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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

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

2010 Cengage Learning

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?

2010 Cengage Learning

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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