Corporate Income Tax Tx 8120

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Corporate Income TaxTx 8120
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Learning Goals
You should be able to

• 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.

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Business Form Choices
Corporate form
Sole proprietorships Partnerships C
corporations S corporations Limited liability
companies
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Quote Worth Re-Quoting
Corporate form
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.
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Check the Box
Corporate form

• 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

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C Corporation Advantages
Corporate form

• 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

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C Corporation Disadvantage(Double Tax)
Corporate form

• 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 ___

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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
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Tax Rate Terminology
Tax rate concepts
Statutory Tax Rates Appear in _____
________ Tax Rate
________ Tax Rate
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Section 11(a)(Domestic Corporations)
Tax rate concepts

• (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
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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

DomesticCorporationsU.S. TaxLiability
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Section 882(a) (Foreign Corporations)
Tax rate concepts

• (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
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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 _at_ 30 tax
• Estimated tax payments
• Income tax liability

ForeignCorporationsU.S. TaxLiability
U.S. taxes FCs at

• Regular rates on U.S. _________ income
• ___ (or treaty rate) on U.S. ___________ income

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Section 11(b)(1)
Tax rate concepts

• (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.
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Section 11(b)(1)
Tax rate concepts

• 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.

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Statutory Tax Rates(Lower Brackets)
Tax rate concepts
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Rates
15
100,000
200,000
300,000
Taxable Income
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Statutory Tax Rates(Upper Brackets)
Tax rate concepts
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35
34
Rates
20 million
5 million
10 million
15 million
Taxable Income
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Marginal Tax Rates
Tax rate concepts
Treating corporate profit as incremental income,
what is a shareholders marginal tax rate on
corporate profit currently distributed as a
dividend?
What is a shareholders marginal tax rate on
corporate profit distributed as a dividend in a
later year?
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Tax rate concepts
Marginal Tax Rates(Examples)
Assume a sole shareholders tax bracket is 35
and her corporations tax bracket is 35. What is
the shareholders 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 shareholders MTR now?
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Filing Requirements
Procedural matters

• 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

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Taxable Years
Procedural matters

• 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)

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Taxable Years(Annualizing Income)
Procedural matters
2. Annualized income x statutory tax rates
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Taxable Years(Example)
Procedural matters
Corporation earns 100,000 taxable income during
short taxable year of 3 months. Without
annualization, the corporations federal income
tax equals 22,250 (i.e., 22.25 average tax
rate). What is the corporations actual ATR?
Annualized tax x statutory
rates
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Accounting Methods
Procedural matters

• 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

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Capital Gains and Losses(Fundamentals)
Property transactions

• Two requirements
• Capital _____, 1221
• _____ or __________, 1222
• Capital gain or loss is long-term if taxpayer
  holds disposed asset gt __ _____, 1222.

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Capital Gains and Losses(Combining)
Property transactions
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
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Corporate Capital Gains and Losses(Implications)
Property transactions

• 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

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Property transactions
Individual Capital Gains and Losses(Implications)

• Net capital gains
• Sec. 1202 gain _at_ ___ (before ___ exclusion)
• Most capital gains _at_ ___
• Individuals in lower brackets _at_ ___
• Net capital losses
• Only ______ annual deduction
• Carried forward __________

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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?

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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?

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Sec. 1231 Gains and Losses
Property transactions

• Sale or exchange (and certain ____________
  conversions) of
• Business property
• _______ and
• ____________ assets
• Held __ __ year

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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

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Property transactions
Sec. 1231 Gains and Losses(Example 1)
In preparing the corporate return for Dr. Judys
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?
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Property transactions
Sec. 1231 Gains and Losses(Example 2)
In preparing the corporate return for Dr. Judys
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?
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Depreciation Recapture(Basics)
Property transactions

• Amount
• - Adjusted
• gain
• Depreciation recapture
• Section gain

Treated as ___________ income
Treated as __________ ______ gain
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Depreciation Recapture(1245)
Property transactions

• Principal categories
• ___________ personalty
• ____________ personalty
• ____ prior depreciation is recaptured (including
  _____ deductions).

