ore, zinc ore,nickel ore, and mica 22%

Gold, silver, copper, iron ore, and certain oilshale, if from deposits in the United States 15%

Borax, granite, limestone, marble, mollusk

shells, potash, slate, soapstone, and carbondioxide produced from a well 14%

Coal, lignite, and sodium chloride 10%

Clay and shale used or sold for use in makingsewer pipe or bricks or used or sold for use as

sintered or burned lightweight aggregates 7%

20


21/48

Clay used or sold for use in making drainageand roofing tile, flower pots, and kindred

products, and gravel, sand, and stone (otherthan stone used or sold for use by a mineowner or operator as dimension or ornamentalstone) 5%

4. Deduction limit limit 50% (100% for oil and

gas property) of your taxable income from theproperty before depletion deduction and the domesticproduction activities deduction5. No basis limit, so deduction may allowed aftercost completely recovered6. Depletable oil or natural gas

Depletable quantity: oil 1,000 barrels. Gas6,000 cubic feet your depletable oil quantity thatyou choose to apply. If you claim depletion on bothoil and natural gas, you must reduce your depletableoil quantity (1,000 barrels) by the number of barrels

you use to figure your depletable natural gas quantity.V. Amortization

A. Intangibles

1. S-L 15years.

2. Including: goodwill, licenses, franchises, and

trademarks

21


22/48

3. Starting on the month of acquisitionB. Others

1. Business start-up expenses or organization costs-180ms2. Research expenses 60ms3. Pollution-control facilities.VI. Summary of Section 1231, 1245, & 1250 Assets

A. Section 1231assets (loss is ordinary, gain iscapital) depreciable property used in the taxpayer'strade or business and held for over twelve months.1. Capital Gain TreatmentA special benefit by allowing capital gain treatment(tax rates of 5% or 15%) on net Section 1231 gainsfrom sales, exchanges, or involuntary conversions ofcertain "non-capital" assets, subject to Section 1245and Section 1250 provisions because certain gains forSection 1231 assets fall under Sections 1245 or 1250.2. Ordinary Loss Treatment Net Section 1231

losses are treated as ordinary losses.a. A capital loss cannot be deducted in excessof capital gains (except for the $3,000 per yearallowance for individual taxpayers), and

22


23/48

b. A Section 1231 net loss is deductedimmediately in full without consideration of

capital gains.B. Section 1245(machinery and equipment) - GainsOnly

1. Personal Business Property

Section 1245 assets are personal properties used in a

trade or business for over twelve months (e.g., autos).2. Recapture all Accumulated DepreciationUpon the sale of a Section 1245 asset (depreciable

personal property):c. The lesser of gain recognized or allaccumulated depreciation is recaptured as

ordinary income under Section 1245, andd. Any remaining gain is capital gain underSection 1231.

C. Section 1250(buildings) - Gains Only1. Real Business Property

Section 1250 assets are real properties used in a tradeor business over twelve months (e.g., a warehouse).2. Recapture Difference Between Straight-line

and Depreciation Taken

e. Section 1250, which differs from 1245, only

recaptures the portion of depreciation taken on

23


24/48

real property (under old assets acceleratedMethod) in excess of straight line.

f. The total amount of the taxable recapture asordinary income for a corporation subject to the

provisions of Section 1250 is equal to the amountof the ordinary income under the general Section1250 rules (above) plus 20% of the straight-line

depreciation that was not recaptured under thegeneral rules.g. The total depreciation recaptured is limited tothe recognized gain

3. Straight-line Depreciation Taken -1231 gaintreatment.4. Excess Gain is Section 1231 Gain(capital gaintreatment)

Sale price (cost S-L depreciation) = Sec. 1231Gain. Capital gain: taxed at 25% maximum rate.VII. Taxation of a C. Corporation

A. Filing Requirements Form 1120 due 2.5months after year end, (March 15, for year end atDec. 31)

1. Legal Holiday or Weekend due on the nextbusiness day

24


25/48

2. Extension (Form 7004) - six months isavailable by filing Form 7004.

3. Accrual Basis vs. Cash Basisa. Cash basis most individuals, qualified

personal service corporations and taxpayerswhose average annual gross receipts 25%misstatement.

