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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
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:

business form choices
Corporate formBusiness Form Choices

Sole proprietorships

Partnerships

C corporations

S corporations

Limited liability companies

quote worth re quoting
Corporate formQuote 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.”

check the box
Corporate formCheck 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
c corporation advantages
Corporate formC 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
c corporation disadvantage double tax
Corporate formC 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 ___%
slide8
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 terminology
Tax rate conceptsTax Rate Terminology

Statutory Tax Rates: Appear in _____

________ Tax Rate

________ Tax Rate

section 11 a domestic corporations
Tax rate conceptsSection 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

slide11
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

section 882 a foreign corporations
Tax rate conceptsSection 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

slide13
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

section 11 b 1
Tax rate conceptsSection 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.

section 11 b 115
Tax rate conceptsSection 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.

statutory tax rates lower brackets
Tax rate conceptsStatutory Tax Rates(Lower Brackets)

34%

34%

25%

Rates

15%

$100,000

$200,000

$300,000

Taxable Income

statutory tax rates upper brackets
Tax rate conceptsStatutory Tax Rates(Upper Brackets)

35%

35%

34%

Rates

$20 million

$5 million

$10 million

$15 million

Taxable Income

marginal tax rates
Tax rate conceptsMarginal 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?

slide19
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?

filing requirements
Procedural mattersFiling 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
taxable years
Procedural mattersTaxable 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)
taxable years annualizing income
Procedural mattersTaxable Years(Annualizing Income)

2. Annualized income x statutory tax rates =

taxable years example
Procedural mattersTaxable 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 = $

accounting methods
Procedural mattersAccounting 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
capital gains and losses fundamentals
Property transactionsCapital Gains and Losses(Fundamentals)
  • Two requirements:
    • Capital _____, §1221
    • _____ or __________, §1222
  • Capital gain or loss is “long-term” if taxpayer holds disposed asset > __ _____, §1222.
capital gains and losses combining
Property transactionsCapital 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

corporate capital gains and losses implications
Property transactionsCorporate 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
slide28
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 __________
slide29
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?

slide30
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?

sec 1231 gains and losses
Property transactionsSec. 1231 Gains and Losses
  • Sale or exchange (and certain ____________ conversions) of
  • Business property
    • _______ and
    • ____________ assets
  • Held __ __ year
slide32
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
slide33
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?

slide34
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?

depreciation recapture basics
Property transactionsDepreciation Recapture(Basics)
  • Amount
  • - Adjusted
  • gain
  • Depreciation recapture
  • Section gain

Treated as ___________ income

Treated as __________ ______ gain

depreciation recapture 1245
Property transactionsDepreciation Recapture(§1245)
  • Principal categories:
    • ___________ personalty
    • ____________ personalty
  • ____ prior depreciation is recaptured (including _____ deductions).
depreciation recapture 1250 and 291
Property transactionsDepreciation 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
slide38
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)

slide39
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

sales to related persons
Property transactionsSales to Related Persons
  • Losses not deductible, §___
  • Gain from selling depreciable property:
    • Treated as ________ income, §1239
    • Ineligible for ____________ method, §453(g)
section 243 a
Dividend received deductionSection 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….

section 243 b
Dividend received deductionSection 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….

section 243 c
Dividend received deductionSection 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”.

mtr example
Dividend received deductionMTR 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 =

slide45
Dividend received deduction

Jody

100%

PCo

70%

SCo

MTRJody =

dividend received deduction
Dividend received deductionDividend 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.
section 246 b
Dividend received deductionSection 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).

drd when taxable income low
Dividend received deductionDRD 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
slide49
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

section 245 a
Dividend received deductionSection 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.

slide51
Dividend received deduction

Dividend from Abroad(Example)

Global, Inc. owns 12% of ForCo (organized in Asia) from which Global receives $100 dividends. ForCo’s E&P shows:

Foreign

E&P

E&P from

ECI

E&P (2006) $ 200 $ 500

E&P (1987-2005) 600 700

To what DRD is Global entitled?

section 246 c 1
Dividend received deductionSection 246(c)(1)

(c) Exclusion of certain dividends.

(1)In general. No deduction shall be allowed under section 243, 244, or 245, in respect of any dividend on any share of stock--

(A) which is held by the taxpayer for 45 days or less during the 91-day period beginning on the date which is 45 days before the date on which such share becomes ex-dividend with respect to such dividend …

slide53
Dividend received deduction

Dividend Chronology

  • ____________ date is when the Board of Directors commits to pay a dividend and records liability as “_________ ________.” “_________ _________” are set aside.
  • ____________ date occurs a few days before record date and is the first day shares trade without the declared dividends.
  • _______ date is when the Board “________” list of shareholders who receive the declared dividend.
  • ________ date is when corporation writes dividend check to shareholders of record and satisfies “_________ ________.”

