Download - Chapter 1 managerial accounting
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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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