25


26/48

b. Reopen a closed if item is ruled deductiblein a subsequent year after having been taken in a

year now closed by the statute of limitations, theIRS will reopen the statute of limitations todisallow the deduction in the previous year.

B. Estimated Payments of Corporate Tax

1. Estimated taxes payments due:on the 15th

day of the 4th, 6th, 9th, and 12th months of their taxyear.2. Each payment: of the estimated tax.Unequal quarterly payments may be made using theannualized income method.3. Penalty will be assessed if these payments arenot made and the amount owed on the return is $500or more.4. Estimated taxes

a. Small Corporations are required to pay thelesser of:

(1) 100% of the tax shown on the return forthe current year, or

(2) 100% of the tax shown on the return forthe preceding year,

26


27/48

(3) Only current year, if no tax for thepreceding year or the preceding tax year

was less than 12 months.b. Large Corporations Must pay estimated taxfor 100% of the tax as shown on the current yearreturn. (a corporation whose taxable income $1million in any of its three preceding tax years)

C. Graduated Tax Rates and Taxable Income1. No exemptions as individuals have2. Taxable income graduated tax rates

Corporations with taxable income above $18,333,333will have all income tax at a flat 35%.D. Consolidated Tax Return

1. Requirements: all the corporations in the group:a. must have been members of an affiliatedgroup at some time during the tax year, andb. must file a consent. The act of filing aconsolidated return by all the affiliated

corporations will satisfy the consent requirement.2. Affiliated Group Defined An affiliated groupmeans that a common parent directly owns:

c. 80% or more of the voting power of alloutstanding stock, and

27


28/48

d. 80% or more of the value of alloutstanding stock

3. Organizations not allowed for consolidated taxreturn:

a. S corporations,b. foreign corporations,c. most real estate investment trusts (REITs),

d. some insurance companiese. most exempt organizations.4. Brother-Sister Corporations Corporationsowned by an individual (not a corporation) with 80%or more of the stock of two or more corporations maynotfile consolidated returns.5. Advantages of FilingConsolidated Return

e. Capital losses of one corporation offsetcapital gains of another corporation;f. Operating losses of one corporation offset theoperating profits of another corporation;

g. Dividends received are 100% eliminated inconsolidation because they are intercompanydividends; andh. A corporation's NOL carryover may beapplied against the income of the consolidated

group.

28


29/48

6. Disadvantages of Filing Consolidated Returna. The disadvantages of filing a consolidated

return include:b. Mandatory compliance with complexregulations;c. In the initial consolidated tax return year, adouble counting of inventory can occur if group

members had intercompany transactionsd. Tax credits may be limited by operatinglosses of other members; ande. The election to file consolidated returns is

binding for future years and may only beterminated by disbanding the group or seeking

permission of the Internal Revenue Service.E. Corporate Alternative Minimum Tax

1. AMT = 20% on alternative minimum taxableincome (AMTI) an exemption amount.

Regular Taxable Income Before NOL

Long-term contracts(percentage)AdjustmentItems toIncome

Installment sale dealer (fullaccr.)Exc.depr. (post 1986)( S-L

40years for real, 150% dec bal)

29


30/48

Percentage depletion(over basis)

+ PreferencesPrivate activity - issued post '86Tax-exempt interest incomePre '87 ACRS excessdepreciation (over S-L)

Municipal interest Taxexempt interest income 75% of thedifference

(neg. adj.limited to past

positive)

Increase CSV life insuranceNon S/L deprec. (after 1989;excess ADS depr. over S-L)Dividends received deduction

(70% under 20% ownership)< A.M.T. NOL Deduction>

Minimum Taxable Income

< A.M.T. Exemption> =$40,000 25% (MTI 150,000)

A. M. T. Income 20%

Gross Alternative Minimum Tax

Tentative A. M. Tax

< Regular Tax Liability >

30


31/48

Alternative Minimum TaxTax due inaddition to

regular tax2. Minimum Tax Credit (MTC)

a. AMT paid would be future year regular taxcreditsb. Carry forward: The MTC may be carried

forward indefinitely, but no carry back.F. Accumulated Earnings Tax1. Condition:

a. C Corporation: > $250,000.b. Personal service corporations: > $150,000c. No Accumulated Earnings Tax on personalholding companies (PHCs), tax-exemptcorporations, or passive foreign investmentcorporations.

