Corporate Income Tax Tx 8120. Learning Goals. Explain _____ and _____ of incorporating, Calculate shareholder-level _____, Discuss corporate _______ requirements, Explain corporate choices in accounting ________ and methods,
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Learning Goals • Explain _____ and _____ of incorporating, • Calculate shareholder-level _____, • Discuss corporate _______ requirements, • Explain corporate choices in accounting ________ and methods, • Describe effects of _________ transactions on corporations and owners, and • Determine impact of dividend received deduction. You should be able to:
Corporate form Business Form Choices Sole proprietorships Partnerships C corporations S corporations Limited liability companies
Corporate form Quote Worth Re-Quoting “Decisions to embrace the corporate form of organization should be carefully considered, since a corporation is like a ________ ____: easy to enter, difficult to live in, and painful to get out of.”
Corporate form Check the Box • Treated as corporation if: • _________ business entity • Unincorporated business entity but box _________ • Publicly traded __________ • Unincorporated business entity • ___________ if box checked or PTP • _________ if ≥ two members and box unchecked • _______ (sole proprietorship) if only one corporate (individual) member and box unchecked
Corporate form C Corporation Advantages • Easy to create • Simple ______ procedures • Often done ____-free • Limited liability • Few restrictions on raising capital • No limit on _______ and _____ of owners • Multiple ________ of stock allowed
Corporate form C Corporation Disadvantage(Double Tax) • Many opportunities for reducing double tax in ______-_____ corporations • Deferring __________ • __________ profits as salary, rent, or interest • _______ tax effect may be small • DRD for _________ shareholders, §243 • Individual shareholders taxed at __% or ___%
Corporate form Reducing Double Tax(Siphoning Strategy) Dividends Rate Tax Salary Rate Tax Dividends of $____ Salary of $____ Profit $100 Salary Taxable Rate Tax C C Profit $100 Rate Tax
Tax rate concepts Tax Rate Terminology Statutory Tax Rates: Appear in _____ ________ Tax Rate ________ Tax Rate
Tax rate concepts Section 11(a)(Domestic Corporations) (a) Corporations in general. A tax is hereby imposed for each taxable year on the taxable income of every corporation. Tax base x Tax rate Tax
Tax rate concepts • Income • - Exclusions • Gross income • Regular deductions and losses • Taxable income before special deductions • Net operating loss deduction • Dividend received deduction • Taxable income • x Statutory tax rates • Income tax before credits • Credits • + Recapture of prior credits • Regular income tax liability • + Alternative minimum tax • + Accumulated earnings tax • + Personal holding company tax • Estimated tax payments • Income tax liability DomesticCorporation’sU.S. TaxLiability
Tax rate concepts Section 882(a) (Foreign Corporations) (a) Imposition of tax. (1) In general. A foreign corporation engaged in trade or business within the United States during the taxable year shall be taxable as provided in section 11, 55, 59A, or 1201(a) on its taxable income which is effectively connected with the conduct of a trade or business within the United States. Tax base x Tax rate Tax
Tax rate concepts • Income • - Exclusions • Effectively connected gross income • Apportioned deductions and losses • Taxable income before special deductions • Net operating loss deduction • Dividend received deduction on ECI • Effectively connected taxable income • x Statutory tax rates • Income tax before credits • Credits • + Recapture of prior credits • Regular income tax liability • + Alternative minimum tax • + Investment income @ 30% tax • Estimated tax payments • Income tax liability ForeignCorporation’sU.S. TaxLiability U.S. taxes FCs at: Regular rates on U.S. _________ income ___% (or treaty rate) on U.S. ___________ income
Tax rate concepts Section 11(b)(1) (b) Amount of tax. (1)In general. The amount of the tax imposed by subsection (a) shall be the sum of-- (A) 15 percent of so much of the taxable income as does not exceed $50,000, (B) 25 percent of so much of the taxable income as exceeds $50,000 but does not exceed $75,000, (C) 34 percent of so much of the taxable income as exceeds $75,000 but does not exceed $10,000,000, and (D) 35 percent of so much of the taxable income as exceeds $10,000,000.
Tax rate concepts Section 11(b)(1) In the case of a corporation which has taxable income in excess of $100,000 for any taxable year, the amount of tax determined under the preceding sentence for such taxable year shall be increased by the lesser of (i) 5 percent of such excess, or (ii) $11,750. In the case of a corporation which has taxable income in excess of $15,000,000, the amount of the tax … shall be increased by an additional amount equal to the lesser of (i) 3 percent of such excess, or (ii) $100,000.
Tax rate concepts Statutory Tax Rates(Lower Brackets) 34% 34% 25% Rates 15% $100,000 $200,000 $300,000 Taxable Income
Tax rate concepts Statutory Tax Rates(Upper Brackets) 35% 35% 34% Rates $20 million $5 million $10 million $15 million Taxable Income
Tax rate concepts Marginal Tax Rates Treating corporate profit as incremental income, what is a shareholder’s marginal tax rate on corporate profit currently distributed as a dividend? What is a shareholder’s marginal tax rate on corporate profit distributed as a dividend in a later year?
