Chapter 11
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    Chapter 11 Chapter 11 Presentation Transcript

    • Chapter 11 Corporate Income Tax 2011 Cengage Learning Income Tax Fundamentals 2011 Gerald E. Whittenburg Martha Altus-Buller
    • Learning Objectives
      • As pertains to corporations:
        • Calculate tax liability using tax rates
        • Compute basic capital gains/losses
        • Ascertain how special deduction may affect taxable income
        • Identify components of Schedule M-1
        • Outline corporate tax return filing and estimated tax payment requirements
        • Understand how S-Corporations operate and are taxed
        • Understand basic tax rules when forming entity
        • Describe accumulated earnings and personal holding company taxes
        • Define elements of alternative minimum tax calculation
      2011 Cengage Learning
    • 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’ – these occur 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.
      2011 Cengage Learning
    • 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 were principals who provided personal services?
      2011 Cengage Learning
    • 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 were principals who 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%)
      2011 Cengage Learning
    • 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
      2011 Cengage Learning
    • Dividends Received Deduction
      • Corporations are allowed a deduction for a percentage of the dividends received from other corporations
        • Attempt to alleviate triple taxation
      • Dividends received deduction is allowed based upon ownership
      2011 Cengage Learning
      • Percentage Ownership Dividends Received % Deduction < 20% 70%
      • 20% or more, less than 80% 80%
      • > 80% 100%
        • Divends received deduction is limited by % of corporate taxable income shown above
        • (calculated before certain deductions)
    • 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 the year corporation begins business
        • $5,000 amount is reduced $1 for each $1 that organizational expenses exceed $50,000
      2011 Cengage Learning
    • 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
      • Charitable contributions limited to 10% of taxable income *
        • Carry forward unused deduction for five years
        • *Calculated before any loss carry backs, net operating losses (NOLs) or the dividend received deduction
      2011 Cengage Learning
    • Example Charitable Contributions
      • Example
      • Ferndale Corp. had net operating income of $400,000 for the current year and made charitable contributions 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 the charitable contribution carry forward?
      2011 Cengage Learning
    • Solution
      • Example
      • Ferndale Corp. had net operating income of $400,000 for the current year and made charitable contributions 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 carry forward?
      • Solution
      • The charitable contribution deduction is $48,000
      • ($400,000 + 80,000) x 10% = $48,000 limit *
      • Therefore, carry forward is $32,000 ($80,000 – 48,000)
      • *Note: had to add back DRD first!!
      2011 Cengage Learning
    • Reconciliation of Income (Loss) per Books with Income Per Return
      • Schedule M-1 of Form 1120 reconciles accounting (book) income to taxable income
      • Amounts added to book income (left column)
        • 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 (right column)
        • 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
      2011 Cengage Learning
    • Filing Requirements & Estimated Tax
      • Form 1120 filed for regular corporation
      • Form 1120S filed for 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, in four installments
      2011 Cengage Learning
    • S Corporations
      • Certain qualified small business 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
      2011 Cengage Learning
    • 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 three consecutive years and corporation has accumulated earnings and profits at the end of each of those years
          • Election is terminated on the date status is revoked
      2011 Cengage Learning
    • Example S Corporation Election
      • Example
      • Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2010. In which year may the corporation first be treated as an S Corporation?
      2011 Cengage Learning
    • Solution
      • Example
      • Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, 2010. In which year may the corporation first be treated as an S Corporation?
      • Solution
      • Since Swannak did not make the S Corporation election within the first 2-1/2 months of the tax year, it will be treated as a regular corporation for 2010. It will become an S Corporation for tax year 2011.
      2011 Cengage Learning
    • 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
        • If shareholder dies, his/her portion of S Corp items
        • will be included in shareholder’s final return
      2011 Cengage Learning
    • 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 mid-year, must allocate losses on a daily basis
      2011 Cengage Learning
    • 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
      2011 Cengage Learning
    • Special Taxes
      • S Corporations, in general, do not pay corporate taxes on their taxable income
      • Certain exceptions exist such as:
        • Built-in gains tax (paid on appreciated assets that were held by corporation prior to S Corp election)
        • Certain tax imposed if corporation has large amount of passive income, such as dividends and income
        • These rules are complex and will not be covered in this text
      2011 Cengage Learning
    • Corporate Formation
      • Shareholders often transfer high-value low-basis assets to a corporation in exchange for stock in company
      • No tax is due on gain from transfer of appreciated assets if following 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
      2011 Cengage Learning
    • 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
      • *Boot is any property other than stock
      2011 Cengage Learning Note: generally, corporate assumption of shareholder liabilities that are attached to property are not considered boot received
    • 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; this is in addition to corporate income 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
      2011 Cengage Learning
    • 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?
      2011 Cengage Learning
    • 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
      • Xinix’ AET = $45,000
      • ($800,000 – 500,000) x 15%
      • Note: this is paid in addition to regular tax
      2011 Cengage Learning
    • 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
      2011 Cengage Learning
    • Corporate AMT
      • Corporate AMT - calculated similar to the individual AMT
      • AMT is 20% of Alternative Minimum Taxable Income (defined below)
        • 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
      2011 Cengage Learning
    • You’re Done with Chapter 11 2011 Cengage Learning