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Chapter 11 Corporate Income Tax 2011 Cengage Learning Income Tax Fundamentals  2011  Gerald E. Whittenburg  Martha Altus-B...
Learning Objectives <ul><li>As pertains to corporations: </li></ul><ul><ul><li>Calculate tax liability using tax rates  </...
Corporate Tax Rates <ul><li>Corporate rates are progressive  </li></ul><ul><ul><li>Marginal rates are from 15% to 39%, dep...
Example Corporate Tax Rates <ul><li>Example </li></ul><ul><li>Johnson & Kelby Inc. (a dental products wholesaler) has taxa...
Solution <ul><li>Example </li></ul><ul><li>Johnson & Kelby Inc. (a dental products wholesaler) has taxable income of $300,...
Corporate Capital Gains  <ul><li>A corporation can choose from two alternative tax treatments on capital gains </li></ul><...
Dividends Received Deduction <ul><li>Corporations are allowed a deduction for a percentage of the dividends received from ...
Amortization of  Organizational Expenditures <ul><li>Examples of organizational expenditures </li></ul><ul><ul><li>Legal/a...
Charitable Contributions <ul><li>Corporations are allowed a deduction for charitable contributions </li></ul><ul><ul><li>C...
Example  Charitable Contributions <ul><li>Example </li></ul><ul><li>Ferndale Corp. had net operating income of $400,000 fo...
Solution <ul><li>Example </li></ul><ul><li>Ferndale Corp. had net operating income of $400,000 for the current year and ma...
Reconciliation of  Income (Loss) per Books with Income Per Return <ul><li>Schedule M-1 of Form 1120 reconciles accounting ...
Filing Requirements & Estimated Tax <ul><li>Form 1120 filed for regular corporation </li></ul><ul><li>Form 1120S filed for...
S Corporations <ul><li>Certain qualified small business corporations may elect to be taxed in a manner similar to partners...
S Corporations  <ul><li>Corporation must make election of S status in a prior year  </li></ul><ul><ul><li>Or within 2-1/2 ...
Example S Corporation Election <ul><li>Example </li></ul><ul><li>Swannak Electronics Corporation is a calendar year corpor...
Solution <ul><li>Example </li></ul><ul><li>Swannak Electronics Corporation is a calendar year corporation that makes an S ...
Income Reporting <ul><li>Must report all elements of income and expense separately on Form 1120S  </li></ul><ul><li>Then e...
Loss Reporting <ul><li>Each shareholder of an S Corp may also report his/her respective share of loss </li></ul><ul><ul><l...
S Corporation  Pass Through Items <ul><li>Many items retain tax character when passing through to the S Corporation’s  sha...
Special Taxes <ul><li>S Corporations, in general, do not pay corporate taxes on their taxable income </li></ul><ul><li>Cer...
Corporate Formation <ul><li>Shareholders often transfer high-value low-basis assets to a corporation in exchange for stock...
Shareholder Basis in Stock <ul><li>A shareholder’s initial basis in his/her stock is calculated as follows </li></ul><ul><...
Accumulated Earnings Tax (AET) <ul><li>Penalty tax designed to prevent a corporation from avoiding tax by retaining earnin...
Example  Accumulated Earnings Tax <ul><li>Example </li></ul><ul><li>Xinix Corporation (a medical device manufacturing firm...
Solution <ul><li>Example </li></ul><ul><li>Xinix Corporation (a medical device manufacturing firm) has accumulated earning...
Personal Holding Company Tax <ul><li>Penalty tax designed to encourage Personal Holding Companies to distribute earnings t...
Corporate AMT <ul><li>Corporate AMT - calculated similar to the individual AMT </li></ul><ul><li>AMT is 20% of Alternative...
