chapter 11 the corporate taxpayer mcgraw-hill/irwin copyright © 2014 by the mcgraw-hill companies,...
TRANSCRIPT
Chapter 11Chapter 11
The Corporate Taxpayer
McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
11-2
Identify legal characteristics of corporations Compute the dividends-received deduction Prepare a Schedule M-1 reconciliation Compute regular tax on corporate income Discuss corporate AMT Describe payment and filing requirements Explain why dividends are taxed twice Discuss the incidence of the corporate income tax
The Corporate TaxpayerThe Corporate Taxpayer
11-3
Limited liability of shareholders Owners of closely-held corporations often are required to personally
guarantee repayment of debt Licensed professionals must still carry malpractice insurance
Unlimited life Legal existence not affected by changes in ownership
Free transferability of interests Through regulated markets with maximum
convenience and minimal transaction cost For closely-held corporations, a buy-sell
agreement may prevent transferability
Centralized management
Corporation Legal CharacteristicsCorporation Legal Characteristics
11-4
Affiliated groups = a parent corporation that directly owns at least 80% of at least one domestic subsidiary + all other domestic subsidiaries that are 80% owned within the group
Affiliated groups may elect to file a consolidated tax return - applies to all members of affiliated group Advantage: losses and profits of
affiliated members offset each other
Affiliated Groups and ConsolidationsAffiliated Groups and Consolidations
11-5
Nonprofit CorporationsNonprofit Corporations
Includes corporations formed exclusively for “religious, charitable, scientific, literary, educational purposes, etc.”
Section 501(c)(3) organizations require IRS recognition of tax-exempt status
Nevertheless, tax-exempt organizations may pay tax on “unrelated business taxable income”
11-6
Page 1 of the Form 1120 resembles a financial income statement or a Schedule C in a personal tax return (Ch 10) See Chapters 6, 7, 8 and 9 for general rules
on business income Corporations entitled to dividends-received deduction Deduct charitable contributions up to 10% of taxable
income BEFORE charitable deductions and before dividends-received deduction Excess contributions can be carried forward for 5 years
Computing Corporate Taxable IncomeComputing Corporate Taxable Income
11-7
Dividends-Received DeductionDividends-Received Deduction
Corporations receiving dividends from other taxable domestic corporations are entitled to this deduction
Ownership % Deduction % < 20% of stock 70% DRD 20%<= % < 80% 80% DRD 80%<= % 100% DRD What was Congress’ reasoning behind the DRD?
To mitigate “triple” taxation
11-8
Dividends-Received Deduction ExampleDividends-Received Deduction Example
Aragorn Corp. owns 35% of Ent Corp. and 88% of Legolas Corp. If Aragorn receives dividends of $10,000 from Ent and $15,000 from Legolas, calculate Aragorn’s DRD.
$10,000 x 80% = $ 8,000
$15,000 x 100% = $15,000
Total DRD $23,000
11-9
Schedules M-1 and M-3 reconcile book income to taxable income
The M-1 was used by all corporations until 2004 and can still be used by corporations with total assets less than $10 million
In 2004, the IRS developed the M-3 for use by large corporations (assets > $10 million); it requires more detailed information than the M-1 and enhances the transparency of book/tax differences
Book Versus Taxable Income - Schedule M-1 & M-3Book Versus Taxable Income - Schedule M-1 & M-3
11-10
Net book income - line 1 Federal tax expense for books - line 2 Lines 3 - 6 explain increases in taxable income
relative to books Lines 7 - 9 explain decreases in taxable income
relative to books Line 10 = taxable income before
NOL and DRD = Line 28, page 1, form 1120
Schedule M-1Schedule M-1
11-11
Example: Schedule M-1Example: Schedule M-1
Wilson Inc. reported $149,250 of net income after tax on its financial statements Wilson reported federal income tax expense of $61,250 Meals and entertainment expense = $15,000 MACRS depreciation = $60,000; book depreciation =
$42,000 Prepare Wilson Inc.’s M-1
Net book income $149,250 + Federal tax expense + 61,250 + 50% of meals & ent.+ 7,500 - MACRS over SL - 18,000 Taxable Income $200,000
11-12
The surtax rates of 39% and 38% eliminate bracket benefits for ‘rich’ corporations
Corporations with taxable income Between $335,000 and $10 million
actually pay a flat rate of 34% Greater than $18.33 million pay a flat rate of 35%
Personal service corporations are taxed at a flat 35% rate Includes health, law, engineering, architecture,
accounting, actuarial science, performing arts, & consulting professionals
Computing Regular TaxComputing Regular Tax
11-13
Available to US taxpayers deriving income from domestic production activities
For 2013, deduction is equal to 9% of the lesser of net production income or taxable income before the deduction
Deduction can’t exceed 50% of US compensation expense
Deduction is equivalent to a reduced tax rate on domestic production income
Domestic Production Activities DeductionDomestic Production Activities Deduction
11-14
Credits directly reduce computed tax $1 of credit provides $1 of benefit $1 of deduction only provides ($1 x the tax rate) of benefit
Tax credits are generally limited to some % of tax before credits. Often a provision permits carry back or carry forward of excess credits
Biggest credits: R&D credit, foreign tax credit (see Chapter 13)
Tax CreditsTax Credits
11-15
To be eligible, taxpayers must engage in specific activities that Congress believes are worthy of government support
The list of credits changes as Congress experiments with new credits and discards those that fail to produce the intended behavioral result
Tax CreditsTax Credits
11-16
Alternative Minimum TaxAlternative Minimum Tax
A second federal tax system parallel to the regular income tax
Created to ensure that every corporation pays a “fair share” of taxes
11-17
New corporation is exempt in Year 1 Exempt in Year 2 if Year 1 sales <=$5 million Exempt in Year 3 if average sales in years 1 and 2
<= $7.5 million Exempt in subsequent years if average gross
receipts for three prior years <= $7.5 million Once a corporation fails to be exempt, it is
ineligible for AMT exemption for all subsequent tax years
Alternative Minimum Tax - Who is Subject?