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Depreciation Recapture(1250 and 291)
Property transactions

• 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

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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)
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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
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Sales to Related Persons
Property transactions

• Losses not deductible, ___
• Gain from selling depreciable property
• Treated as ________ income, 1239
• Ineligible for ____________ method, 453(g)

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Section 243(a)
Dividend received deduction

• (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.

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Section 243(b)
Dividend received deduction

• (b) Qualifying dividends.
• (1) In general. For purposes of this section,
  the term qualifying dividend 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.
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Section 243(c)
Dividend received deduction

• (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.
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MTR Example
Dividend received deduction
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 SCos profit?
MTRJody tSCo tPCo (1 - tSCo) (1 - DRD)
tJody 1 - tSCo - tPCo (1 - tSCo) (1 -
DRD) MTRJody
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Dividend received deduction
Jody
100
PCo
70
SCo
MTRJody
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Dividend Received Deduction
Dividend received deduction
Ownership
DRD Percentage
lt 20 ___ 20 but lt 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.

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Section 246(b)
Dividend received deduction

• (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).

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DRD When Taxable Income Low
Dividend received deduction
Taxable income before _______ deductions U.S.
___________ activities deduction
(____) Capital loss carryback
deductions Taxable income x
percentage _______ on dividend received
deduction
Ownership
DRD Percentage
lt 20 70 20 but lt 80 80

• Taxable income before ________ deductions
• Dividend received times percentage
• Net operating loss

However, unlimited DRD allowed when _____
results.
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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
(lt 20) in several corporations. Compute Borders
taxable income.
Ignoring DRD Limit
Considering DRD Limit
Net business loss Dividend income DRD Taxable
income
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Section 245(a)
Dividend received deduction

• (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.

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Dividend received deduction
Dividend from Abroad(Example)
Global, Inc. owns 12 of ForCo (organized in
Asia) from which Global receives 100 dividends.
ForCos EP shows
Foreign EP
EP from ECI
EP (2006) 200 500 EP (1987-2005) 600 700
To what DRD is Global entitled?
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Section 246(c)(1)
Dividend received deduction

• (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
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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
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45-Day Rule Prohibits DRD
Dividend received deduction

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

Arbitrage sells all Target stock _at_ __ per share
Target, Inc. declares __ per share dividend
Results Absent 246(c)(1)
Arbitrage, Inc. buys 21 of Target _at_ __ per share

• Dividends MTR
• _________ loss (equal to dividend) deductible
  against capital gains subject to MTR of ____

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Section 246A(a)
Dividend received deduction

• (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.
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Debt Financing Reduces DRD
Dividend received deduction

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

Corporation
Buy stock (lt 50 or, if Target closely held, lt
20)
Results Absent 246A(a)

• Dividends MTR
• Related interest deductible against income
  subject to MTR of ___

Target
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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 .
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Lind et al., pp. 192-93
Dividend received deduction
TargetCo declares 1 per share dividend
ArbitCo receives 1,000 dividend
June 1 (declaration)
June 8 (record)
June 27 (payment)
June 3
June 30
June 5 (ex-dividend)
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?
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Lind et al., pp. 192-93 (continued)
Dividend received deduction
TargetCo declares 1 per share dividend
ArbitCo receives 1,000 dividend

June 1 (declaration)
June 8 (record)
June 27 (payment)
June 3
Dec. 1
June 5 (ex-dividend)
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?
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Lind et al., pp. 192-93 (continued)
Dividend received deduction
TargetCo declares 2 per share dividend
ArbitCo receives 2,000 dividend

June 1 (declaration)
June 8 (record)
June 27 (payment)
June 3
Dec. 1
June 5 (ex-dividend)
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?
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Lind et al., pp. 192-93 (continued)
Dividend received deduction
TargetCo declares 2 per share dividend
ArbitCo receives 2,000 dividend

June 1 (declaration)
June 8 (record)
June 27 (payment)
June 3
Much later
June 5 (ex-dividend)
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?
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Net Operating Losses
Miscellaneous items

• Gross income
• Regular deductions and losses
• Taxable income ltlossgt 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

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Miscellaneous items
Charitable Contributions

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