Tax rate concepts Marginal Tax Rates(Examples) Assume a sole shareholder’s tax bracket is 35% and her corporation’s tax bracket is 35%. What is the shareholder’s MTR on $100 the corporation earns and distributes? Assume the same tax rates mentioned above except the corporation defers paying a dividend for three years. Using a discount rate of 10%, what is the shareholder’s MTR now?
Procedural matters Filing Requirements • File Form 1120 by ___th day of __rd month • Schedule ___ is balance sheet • Schedule ___ reconciles book and taxable income • Schedule ___ reconciles retained earnings • Schedule ___ for midsize and large corporations • Section 6012(a)(2) requires a _______, even if taxable income is zero. • Form 7004 provides an automatic __-month extension
Procedural matters Taxable Years • Selecting initial taxable year on first return • Choices include • ________ year, §441(d) • _______ year, §441(e) • Annual period of __ or ___ weeks ending on same day of week, §441(f) • Income of initial and last year not __________ • Changing taxable year, §442 • Usually needs IRS ________ • Income of short period __________, §443(b)(1)
Procedural matters Taxable Years(Annualizing Income) 2. Annualized income x statutory tax rates =
Procedural matters Taxable Years(Example) Corporation earns $100,000 taxable income during short taxable year of 3 months. Without annualization, the corporation’s federal income tax equals $22,250 (i.e., 22.25% average tax rate). What is the corporation’s actual ATR? Annualized tax = $ x statutory rates = $
Procedural matters Accounting Methods • Corporations generally use ______ method. • Cash method can be used by: • Corporations with average annual gross receipts ≤ $__ million over __-year testing period for all post-1985 years • Qualified ________ service corporations • Corporations in _________ business
Property transactions Capital Gains and Losses(Fundamentals) • Two requirements: • Capital _____, §1221 • _____ or __________, §1222 • Capital gain or loss is “long-term” if taxpayer holds disposed asset > __ _____, §1222.
Property transactions Capital Gains and Losses(Combining) Short-Term Capital Gains Net ST Gain Net LT Gain Net ST gain and ___ capital gain Net ST Capital Gain or Loss or Short-Term Capital Losses Net ST Gain Net LT Loss Capital gain ________ or ___ capital loss or Long-Term Capital Gains Net ST Loss Net LT Gain ___ capital loss or ___ capital gain Net LT Capital Gain or Loss or Long-Term Capital Losses Net ST Loss Net LT Loss ___ capital loss
Property transactions Corporate Capital Gains and Losses(Implications) • Net capital gains and capital gain net income • Taxed same as __________ income • Beneficial since they absorb ________ __________ • Net capital losses • Not currently _____________ • Carried back __ and forward __ years
Property transactions Individual Capital Gains and Losses(Implications) • Net capital gains • Sec. 1202 gain @ ___% (before ___% exclusion) • Most capital gains @ ___% • Individuals in lower brackets @ ___% • Net capital losses • Only ______ annual deduction • Carried forward __________
Property transactions Capital Gains and Losses(Example 1) The average tax rate of Powertie, Inc. each year is 34%. In 2006, Powertie incurs a net capital loss of $15,000. In prior years, Powertie reported the following amounts of capital gain net income: 2002 2003 2004 2005 How much of the $15,000 loss can Powertie deduct on its 2006 return? What tax refund can Powertie claim? How much of the $15,000 loss carries forward?
Property transactions Capital Gains and Losses(Example 2) Bob is a successful day trader who has been in the 28% tax bracket for several years. However, the market was bad this year, and Bob incurred a net capital loss of $40,000. Capital gain net income in prior years was: 2003 2004 2005 How much of the $40,000 loss can Bob deduct on his 2006 return? What tax refund can Bob claim? How much of the $40,000 loss carries forward?
Property transactions Sec. 1231 Gains and Losses • Sale or exchange (and certain ____________ conversions) of • Business property • _______ and • ____________ assets • Held __ __ year
Property transactions Sec. 1231 Gains and Losses • If net §1231 loss occurs: • Treat as _________ deduction and • No _____ against net capital gain • If net §1231 gain occurs: • Treat as ________ income to extent of non-recaptured ______ ______ in prior 5 years, • Treat remaining net §1231 gain as long-term _______ gain
Property transactions Sec. 1231 Gains and Losses(Example 1) In preparing the corporate return for Dr. Judy’s veterinarian practice, you calculate the following gains and losses: Long-term capital gain Long-term capital loss §1231 gain §1231 loss Net §1231 loss from two years ago How are these transactions reflected on the corporate return?
Property transactions Sec. 1231 Gains and Losses(Example 2) In preparing the corporate return for Dr. Judy’s veterinarian practice, you calculate the following gains and losses: Net capital loss (before §1231) §1231 gain §1231 loss Net §1231 loss from two years ago Net capital loss from four years ago How are these transactions reflected on the corporate return?
Property transactions Depreciation Recapture(Basics) • Amount • - Adjusted • gain • Depreciation recapture • Section gain Treated as ___________ income Treated as __________ ______ gain
Property transactions Depreciation Recapture(§1245) • Principal categories: • ___________ personalty • ____________ personalty • ____ prior depreciation is recaptured (including _____ deductions).