You’re Done with Chapter 11 2011 Cengage Learning
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Chapter 11

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  1. 1. Chapter 11 Corporate Income Tax 2011 Cengage Learning Income Tax Fundamentals 2011 Gerald E. Whittenburg Martha Altus-Buller
  2. 2. Learning Objectives <ul><li>As pertains to corporations: </li></ul><ul><ul><li>Calculate tax liability using tax rates </li></ul></ul><ul><ul><li>Compute basic capital gains/losses </li></ul></ul><ul><ul><li>Ascertain how special deduction may affect taxable income </li></ul></ul><ul><ul><li>Identify components of Schedule M-1 </li></ul></ul><ul><ul><li>Outline corporate tax return filing and estimated tax payment requirements </li></ul></ul><ul><ul><li>Understand how S-Corporations operate and are taxed </li></ul></ul><ul><ul><li>Understand basic tax rules when forming entity </li></ul></ul><ul><ul><li>Describe accumulated earnings and personal holding company taxes </li></ul></ul><ul><ul><li>Define elements of alternative minimum tax calculation </li></ul></ul>2011 Cengage Learning
  3. 3. Corporate Tax Rates <ul><li>Corporate rates are progressive </li></ul><ul><ul><li>Marginal rates are from 15% to 39%, depending on taxable income </li></ul></ul><ul><ul><li>There are eight brackets </li></ul></ul><ul><ul><li>There are a number of ‘tax bubbles’ – these occur when tax rate schedules recaptures savings from prior brackets </li></ul></ul><ul><li>For corporations with large income (more than $18.33 million) the rate is a flat 35% </li></ul><ul><li>Qualified personal service corps taxed at flat 35% </li></ul><ul><ul><li>Architects, CPAs, consultants, etc. </li></ul></ul>2011 Cengage Learning
  4. 4. Example Corporate Tax Rates <ul><li>Example </li></ul><ul><li>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? </li></ul>2011 Cengage Learning
  5. 5. Solution <ul><li>Example </li></ul><ul><li>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? </li></ul><ul><li>Solution </li></ul><ul><li>Corporate tax = $100,250 </li></ul><ul><li>$22,250 + (39%)($300,000 – 100,000) </li></ul><ul><li>If Johnson & Kelby is a qualified personal service corporation, corporate tax = $105,000 ($300,000 x 35%) </li></ul>2011 Cengage Learning
  6. 6. Corporate Capital Gains <ul><li>A corporation can choose from two alternative tax treatments on capital gains </li></ul><ul><ul><li>Taxed at ordinary rates </li></ul></ul><ul><ul><li> or </li></ul></ul><ul><ul><li>Elect to pay an alternative tax (35%) on net long-term capital gain (LTCG) </li></ul></ul><ul><li>Essentially equivalent to maximum regular corporate tax (no tax benefit to LTCG) </li></ul><ul><li>Bottom line: there is no difference in tax on ordinary vs. capital income </li></ul>2011 Cengage Learning
  7. 7. Dividends Received Deduction <ul><li>Corporations are allowed a deduction for a percentage of the dividends received from other corporations </li></ul><ul><ul><li>Attempt to alleviate triple taxation </li></ul></ul><ul><li>Dividends received deduction is allowed based upon ownership </li></ul><ul><li> </li></ul>2011 Cengage Learning <ul><li>Percentage Ownership Dividends Received % Deduction < 20% 70% </li></ul><ul><li>20% or more, less than 80% 80% </li></ul><ul><li>> 80% 100% </li></ul><ul><ul><li> Divends received deduction is limited by % of corporate taxable income shown above </li></ul></ul><ul><ul><li>(calculated before certain deductions) </li></ul></ul>
  8. 8. Amortization of Organizational Expenditures <ul><li>Examples of organizational expenditures </li></ul><ul><ul><li>Legal/accounting services incidental to organization </li></ul></ul><ul><ul><li>Incorporation fees </li></ul></ul><ul><li>Organizational expenditures are capitalized and then amortized over 180 months </li></ul><ul><li>However, can make election to deduct up to $5,000 of organization costs in the year corporation begins business </li></ul><ul><ul><li>$5,000 amount is reduced $1 for each $1 that organizational expenses exceed $50,000 </li></ul></ul>2011 Cengage Learning
  9. 9. Charitable Contributions <ul><li>Corporations are allowed a deduction for charitable contributions </li></ul><ul><ul><li>Cash basis taxpayers can deduct when paid </li></ul></ul><ul><ul><li>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 </li></ul></ul><ul><li>Charitable contributions limited to 10% of taxable income * </li></ul><ul><ul><li>Carry forward unused deduction for five years </li></ul></ul><ul><ul><li>*Calculated before any loss carry backs, net operating losses (NOLs) or the dividend received deduction </li></ul></ul>2011 Cengage Learning
