llm corporate tax instructor: dwight drake taxation of corporations and shareholders law t 501...

LLM Corporate Tax Instructor: Dwight Drake

Taxation of Corporations and Shareholders

Law T 501

University of Washington School of LawLLM Program in Taxation

Instructor: Dwight Drake

Fall 2009


Contact Info – Office Hours

Email: [email protected]

Phones: 425.281.1493, 425.222.5988, 360.778.1862

URL:http://faculty.washington.edu/djdrake/CorpTaxindex.shtml

Office Hours: Room 416 - Thursday 11:30 a.m. to 1:00 p.m. - By Appointment.

Whenever else you can catch me!

mailto:[email protected]

http://faculty.washington.edu/djdrake/


Course Objectives

• Substantive knowledge base – Corporate Taxation

• Develop, hone tax learning skills

• Internalize the “Concepts”

• Strengthen analytical, problem-solving skills

• Introduce the planning process

• Your role – design, not default


America’s Privately-Owned Businesses

• 29 Million

• 99 % of all employers

• 75% of all new jobs

• 53% of private workforce

• 70% of all first jobs

• 50% of all sales

• Largest client base for professionals

• Badly under-serviced by Bar


The Lawyer’s Role as an Advisor to Business Owners, Professionals and

Entrepreneurs

Flash Presentation (20 Min. approx) byDwight Drake

Law School Website-Career-Students-Job Resources-Career Tools-Flash

Note: It takes a few minutes to load

http://www.law.washington.edu/Career/Handouts/Flash

http://www.law.washington.edu/Career/Handouts/Flash


Some Tips…• First: Beat Up Code. Learn to talk Code

• Find the “Concept” of each section.

• Then Text and Regs. to fill gaps for you.

• First work Problems hard on your own.

• Download PP Slides in advance of class – reconcile with your own answers. This is key learning moment.

• Think and mentally prepare your pitch.

• Track class discussion.

• Write personal summary following class.

• Get ahead – Stay ahead!


Grade Criteria

• 100% final

• No tricks or gimmicks

• Focus on problems and class discussion

• Can use any non-living thing

• Key is to have your reminder aids well organized

• Premium on knowing scope of materials well

• Completely “Ace-Able” by all!


Federal Tax Sources

2001 2002 2003 2004 2005 2006 2007

Pers. Income 994.3 858.3 793.7 809.0 927.2 1,043.9 1,163.5 Corp. Income 151.1 148.0 131.8 189.4 278.4 353.9 370.2Social Insurance 694.0 700.8 713.0 733.4 794.1 837.8 869.6Excise Taxes 66.2 67.0 67.5 69.9 73.1 74.0 65.1Estate & Gift 28.4 26.5 22.0 24.8 24.8 27.9 26.0Misc. 57.2 52.5 54.4 53.9 56.4 74.0 65.1

Total Revenue 1,991.2 1,853.2 1,782.3 1,880.3 2,153.9 2,407.3 2,567.7

All in billions


Business Entity Forms

• C Corporations - Subchapter C (§§301-385)

• S Corporations - Subchapter S (§§1361-1379)

• Unincorporated Single Owner - Individual Proprietorship

• General Partnerships – Subchapter K (§§701-777)

• Limited Partnerships – Subchapter K (§§701-777)

• Limited Liability Companies - Subchapter K (§§701-777)


Copyright 2005 Dwight Drake. All Rights Reserved.Business Planning: Closely Held Enterpriseswww. drake-business-planning.com

US BusinessesProjected Revenues 2007

Corporations $ 21.58 Trillion (84.2%)

Sole Proprietorships $ 1.23 Trillion (4.8%)

Partnerships $ 1.35 Trillion (5.3%)

Limited Liab. Companies $ 1.45 Trillion (5.7%) Total $ 25.61 Trillion



Duncan and Sandy Smith Plan

Daughter Trust

Son Trust

Daughter Trust

GC Trust – 1

GC Trust – 2

GC Trust – 3

GC Trust – 4

GC Trust – 5

GC Trust – 6

Duncan and Sandy Living Trust

PersonalResidenceTrust

FamilyL.L.C.(Growth)

FamilyL.L.C.(New)

DynastyInsuranceTrust

CharitableRemainderTrust

CCorporation

HoldingS Corp(Parent)

AlmaMater

Qualified Retirement

Plan

QSSSCorp(One)

QSSSCorp(Two)

IncomeCharitableDeduction

Assets

Remainder

Contributions

Distributions

Distributions

Compensation

Distributions

HomeTermUse

Assets

Assets

Cash

Remainder

Income

Units

Units

Income,support


Our Focus Issues – The Big Picture

• Taxation of Corporations

• Entity Formation Tax Issues

• Capital Structure Tax Issues

• Dividends and Other of Non-Liquidating Distributions

• Transactions Between the Corporation and Its Shareholders

• Corporate Liquidations

• Taxable Transfers of Corporate Assets or Stock

• Brief Introduction to Corporate Tax-Free Reorganizations


The Big Overriding Traps

• Sham Transaction

• Business Purpose

• Step-Transaction

• Substance Over Form

• Section 482


Trap One: Sham Transaction

Business Entity

Phony Off ShoreOperation

Common Owner

Service Fees

Cash Transfers

Note: No Business Purpose


C Corp

Shareholder

Trap Two: Form Over Substance

10k for stock 500k loan - Deductible interest - No repayment plan

What’s wrong here?