11-18
Year 1 sales = $4 million Exempt from AMT because it’s year 1
Year 2 sales = $8 million Exempt because Year 1 sales <=$5 million
Year 3 sales = $12 million Exempt because average of years 1 and 2 = $6 million,
which is <= $7.5 million Year 4 sales = $2 million
Subject to AMT because average of years 1, 2 & 3 = $8 million, which is > $7.5 million
Thus, the firm is subject to AMT in all subsequent years
Example: AMT ExemptionExample: AMT Exemption
11-19
Alternative minimum taxable income (AMTI) less Exemption = AMTI in excess of Exemption x 20% = Tentative minimum tax (TMT) less Regular Tax = Alternative minimum tax (AMT)
Alternative Minimum Tax - OverviewAlternative Minimum Tax - Overview
11-20
Starts with regular taxable income Add AMT preferences Add or subtract AMT adjustments Subtract AMT NOL
Alternative Minimum Taxable Income (AMTI)Alternative Minimum Taxable Income (AMTI)
11-21
Preferences are always positive additions to AMTI Examples
Tax-exempt interest income from private activity bonds - municipal bonds issued to fund non-government activities
Percentage depletion in excess of cost basis
AMT PreferencesAMT Preferences
11-22
AMT AdjustmentsAMT Adjustments
Represent timing differences between regular taxable income and alternative minimum taxable income - will eventually reverse, perhaps over several periods
Examples Differences between MACRS and ADS depreciation
amounts Completed-contract method Amortization of pollution control facilities ACE adjustment
11-23
Adjustment equals 75% of difference between ‘adjusted current earnings’ and AMTI before ACE adjustment and AMT NOL Adjusted current earnings an economic measure of
earnings that approximates financial statement net income
Any negative ACE adjustment (ACE > AMTI before ACE and AMT NOL) limited to cumulative positive ACE adjustments from prior years
ACE AdjustmentACE Adjustment
11-24
AMT NOL amount computed using alternative taxable income approach
Deduction limited to 90% of AMTI before the AMT NOL Example: If AMTI before consideration of any NOL is
$100,000, the maximum allowable AMT NOL deduction is $90,000
AMT NOL DeductionAMT NOL Deduction
11-25
Exemption = $40,000 but is reduced by 25% of the amount that AMTI exceeds $150,000
AMTI in excess of the Exemption is multiplied by 20% = Tentative Minimum Tax (TMT)
If TMT > Regular tax, then TMT less Regular Tax = Alternative Minimum Tax (AMT)
If TMT < Regular tax, AMT = 0 Corporations with modest AMT adjustments and
preferences avoid AMT
AMT - More DetailsAMT - More Details
11-26
Minimum tax credit Results when AMT is paid Reduces regular tax in subsequent year Can’t reduce regular tax to less than TMT Carries forward indefinitely
Corporate AMT is not designed as a permanent tax increase, but only accelerates the payment of tax
Eliminating the AMT is a frequent taxdebate in the news
AMT TimingAMT Timing
11-27
Tax return due 15th day of 3rd month, may extend to 15th day of 9th month However, the extension does not extend the payment
deadline Estimated payments are due on the 15th day of
4th, 6th, 9th, and 12th months Must pay 100% of tax due; Small corporations
(TI < $1 million) may use safe-harbor rule of paying 100% of prior year tax
Underpayment penalty is computed like interest expense but is nondeductible
Payment and Filing Requirements
11-28
Interest payments are deductible, while payments on stock (i.e., dividends) are non-deductible
This creates a bias in favor of debt financing Non-tax costs associated with debt financing
include large cash flow commitments and a greater risk of insolvency
The non-tax costs often outweigh the tax savings associated with debt
Distributions to Investors Distributions to Investors (Creditors & Shareholders)(Creditors & Shareholders)
11-29
Alternatives to Double Taxation of DividendsAlternatives to Double Taxation of Dividends
Treat corporations as pass-through entities Administratively cumbersome, if not impossible
Make dividends nontaxable Current policy of taxing dividends to individuals at 15% is
a step in this direction
Tax credit for individuals for the corporate tax attributable to dividends included in individual taxpayers’ income
All of these alternatives would result in significant revenue loss to the Treasury
11-30
Corporations do not pay taxes - people do What are examples of ways that the incidence of
the corporate tax could be born by individual taxpayers in the U.S.? Higher consumer prices Lower employee wages Lower dividends
Incidence of the Corporate TaxIncidence of the Corporate Tax
11-31