2. AE Tax rate: a flat 15%.3. To avoid AET: must be:

a. A demonstrated specific, definite, and feasible planfor the use of accumulation (reasonable needs); or

b. A need to redeem the corporate stock included in adeceased stockholder's gross estate.

4. Not self-assessed Tax: AE Tax assessed by IRS

audit, not self assessed.

31


32/48

5. To reduce AE Tax: A dividend paid by thedue date of the tax return or hypothetical "consent"

dividends may reduce or eliminate the tax.6. AET Calculation

32


33/48

G. Personal Holding Company Tax Tax Shelters

TAXABLE INCOME

Before:Dividends receiveddeduction

Net operating lossCharity deductionCapital loss carryover

< All Charity >< All Capital Losses>

< Taxes>

< Dividends Paid>

During tax year

Within 2&1/2, months

Consent dividends

Accumulated Taxable Income

Lifetime Credit:250,000(Reg.corp)

BusinessNeed:

or Beg. E&P150,000(Serv.corp.)

Beg. Excess

Remaining Credit

Current AccumulatedTaxable Income

15%

Accumulated Earnings Tax

33


34/48

1. Definition of Personal Holding Company

a. Ownership: > 50% owned by 5 at any time

during the last half of the tax yearb. AGI: 60% of adjusted ordinary gross incomeconsisting of:

(1) Net rent (if less than 50% of ordinarygross income);

(2) Interest that is taxable (nontaxable isexcluded);

(3) Royalties (but not mineral, oil, gas, orcopyright royalties)(4) Dividends from an unrelated domesticcorporation.

2. Additional Tax Assessed

a. Taxed Rate: 15% addition tax on personalholding company net income not distributed.b. Net income not distributed = Taxable income

Federal income taxes Net L-T capital gain

(net of tax).c. No addition tax if distributed (actualdividends paid or consent dividends).d. No Accum. Earnings Tax.

3. Self-assessed Taxby filing Schedule 1120 PH

with 1120.

34


35/48

H. Personal Service Corporations:1. No Graduated Rates, a flat tax rate of 35%

2. Professional service companies: accounting,law, consulting, engineering, architecture, health, andactuarial science.VIII. Corporate Earnings and Profits (E&P)

E&P (taxation) Retained Earnings (GAAP): for

example, while non-taxable dividends reduceretained earnings, they have no effect on E&P (non-profit distribution)A. General

1. Required for Corporate Income Tax Return

Preparation The calculation of E&P (both the

current and prior accumulated amounts) is required inthe preparation of the corporate income tax return.2. Impact on Corporate Distributions and Other

Activities

a. E&P the ability to pay a dividend, while

Retained earnings net financial position, used toevaluate its common stock,

b. The calculation of E&P tax impact ofcorporate distributions, or non-liquidatingdividends (note that special rules exist for 20%

shareholders).

35


36/48

c. E&P is a factor in the determination ofcorporate reorganizations, accumulated earnings

tax, stock redemptions, partial liquidations, andthe tax status of certain S corporations that have

previously been C corporations (e.g., passiveincome limit rules).

3. Start with Corporate Taxable Income

E&P is calculated by adjusting the taxableincome of the corporation. Any items not in taxableincome but may impact ability to pay dividendswould be included in E&P.B. Adjustments

1. Positive and Negative Adjustments alwayspositive, always negative, or either positive ornegative.2. Temporary or Permanent presents thecorporate Schedule M-1.

C. Current Earnings and Profits General

Calculation Corporate taxable income:1. Negative Adjustments (not deductible on tax)

a. Federal income tax expenseb. Non-deductible penalties, fines, politicalcontributions, etc.