Ex-Dividend

Payment

Declaration

Record

NYSE sets at __

business days

Varies, but often about __ weeks

______ usually establishes

45 day rule prohibits drd
Dividend received deduction45-Day Rule Prohibits DRD

Rationale: Prevents corporation from buying stock just before ________ date and selling stock immediately afterwards

Target, Inc. declares $__ per share dividend

Arbitrage sells all Target stock @ $__ per share

Results Absent §246(c)(1)

Arbitrage, Inc. buys 21% of Target @ $__ per share

  • Dividend’s MTR =
  • _________ loss (equal to dividend) deductible against capital gains subject to MTR of ____%
section 246a a
Dividend received deductionSection 246A(a)

(a) General rule.

In the case of any dividend on debt-financed portfolio stock, there shall be substituted for the percentage which (but for this subsection) would be used in determining the amount of the deduction allowable under section 243, 244, or 245(a) a percentage equal to the product of--

(1) 70 percent (80 percent in the case of any dividend from a 20-percent owned corporation …), and

(2) 100 percent minus the average indebtedness percentage.

debt financing reduces drd
Dividend received deductionDebt Financing Reduces DRD

Rationale: Prevents corporation from _______ interest while paying ____ ____ on related dividend income

Corporation

Buy stock

(< 50% or, if Target closely held, < 20%)

Results Absent §246A(a)

  • Dividend’s MTR =
  • Related interest deductible against income subject to MTR of ___%

Target

slide57
Dividend received deduction

Section 1059(a)

(a) General rule.

If any corporation receives any extraordinary dividend with respect to any share of stock and such corporation has not held such stock for more than 2 years before the dividend announcement date--

(1) Reduction in basis. The basis of such corporation in such stock shall be reduced (but not below zero) by the nontaxed portion of such dividends.

(2) Amounts in excess of basis. If the nontaxed portion of such dividends exceeds such basis, such excess shall be treated as gain ….

slide58
Dividend received deduction

Lind et al., pp. 192-93

TargetCo declares $1 per share dividend

ArbitCo receives $1,000 dividend

June 1

(declaration)

June 3

June 5

(ex-dividend)

June 8

(record)

June 27

(payment)

June 30

ArbitCo buys 1,000 shares of TargetCo for $15 per share

ArbitCo sells 1,000 shares of TargetCo for $14 per share

(a) What might ArbitCo be seeking to accomplish?

What is the actual tax result?

slide59
Dividend received deduction

Lind et al., pp. 192-93

(continued)

TargetCo declares $1 per share dividend

ArbitCo receives $1,000 dividend

June 1

(declaration)

June 3

June 5

(ex-dividend)

June 8

(record)

June 27

(payment)

Dec. 1

ArbitCo buys 1,000 shares of TargetCo for $15 per share

ArbitCo sells 1,000 shares of TargetCo for $14 per share

(b) What if ArbitCo waits until Dec. 1 to sell TargetCo stock?

slide60
Dividend received deduction

Lind et al., pp. 192-93

(continued)

TargetCo declares $2 per share dividend

ArbitCo receives $2,000 dividend

June 1

(declaration)

June 3

June 5

(ex-dividend)

June 8

(record)

June 27

(payment)

Dec. 1

ArbitCo buys 1,000 shares of TargetCo for $15 per share

ArbitCo sells 1,000 shares of TargetCo for $13 per share

(c) In addition, what if dividend is $2 per share instead of $1?

slide61
Dividend received deduction

Lind et al., pp. 192-93

(continued)

TargetCo declares $2 per share dividend

ArbitCo receives $2,000 dividend

June 1

(declaration)

June 3

June 5

(ex-dividend)

June 8

(record)

June 27

(payment)

Much later

ArbitCo buys 1,000 shares of TargetCo for $15 per share

ArbitCo sells 1,000 shares of TargetCo for $13 per share

(d) In addition to assuming the dividend equals $2 per share, what if ArbitCo waits until 25 months after the dividend to sell its TargetCo shares?

net operating losses
Miscellaneous itemsNet Operating Losses
  • Gross income
  • Regular deductions and losses
  • Taxable income before special deductions
  • Dividend received deduction
  • Net operating loss, §___

Carryback __ Years or Forgo

Carryforward __ Years

Election to forgo:

Made by due date (including extensions)

__________ but applies only to that year

slide63
Miscellaneous items

Charitable Contributions

  • If ________ basis, donations the ______ authorizes during year are deductible if paid by return’s ________ due date
  • Limited to ___% of taxable income before:
    • Charitable contribution deduction,
    • Dividend received deduction, and
    • NOL and capital loss carryback
  • Carryforward __ years (_____ basis)
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