Trap Three: Step Transaction

Business Entity

Child of owner Owner

Cash proceeds sale of asset

Asset Gift

Note: No Business Purpose

Cash Gift


Trap Four: Section 482

C Corp A

Common owners

C Corp B

Bargain sale

Imputed Income

Imputed DividendImputedContribution


Calculating the Entity’s Taxable Income

Taxable Income = Gross income - Allowable Deductions Section 63

Gross Income = “all income from whatever source”. Section 61

Deductions = “all ordinary and necessary expenses paid or incurred in carrying on any trade or business” + Special Deductions Section 162


• No personal expenses.

• No exemptions.

• Capital losses only to extent of capital gains.

• 10% charitable contribution limitation vs. 50% for personal

• Any tax year, except for “personal service C corps” and S corp.

• Must use accrual accounting method unless farm, personal service corps or gross receipts under 5 mill.

• Deductions and loss limits on transactions between C Corp and more-than-50% owner per 267.

Compared to Personal Income Taxes…


• Section 162(m) $1 mill executive comp limit for public C corps

• Section 243 Dividend Deduction - 70%, 80%, or 100%

• Section 199 Domestic Production Deduction - % of lesser of taxable income or “qualified production income”. - 6% 2007-09, 9% after 09. - Key limitation: 50% of w-2 wages. - Key definitions related to “qualified production income” from FSC and DISC regs. - With repeal of Extraterritorial income (ETI) rules, real winners are manufactures who sell in U.S.

Select Corp Deduction Provisions


C Corp Bracket Racquet First 50k 15%

Next 25k 25%

Next 9 mill, 925k 34%

Over 10 mill 35%

Plus…

First Bubble: If over 100k, lesser of 5% of excess or 11.75k

Second Bubble: If over 15 mill, lesser of 3% of excess or 100k.

Bad News: If qualified personal service corporation, flat 35%


C Corp Alternative Minimum Tax

Good New! Not apply:• In first year of corp• In first three years if average gross receipts under 5 mill• In any year if gross receipts in preceding three years less 7.5 mill.

Bottom Line: All Small C corps Safe.

AMT Burden:

• Add back Section 56 adjustments• Add back 75% of Adjusted Current Earnings account• AMT rate is 20%

The “Push to Kill It” is on!


C Corp Losses


Losses

C Corp

Shareholders

Carry Back Carry Forward

Never Pass Thru


Basis Game

Corporation’sInside Basis in Assets

Shareholder’s Outside Basis in Assets

Contributions Distributions


C Corp Non-Basis Booster


0

200

400

600

800

1000

1200

1400

1600

1800

2000

Capital 1st Yr.Income

2nd Yr.Income

3rd Yr.loss

4th yr.income

Stock Basis


S Corp, Partnership, LLC Loss


Loss

S Corp

Owners

Pass Thru

Hurdles:

• Basis limitations (704(d) and 1366(d))

• At-risk limitations (465)

• Passive activity limitations (469)


S Corp, Partnership, LLC Income


Income

S Corp

Owners

Pass Thru

Impacts:

• No entity level tax

• 1366(a) separately stated items

• Entity level accounting period & elections

• Generally calendar year


S Corp Basis Adjustments Per 1367

Contributions Distributions Income Losses

Basis UpBasis Up

Basis Down Basis Down


Pass-Thru Entity Basis Booster


0

200

400

600

800

1000

1200

1400

1600

1800

2000

Capital 1st Yr.Income

2nd Yr.Income

3rd Yr.loss

4th yr.income

Stock Basis


Problem P. 24

(a) Boots Inc. Taxable Income and Regular Tax

Inventory Sales 2,500,000

Dividends 100,000

Capital Gains 200,000

Gross Income 2,800,000

Operating Expenses 600,000

Depreciation 800,000

Capital Loss (limited to gain) 200,000

Passive activity loss 130,000

Dividend received deduction (243) 70,000

Taxable Income 1,000,000


Problem P. 24

Tax liability:

15% of 50k = 7,500

25% of 25k = 6,250

34% of 925k = 314,500

First bubble = 11,750

Tax 340,000 (Note: Flat 34% Rate)


Problem P. 24

(b) Dividends totaling $660,000 distributed:

Shareholders tax @ 20% = 132,000

Corporate tax = 340,000

Total tax hit 472,000.

Combined tax rate 47.2%

Note: Without Bush favorable capital gain rate, due to expire at the end of 2010, Shareholder tax goes to $264k @ 40% combined rate and total tax hit goes to 60.4%.


Problem P. 24

(c) Compensation of $1 million paid to Emil and Betty

Shareholders tax @ 40% = 400,000

Corporate tax = 0

Total income tax hit = 400,000.

Combined tax rate 40%

But this not all - there’s another tax that no one ever wants to talk about: The Payroll Tax.


Problem P. 24

(c) Payroll Tax:

15.3% of first 106.8k per person (2009 Amount).

2.9% on excess per person.

Half deductible by corp.

Impact in this situation:

Payroll taxes 52,360

Shareholder income 400,000

Corporate tax 0

Total income tax hit = 452,360.

Combined tax rate 45.2%


Problem P. 24

(c) Note impact if S corporation:

- No corporate tax

- No payroll tax

- If passive losses good, total income passed thru to shareholders is 1,067,000 (no 70k 264 dividends deduction, and 3k capital loss). Tax as follows to shareholders:

100k dividends @ 20% = 20,000

967k @ 40% = 386,800

Total Tax 406,800 (40.7%)


Earnings Bailout – The New Math

C Corp C Corp S Corp

Dividend Bail Comp Bail Owner Bail

100k Income

C Corp Tax 22,250 0 0

Shareholder Inc Tax 11,662 20,674 22,627

Payroll Tax 0 13,854 0

Total 33,912 34,528 22,627

Percentage 33.9% 34.5% 22.6%

llm corporate tax instructor: dwight drake taxation of corporations and shareholders law t 501...

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