36


37/48

c. Officer life insurance premiums[corporation is the beneficiary]

d. Expenses for production of tax-exemptincome (non-taxable income expenses)e. Non-deductible charitable contributionsf. Non-deductible capital losses

2. Positive Adjustments (not included in taxable

income)a. Refunds of federal income tax paidb. Tax-exempt incomec. Refunds of items that were not subject toregular tax under the tax benefit ruled. NOL deductionse. Life insurance proceeds where corporation isthe beneficiaryf. Dividends received deduction used tocalculate regular taxable incomeg. Carryovers of capital losses that impacted

taxable incomeh. Carryovers of charitable contributions thatimpacted taxable incomei. Non-taxable cancellation of debt not used toreduce basis of property

3. Positive or Negative Adjustments

37


38/48

a. Losses and gains that have differenteffects on taxable income vs. E&P

b. Changes in the cash surrender value ofcertain life insurance policiesc. Excess depreciation for E&P over that forregular income taxd. Differences in allowable deductions for

organizational and start-up expensese. Installment income method adjustmentsf. Completed contract income vs. percentage-of-completion income adjustmentsg. Amortization of intangible drilling costsadjustmentsh. Section 179 expense per regular tax vs.ratable depreciation on the same property using afive-year life:i. = CURRENT EARNINGS AND PROFITS(E&P)

D. Accumulated Earnings and Profits1. General Calculation the accumulated E&P tocarry forward to next year:Accumulated E&P as of the beginning of the year

+/- Current E&P for the tax year

Distributions deemed from current E&P

38


39/48

Distributions from accumulated E&P

= Accumulated E&P as of the end of the year

2. Classification of Distributiona. current E&P, pro rate basis to eachdistributionb. accumulated E&P, chronological order,

beginning with the earliest distributionIX. Corporate Distributions taxable if classifiedas dividends.A. Dividends Defined a distribution of property

by a corporation out of its earnings and profits(E&P):

Current E&P (byyear-end) (Pro rated)

Taxabledividend Separated

not netAccumulated E&P(distribution date)

Taxabledividend

Return of capital (no

E&P)

Tax free & reduces

basis of common stockCapital gaindistribution (noE&P/no basis

Taxable income as acapital gain

1. General Netting Rules

39


40/48

a. If current E&P is positive andaccumulated E&P is negative, distributions are

dividends = current E&P only.b. If current E&P is negative and accumulatedE&P is positive, the two amounts are netted, anddistributions are dividends = net positive.c. If current and accumulated E&P are net

negative, distributions are not dividends at all.2. Preferred vs. Common a. Receiving priority over commonb. Taxable income

B. Source of Distributions

1. Order of Distribution Allocationa. current E&P first Pro rateb. accumulated E&P. chronological orderc. nontaxable return of capitald. capital gain distributions (taxable income) bythe shareholder, if any excess remains, it is

classified as "excess distributions"C. Constructive Dividends

1. Excessive salaries paid to shareholderemployees2. Excessive rents and royalties

40


41/48

3. "Loans" to shareholders where there is nointent to repay

4. Sale of assets below fair market valueD. Stock Dividends

1. Definition a distribution by a corporation of itsown stock to its shareholders.2. Generally Not Taxable unless the shareholder

has a choice of receiving cash or other property.3. Determination of Value the value oftaxablestock dividend is the fair market value on thedistribution date.4. Allocation of Basis The basis of stock dividend= total old stock basis / # of stock(old + new)E. (Shareholder)Taxable Amount

1. Individual Shareholder

a. Cash dividends - amount receivedb. Property dividends - FMV of propertyreceived

2. Corporate Shareholders (subject to thedividends received deduction)

a. Cash dividends - amount receivedb. Property dividends - FMV of propertyreceived

41


42/48

F. Corporation Paying Dividend - TaxableAmount

1. General Rule not a taxable event. A dividendis a reduction of earnings and profits (retainedearnings).2. Property Dividends distribution of appreciated

property, tax as follows:

a. Gain recognized as if sold (FMV adjustedbasis). Gain added to current E&P.FMV Property< Net Book Value>Corp. Gain Current E&P

42

Pass Key

1. Corporation has no E&P (dividend would notbe taxable income)2. Corporation distributes appreciated propertyas a dividend

3. Corporation has a recognized gain (onproperty dividend)4. Corporate gain increase/creates corporateE&P5. Dividend to shareholder is now taxable


43/48

b. Dividend = FMV of property to the extentof current E&P

c. no loss recognized when depreciableproperty is distributed

G. Stock Redemption qualifies for sale orexchange treatment, gain or loss is recognized1. Proportional- Taxable dividend income (to

shareholder-ordinary income) for redeems or cancelsthe stock pro-rata for all shareholders.2. Disproportional (substantially disproportionate)- Sale by shareholder subject to taxable capitalgain/loss to shareholder percentage of ownershipchanged after redemption3. Partial liquidation of corporation (stock held

by a non-corporate shareholder) Treated as anexchange of stock, not as a dividend.4. Complete buy-out of shareholder-Shareholder's entire interest is redeemed, and the

transaction is treated as an exchange of stock.5. Redemption not essentially equivalent to adividend - Treated as an exchange of stock.6. Redemption to pay estate taxes-or expenses -Treated as an exchange when the corporation

redeems stock that has been included in the

43


44/48

decedent's gross estate (subject to dollar and timelimitations).

