Chapter 11 corporate income tax
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Chapter 11 Corporate Income Tax. Income Tax Fundamentals 2010 Gerald E. Whittenburg & Martha Altus-Buller. Corporate Tax Rates. Corporate rates are progressive Marginal rates are from 15% to 39%, depending on taxable income There are eight brackets

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Chapter 11 Corporate Income Tax

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Chapter 11 corporate income tax

Chapter 11Corporate Income Tax

Income Tax Fundamentals 2010

Gerald E. Whittenburg &

Martha Altus-Buller

2010 Cengage Learning


Corporate tax rates

Corporate 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’ - occurs 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.

2010 Cengage Learning


Example corporate tax rates

Example Corporate Tax Rates

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 provided personal services?

2010 Cengage Learning


Solution

Solution

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 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%)

2010 Cengage Learning


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

2010 Cengage Learning


Dividends received deduction

Dividends Received Deduction

  • Corporations are allowed a deduction for a % of the dividends received from other corporations

    • Attempt to alleviate triple taxation

  • Dividends received deduction is allowed based upon ownership

  • Percentage Ownership Dividends Received % Deduction < 20% 70%

  • 20% or more, less than 80% 80%

  • > 80% 100%

    • Deductions limited by % and other items

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Amortization of organizational expenditures

Amortization of Organizational 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 year corporation begins business

    • $5,000 amount is reduced $1 for each $1 that organizational expenses exceed $50,000

2010 Cengage Learning


Charitable contributions

Charitable 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

  • Limited to 10% of taxable income*

    • Carry forward unused deduction for five years

      *Calculated before any loss carrybacks, NOLS or the dividend received deduction

2010 Cengage Learning


Example charitable contributions

Example Charitable Contributions

Example

Ferndale Corp. had net operating income of $400,000 for the current year and made a charitable contribution 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 its charitable contribution carryforward?

2010 Cengage Learning


Solution1

Solution

Example

Ferndale Corp. had net operating income of $400,000 for the current year and made a charitable contribution 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 carryforward?

Solution

The charitable contribution deduction is $48,000

($400,000 + 80,000) x 10% = $48,000 limit*

Therefore, carryforward is $32,000 ($80,000 – 48,000)

*Note: had to add back DRD first!!

2010 Cengage Learning


Reconciliation of tax to book income schedule m 1

Reconciliation of Tax to Book Income: Schedule M-1

  • Schedule M-1 of Form 1120 reconciles book to tax income

    • Computed before NOLs and special deductions

  • Amounts added to book income

    • 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

    • 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-1

2010 Cengage Learning


Filing requirements estimated tax

Filing Requirements & Estimated Tax

  • Form 1120 - regular corporation

  • Form 1120S - 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

2010 Cengage Learning


S corporations

S Corporations

  • Certain 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

2010 Cengage Learning


S corporations1

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 shareholders

      or

    • Involuntarily revoked

      • If corporation ceases to be a small business corporation

        or

      • If corporate passive income is 25% or more for 3 consecutive years and corporation has accumulated earnings and profits at the end of each of those years

2010 Cengage Learning


Example s corporation election

Example S Corporation Election

Example

Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2009. What year may the corporation first be treated as an S Corporation?

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Solution2

Solution

Example

Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2009. What year may the corporation first be treated as an S Corporation?

Solution

Since Swannak did not make its election within the first 2-1/2 months of the tax year, it will be treated as a regular corporation for the current year, and will become an S Corporation for tax year 2010.

2010 Cengage Learning


Income reporting

Income 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

2010 Cengage Learning


Loss reporting

Loss 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 midyear, must allocate losses on a daily basis

2010 Cengage Learning


S corporation pass through items

S Corporation Pass 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

2010 Cengage Learning


Corporate formation

Corporate Formation

  • Shareholders often transfer assets to a corporation in exchange for stock

  • No tax is due on gain from transfer of appreciated assets if 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

2010 Cengage Learning


Shareholder basis in stock

Shareholder 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 recognized

    Less 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

Note: generally assumption of shareholder liabilities that are attached to property are not considered boot received.

2010 Cengage Learning


Accumulated earnings tax aet

Accumulated Earnings Tax (AET)

  • Penalty tax designed to prevent a corporation from avoiding tax by retaining earnings

  • 15% AET imposed on “unreasonable” accumulation of earnings in addition to corporate 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

2010 Cengage Learning


Example accumulated earnings tax

Example Accumulated 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?

2010 Cengage Learning


Solution3

Solution

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?

Solution

Its AET = $45,000 (in addition to regular tax)

($800,000 – 500,000) x 15%

2010 Cengage Learning


Personal holding company tax

Personal 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

2010 Cengage Learning


Corporate amt

Corporate AMT

  • Corporate AMT - calculated similar to the individual AMT

  • AMT is 20% of Alternative Minimum Taxable Income

    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 > $150,000

2010 Cengage Learning


You re done with chapter 11

You’re Done with Chapter 11

2010 Cengage Learning


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