  10. 10. Example Charitable Contributions <ul><li>Example </li></ul><ul><li>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? </li></ul>2011 Cengage Learning
  11. 11. Solution <ul><li>Example </li></ul><ul><li>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? </li></ul><ul><li>Solution </li></ul><ul><li>The charitable contribution deduction is $48,000 </li></ul><ul><li>($400,000 + 80,000) x 10% = $48,000 limit * </li></ul><ul><li>Therefore, carry forward is $32,000 ($80,000 – 48,000) </li></ul><ul><li>*Note: had to add back DRD first!! </li></ul>2011 Cengage Learning
  12. 12. Reconciliation of Income (Loss) per Books with Income Per Return <ul><li>Schedule M-1 of Form 1120 reconciles accounting (book) income to taxable income </li></ul><ul><li>Amounts added to book income (left column) </li></ul><ul><ul><li>Federal tax expense </li></ul></ul><ul><ul><li>Capital losses </li></ul></ul><ul><ul><li>Income recorded on tax return but not on books </li></ul></ul><ul><ul><li>Expenses recorded on books but not on tax return </li></ul></ul><ul><li>Amounts deducted from book income (right column) </li></ul><ul><ul><li>Income recorded on books but not on tax return </li></ul></ul><ul><ul><li>Expenses recorded on tax return but not on books </li></ul></ul><ul><ul><li>See chapter for other items included on Schedule M-1 </li></ul></ul>2011 Cengage Learning
  13. 13. Filing Requirements & Estimated Tax <ul><li>Form 1120 filed for regular corporation </li></ul><ul><li>Form 1120S filed for S Corporation </li></ul><ul><ul><li>Returns are due by the 15th day of the third month after year-end </li></ul></ul><ul><ul><li>Can file Form 7004 and receive automatic 6-month extension </li></ul></ul><ul><li>Corporations must make estimated tax payments in similar manner as self-employed taxpayers, in four installments </li></ul>2011 Cengage Learning
  14. 14. S Corporations <ul><li>Certain qualified small business corporations may elect to be taxed in a manner similar to partnerships </li></ul><ul><li>Qualified small business corporation may elect S Corporation status if several criteria apply </li></ul><ul><ul><li>Operates as a domestic corporation </li></ul></ul><ul><ul><li>Has 100 or fewer shareholders </li></ul></ul><ul><ul><ul><li>Shareholders may not be corporations or partnerships </li></ul></ul></ul><ul><ul><li>Has only one class of stock </li></ul></ul><ul><ul><li>Has only shareholders that are U.S. citizens or resident aliens </li></ul></ul>2011 Cengage Learning
  15. 15. S Corporations <ul><li>Corporation must make election of S status in a prior year </li></ul><ul><ul><li>Or within 2-1/2 months of the current tax year </li></ul></ul><ul><li>S Corp status stays in effect until revocation * </li></ul><ul><ul><li>Status can be voluntarily revoked by consent of shareholders </li></ul></ul><ul><ul><li>or </li></ul></ul><ul><ul><li>Involuntarily revoked </li></ul></ul><ul><ul><ul><li>If corporation ceases to be a small business corporation </li></ul></ul></ul><ul><ul><ul><li>or </li></ul></ul></ul><ul><ul><ul><li>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 </li></ul></ul></ul><ul><ul><ul><li>Election is terminated on the date status is revoked </li></ul></ul></ul>2011 Cengage Learning
  16. 16. Example S Corporation Election <ul><li>Example </li></ul><ul><li>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? </li></ul>2011 Cengage Learning
  17. 17. Solution <ul><li>Example </li></ul><ul><li>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? </li></ul><ul><li>Solution </li></ul><ul><li>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. </li></ul>2011 Cengage Learning
  18. 18. Income Reporting <ul><li>Must report all elements of income and expense separately on Form 1120S </li></ul><ul><li>Then each shareholder reports his/her share of these items of corporate income/expense on personal return </li></ul><ul><ul><li>K-1 takes total shareholder income/expenses and allocates each item to each shareholder based upon his/her ownership percentage </li></ul></ul><ul><ul><li>If shareholder dies, his/her portion of S Corp items </li></ul></ul><ul><ul><li>will be included in shareholder’s final return </li></ul></ul>2011 Cengage Learning
  19. 19. Loss Reporting <ul><li>Each shareholder of an S Corp may also report his/her respective share of loss </li></ul><ul><ul><li>Cannot take a loss in excess of adjusted basis in stock </li></ul></ul><ul><ul><li>If loss exceeds adjusted basis in stock plus loans, shareholder can carry it forward </li></ul></ul><ul><li>If shareholder entered/departed S Corp mid-year, must allocate losses on a daily basis </li></ul>2011 Cengage Learning
