Chapter 11 Corporate Income Tax

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Chapter 11Corporate Income Tax

• Income Tax Fundamentals 2010
• Gerald E. Whittenburg
• Martha Altus-Buller

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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.

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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 corporations tax
  liability? How would the answer change if it was
  an architectural firm, and Johnson Kelby
  provided personal services?

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Solution

• Example
• Johnson Kelby Inc. (a dental products
  wholesaler) has taxable income of 300,000 for
  the current year. What is the corporations 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)

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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

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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 lt 20 70 20
or more, less than 80 80 gt 80
100 Deductions
limited by and other items
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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

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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

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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
  Ferndales charitable contribution deduction
  what is its charitable contribution carryforward?

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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
  Ferndales 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!!

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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

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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

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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

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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

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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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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.

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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

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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

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S Corporation Pass Through Items

• Many items retain tax character when passing
  through to the S Corporations 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

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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

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Shareholder Basis in Stock

• A shareholders 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.
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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

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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?

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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

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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

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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
  lt 7.5 million over a three-year period
• Exemption is 40,000, but is phased out when
  AMTI gt 150,000

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Youre Done with Chapter 11