X. Corporate LiquidationIf a corporation is liquidated, the transaction issubject to double taxation (that is, the corporation andthe shareholder must generally recognize gain orloss). Note that the corporation generally deducts its

liquidation expenses (e.g., filing fees, andprofessional fees) on its final tax return. Corporationliquidations take two general forms:

A. Corporation Sells Assets and Distributes Cashto Shareholders

1. Corporation recognizes gain or loss (as normal)on the sale of the assets, and

Sale PriceTaxable Gain/Loss

2. Shareholders recognize gain or loss to extent

cash exceeds adjusted basis of stock.ProceedsTaxable Gain/Loss

B. Corporation Distributes Assets to

Shareholders:

44


45/48

1. Corporation recognizes gain or loss as if itsold the assets for the FMV, and

Property FMVTaxable Gain/Loss

2. Shareholders recognize gain or loss to extentFMV of assets received exceeds the adjusted basis of

stock. Property FMVTaxable Gain/Loss

C. Tax-free Reorganizations1. Reorganization Defined

a. Mergers or consolidations (Type A);

b. The acquisition by one corporation ofanother corporation's stock, stock for stock (TypeB);

c. The acquisition by one corporation ofanother corporation's assets, stock for assets(Type C);d. Dividing of the corporation into separateoperating corporations (Type D);e. Recapitalizations (Type E); and

45


46/48

f. Mere change in identity, form, or place oforganization (Type F).

2. Parent/Subsidiary Liquidationa. No gain or lossby either the parent or thesubsidiary when the parent, who owns at least80%, liquidates its subsidiary.b. Parent assumes the basis of the subsidiary's

assets as well as any unused NOL or capital lossor charitable contribution carryovers.3. Nontaxable Event - reorganizations

a. Corporation Nontaxable(1) Nontaxable transaction.(2) All tax attributes remain.

b. Shareholder -Nontaxable(1) Nontaxable transaction.(2) Retain his/her original basis on stocks(3) Gain to the extent he/she receives boot(cash) in the reorganization.

4. Continuity of Business nontaxablereorganization requirements the acquiring

corporation must:

a. continue the business of the old entity (orentities), or

46


47/48

b. use a significant portion of the oldcorporation's assets.

5. Control Requirement nontaxablereorganization control test:

At least acquired 80% of the total voting power of allclasses of stocks, andAt least 80% of all other classes of stock.

6. Distinguish Reorganization from LiquidationPass Key

Business

Activity

Corp.

Conseq

Sharehold.

Conseq.

LiquidationComplete

ceasesTaxable Taxable

Reorganization Continues Nontaxable Nontaxable

D. Worthless Stock- Section 1244 Stock (smallbusiness stock) ordinary loss treatment for worthless

stock

1. Qualification

a. Must be an original stock holderb. Stock acquired by cash or property, not bystock, securities, or service

c. Cash or property for first $1,000,000 ofcapital stock

2. Maximum Ordinary Loss Deduction

47


48/48

a. Married-$100,000

b. Single - $50,000

E. Small Business Stock- 50% Exclusion ofGain1. Qualification

a. Must be a non-corporate shareholder(individual or partnership)

b. Hold stock for more than 5 years.

c. Stock must be:(1) issued after August 10, 1993.(2) Acquired at the original issuance.(3) C corporation only (not an Scorporation).

(4) Capital < $50 million as of date of stockissuance.(5) Corporations 80% (or more) of assetsmust be used in qualified trades or

businesses.2. Maximum exclusion - limited to 50% of thegreater of:a. 10 times the taxpayer's basis in the stock, or

b. $10 million dollars (shareholder by shareholderbasis)

48

C Corporation Operation

Documents

Transcript of C Corporation Operation