  20. 20. S Corporation Pass Through Items <ul><li>Many items retain tax character when passing through to the S Corporation’s shareholders on individual K-1 </li></ul><ul><li>Examples of such items include </li></ul><ul><ul><li>Capital gains/losses </li></ul></ul><ul><ul><li>§1231 gains/losses </li></ul></ul><ul><ul><li>Dividend Income </li></ul></ul><ul><ul><li>Charitable contributions </li></ul></ul><ul><ul><li>Tax-exempt interest </li></ul></ul><ul><ul><li>Most credits </li></ul></ul>2011 Cengage Learning
  21. 21. Special Taxes <ul><li>S Corporations, in general, do not pay corporate taxes on their taxable income </li></ul><ul><li>Certain exceptions exist such as: </li></ul><ul><ul><li>Built-in gains tax (paid on appreciated assets that were held by corporation prior to S Corp election) </li></ul></ul><ul><ul><li>Certain tax imposed if corporation has large amount of passive income, such as dividends and income </li></ul></ul><ul><ul><li>These rules are complex and will not be covered in this text </li></ul></ul>2011 Cengage Learning
  22. 22. Corporate Formation <ul><li>Shareholders often transfer high-value low-basis assets to a corporation in exchange for stock in company </li></ul><ul><li>No tax is due on gain from transfer of appreciated assets if following conditions met </li></ul><ul><ul><li>Shareholder transferred cash or property </li></ul></ul><ul><ul><li> and </li></ul></ul><ul><ul><li>Shareholder made transfer solely in exchange for stock * </li></ul></ul><ul><ul><ul><li>Shareholder is not providing a service and all taxpayers together own at least 80% of stock after transaction </li></ul></ul></ul><ul><ul><li>*If shareholder receives boot in addition to stock, </li></ul></ul><ul><ul><li>transaction may qualify for partial nonrecognition of gain </li></ul></ul>2011 Cengage Learning
  23. 23. Shareholder Basis in Stock <ul><li>A shareholder’s initial basis in his/her stock is calculated as follows </li></ul><ul><li> Basis of property transferred </li></ul><ul><li>Less Boot received * </li></ul><ul><li>Plus Gain recognized </li></ul><ul><li>Less Liabilities transferred </li></ul><ul><li>Basis in stock </li></ul><ul><li>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 </li></ul><ul><li>*Boot is any property other than stock </li></ul>2011 Cengage Learning Note: generally, corporate assumption of shareholder liabilities that are attached to property are not considered boot received
  24. 24. Accumulated Earnings Tax (AET) <ul><li>Penalty tax designed to prevent a corporation from avoiding tax by retaining earnings </li></ul><ul><li>15% AET imposed on “unreasonable” accumulation of earnings; this is in addition to corporate income tax </li></ul><ul><ul><li>Corporation may accumulate up to $250,000 a year that is exempt from AET tax or $150,000 for a service corporation </li></ul></ul><ul><ul><li>May accumulate more if can prove a valid business purpose </li></ul></ul>2011 Cengage Learning
  25. 25. Example Accumulated Earnings Tax <ul><li>Example </li></ul><ul><li>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? </li></ul>2011 Cengage Learning
  26. 26. Solution <ul><li>Example </li></ul><ul><li>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? </li></ul><ul><li>Solution </li></ul><ul><li>Xinix’ AET = $45,000 </li></ul><ul><li>($800,000 – 500,000) x 15% </li></ul><ul><li>Note: this is paid in addition to regular tax </li></ul>2011 Cengage Learning
  27. 27. Personal Holding Company Tax <ul><li>Penalty tax designed to encourage Personal Holding Companies to distribute earnings to shareholders </li></ul><ul><ul><li>Tax is 15% on undistributed earnings </li></ul></ul><ul><li>Corporation is not liable for both the personal holding company tax and the AET in the same year </li></ul>2011 Cengage Learning
  28. 28. Corporate AMT <ul><li>Corporate AMT - calculated similar to the individual AMT </li></ul><ul><li>AMT is 20% of Alternative Minimum Taxable Income (defined below) </li></ul><ul><ul><li> Taxable Income </li></ul></ul><ul><ul><li>+/- Adjustments </li></ul></ul><ul><ul><li>+ Preferences </li></ul></ul><ul><ul><li>- Exemption* </li></ul></ul><ul><ul><ul><li> Alternative Minimum Taxable Income (AMTI) </li></ul></ul></ul><ul><li>Small corporations are not subject to the AMT </li></ul><ul><ul><li>Defined as having average annual gross receipts < $7.5 million over a three-year period </li></ul></ul><ul><ul><li>*Exemption is $40,000, but is phased out when AMTI > $150,000 </li></ul></ul>2011 Cengage Learning
  29. 29. You’re Done with Chapter 11 2011 Cengage Learning
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