Property transactions Depreciation Recapture(§§1250 and 291) • Section 1250 • Applies to residential rental (nonresidential) ______ acquired before 1987 (1981) • Recaptures only “______” depreciation over SL • Section 291 • Applies to §____ property of corporations • Recaptures ___% of difference between §_____ and §_____ recapture
Property transactions Depreciation Recapture(Example 1) Hank is the sole shareholder of Middle Earth Mining, Inc. Middle Earth experienced the following: Gain on sonar equipment Loss on mining carts Middle Earth had deducted $24,000 depreciation on the sonar equipment and $11,000 on the carts. How are these transactions reflected on the corporate return? Gain on sonar equipment: §1245 income of §1231 gain of Loss on mining carts: §1231 loss of Net §1231 loss of (ordinary) and §1245 gain of (ordinary)
Property transactions Depreciation Recapture(Example 2) Lorent, Inc. sells an apartment building for $500,000 that it originally bought for $400,000 in 1985. Before the sale, Lorent deducted $366,000 ACRS depreciation (straight-line would have been $357,000). Calculate the §1231 gain, §1250 recapture, and §291 recapture. Amount realized Original cost ACRS depreciation Adjusted basis Recognized gain §1250 ordinary income §291 ordinary income §1231 gain ACRS SL §1250 recapture §1245 less §1250 §291 recapture
Property transactions Sales to Related Persons • Losses not deductible, §___ • Gain from selling depreciable property: • Treated as ________ income, §1239 • Ineligible for ____________ method, §453(g)
Dividend received deduction Section 243(a) (a) General rule. In the case of a corporation, there shall be allowed as a deduction an amount equal to the following percentages of the amount received as dividends from a domestic corporation which is subject to taxation under this chapter: (1) 70 percent, in the case of dividends other than dividends described in paragraphs (2) and (3); (2) 100 percent, in the case of dividends received by a small business investment company…; and (3) 100 percent, in the case of qualifying dividends….
Dividend received deduction Section 243(b) (b) Qualifying dividends. (1)In general. For purposes of this section, the term “qualifyingdividend” means any dividend received by a corporation-- (A) if at the close of the day on which such dividend is received, such corporation is a member of the same affiliated group as the corporation distributing such dividend….
Dividend received deduction Section 243(c) (c) Retention of 80-percent dividends received deduction for dividends from 20-percent owned corporations. (1)In general. In the case of any dividend received from a 20-percent owned corporation-- (A) subsection (a)(1) of this section, … shall be applied by substituting “80 percent” for “70 percent”.
Dividend received deduction MTR Example Jody owns 100% of PCo, which owns 70% of SCo. SCo earns profit and distributes the entire after-tax amount as a current dividend. PCo, in turn, pays the entire amount received (after tax) to its sole individual owner. What is the maximum MTR of Jody related to SCo’s profit? MTRJody = tSCo + tPCo (1 - tSCo) (1 - DRD) + tJody [1 - tSCo - tPCo (1 - tSCo) (1 - DRD)] MTRJody =
Dividend received deduction Jody 100% PCo 70% SCo MTRJody =
Dividend received deduction Dividend Received Deduction Ownership DRD Percentage < 20% ___% ≥ 20% but < 80% ___% ≥ 80% (affiliated) ___% • DRD may be limited or disallowed if: • Taxable income is ____, • Dividend received from ______ corporation, • Stock is held for ______ time, or • Stock is acquired with _____ financing.
Dividend received deduction Section 246(b) (b) Limitation on aggregate amount of deductions. (1)General rule. Except as provided in paragraph (2), the aggregate amount of the [dividend received] deductions allowed … shall not exceed the percentage … of the taxable income computed without regard to the deductions allowed by sections 172, 199, [dividend received deduction] … and without regard to any capital loss carryback …. (2) Effect of net operating loss. Paragraph (1) shall not apply for any taxable year for which there is a net operating loss (as determined under section 172).
Dividend received deduction DRD When Taxable Income Low Taxable income before _______ deductions + U.S. ___________ activities deduction (§____) + Capital loss carryback deductions Taxable income x percentage _______ on dividend received deduction Ownership DRD Percentage < 20% 70% ≥ 20% but < 80% 80% However, “unlimited” DRD allowed when _____ results. • Taxable income before ________ deductions • Dividend received times percentage • Net operating loss
Dividend received deduction DRD Limit(Example) Border, Inc. earned $30 million in consulting fees, but incurred $32 million of business deductions and losses. Border also received $___ million dividend income from minority interests (< 20%) in several corporations. Compute Border’s taxable income. Ignoring DRD Limit Considering DRD Limit Net business loss Dividend income DRD Taxable income
Dividend received deduction Section 245(a) (a) Dividends from 10-percent owned foreign corporations. (1)In general. In the case of dividends received by a corporation from a qualified 10-percent owned foreign corporation, there shall be allowed as a deduction an amount equal to the percent (specified in section 243 for the taxable year) of the U.S.-source portion of such dividends.