chapter 11
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Chapter 11Chapter 11Corporate Income TaxCorporate Income Tax
2011 Cengage Learning
Income Tax Fundamentals 2011
Gerald E. Whittenburg Martha Altus-Buller
Learning ObjectivesLearning Objectives As pertains to corporations:
Calculate tax liability using tax rates Compute basic capital gains/lossesAscertain how special deduction may affect taxable
incomeIdentify components of Schedule M-1Outline corporate tax return filing and estimated tax
payment requirementsUnderstand how S-Corporations operate and are taxedUnderstand basic tax rules when forming entityDescribe accumulated earnings and personal holding
company taxesDefine elements of alternative minimum tax calculation
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Corporate Tax RatesCorporate 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 recaptures 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 Example Corporate Tax RatesRates
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?
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SolutionSolution
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?
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 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 DeductionDividends 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%
Divends received deduction is limited by % of corporate taxable income shown above
(calculated before certain deductions)
Amortization of Amortization of Organizational ExpendituresOrganizational Expenditures
Examples of organizational expenditures◦ Legal/accounting services incidental to organization◦ Incorporation fees
Organizational expenditures 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 ContributionsCharitable 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 Example Charitable ContributionsCharitable 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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SolutionSolution
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) Reconciliation of Income (Loss) per Books with Income Per per Books with Income Per
ReturnReturn 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-12011 Cengage Learning
Filing Requirements & Estimated TaxFiling Requirements & Estimated Tax
Form 1120 filed for regular corporationForm 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 CorporationsS 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 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
shareholdersor
◦ 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 Example S Corporation ElectionElection
Example
Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2010. In which year may the corporation first be treated as an S Corporation?
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SolutionSolution
Example
Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2010. 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 2010. It will become an S Corporation for tax year 2011.
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Income ReportingIncome 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 ReportingLoss Reporting
Each shareholder of an S Corp may also report his/her respective share of loss◦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 S Corporation Pass Through ItemsPass 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 TaxesSpecial 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 FormationCorporate 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 StockShareholder 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 recognizedLess Liabilities transferred 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 stock2011 Cengage Learning
Note: generally, corporate assumption of shareholder liabilities that are attached to property are not considered boot received
Accumulated Earnings Tax Accumulated Earnings Tax (AET)(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 tax◦ Corporation may accumulate up to $250,000 a year
that is exempt from AET tax or $150,000 for a service corporation
May accumulate more if can prove a valid business purpose
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Example Example Accumulated Earnings TaxAccumulated 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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SolutionSolution
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 TaxPersonal 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 AMTCorporate 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 > $150,0002011 Cengage Learning
You’re Done with Chapter You’re Done with Chapter 1111
2011 Cengage Learning