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2013 cch basic principles ch16 piii


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2013 cch basic principles ch16 piii

  1. 1. Chapter 16 Partnerships, Corporations, and S Corporations Part III: C Corporations©2012 CCH. All Rights Reserved.4025 W. Peterson Ave.Chicago, IL 60646-60851 800 248
  2. 2. Chapter 16 Contents 1. Corporation Defined 2. C Corporations—Special Types 3. C Corporations—Tax Years 4. C Corporations—Accounting Methods 5. C Corporations—Tax Formula 6. C Corporations—Comparison with Individual Taxpayers 7. Income Items Requiring Special Treatment 8. Exclusions Requiring Special Treatment 9. Deductions Requiring Special Treatment—Organizational Expenditures 10. Dividends Received Deduction—Example 1 11. Dividends Received Deduction—Example 2 12. Deductions Requiring Special Treatment—Charitable Contributions 13. Charitable Contributions—Example 14. Deductions Requiring Special Treatment 15. Deductions Requiring Special Treatment—Bond and Stock Redemptions at a Premium 16. Deductions Requiring Special Treatment—Compensation and Educational ReimbursementChapter 16, Exhibit Contents A CCH Federal Taxation Basic Principles2 of 92
  3. 3. Chapter 16 Contents 17. Educational Expenses 18. Rules For Net Operating Losses (NOLs) 19. Net Operating Losses (NOLs)—Example 20. Capital Gains and Losses 21. Depreciation Expense 22. Code Sec. 291 Depreciation for Corporations—Example 23. Reconciling Book and Taxable Income 24. Corporate Tax Rates 25. Corporate Tax Credits 26. Template for Computing the Foreign Tax Credit/Deduction 27. Foreign Tax Credits—Example 28. Formation of Corporations—Overview of Code Sec. 351 29. Code Sec. 351 Contribution of Part Property/Part Services— Example 30. Code Sec. 351 Contributions—Tax Effect on ShareholdersChapter 16, Exhibit Contents B CCH Federal Taxation Basic Principles3 of 92
  4. 4. Chapter 16 Contents 30. Code Sec. 351 Contributions—Tax Effect on Shareholders 31. Code Sec. 351 Contributions—Tax Effect on Corporations 32. Code Sec. 351 Contributions—Example 1 33. Code Sec. 351 Contributions—Example 2 34. Nonstock Distributions—Effect on Shareholder of C CorporationChapter 16, Exhibit Contents C CCH Federal Taxation Basic Principles4 of 92
  5. 5. Corporation Defined Definition of Corporation. Either an organization incorporated under state law, or an unincorporated association that has “checked the box” for corporate tax treatment on Form 8832 (Entity Classification Election). Code Sec. 7701; Reg. §301.7701-1 to 3.Chapter 16, Exhibit 1a CCH Federal Taxation Basic Principles5 of 92
  6. 6. Corporation Defined Two Classifications of Corporate Entities.  C corporations. Taxpaying entities. (This results in what is known as a double tax effect. The corporation computes tax on the net income. When a corporation distributes its income, the corporation’s shareholders report dividend income on their own tax returns.)  S corporations. Not subject to regular corporate income tax. They are treated in a manner similar to partnerships, i.e., as pass-through entities, in that net profit or loss flows through to the owners to be reported on their separate returns.Chapter 16, Exhibit 1b CCH Federal Taxation Basic Principles6 of 92
  7. 7. C Corporations—Special Types Professional association [PA]. An association of professionals (e.g., accountants, doctors, lawyers) treated as a C corporation for tax purposes if it has: a. Organized under a state’s Professional Association Act; AND b. “Checked the box” on Form 8832 for corporate tax treatment. [One individual may be a professional association.]Chapter 16, Exhibit 2a CCH Federal Taxation Basic Principles7 of 92
  8. 8. C Corporations—Special Types Personal Service Corporation [PSC]. C corporation whose shareholder-employee(s) owns over 10% of the stock and provides personal services (e.g., acting, entertainment, medical, legal, consulting, or other services performed through their personal efforts). Generally, a PSC must use a calendar tax year. Code Sec. 441(i). PSCs are subject to a flat 35% tax rate.Chapter 16, Exhibit 2b CCH Federal Taxation Basic Principles8 of 92
  9. 9. C Corporations—Special Types Personal Holding Company [PHC]. A nonexempt, closely held corporation, with a significant portion of its income that is passive in nature (e.g., from dividends or interest). PHCs are subject to a 15% penalty tax on excess personal holding company income in addition to the regular corporate income tax.Chapter 16, Exhibit 2c CCH Federal Taxation Basic Principles9 of 92
  10. 10. C Corporations—Special Types Q: When is a corporation deemed to be “closely held”? A: When more than 50% of the value of the outstanding stock was owned by five or fewer individuals during the second half of the year. Q: When is passive income deemed to be “significant”? A: When passive income is 60% or more of “adjusted ordinary gross income” [AOGI]. AOGI is gross income less capital gains and Code Sec. 1231 gains, less adjustments such as certain expenses connected with rental and royalty income.Chapter 16, Exhibit 2d CCH Federal Taxation Basic Principles10 of 92
  11. 11. C Corporations—Tax Years Every newly organized corporation other than a personal service corporation (PSC) has the unrestricted right to select its annual tax year, regardless of the tax years employed by its shareholders. PSCs generally must use a calendar year-end. However, they may use a fiscal year-end under the same conditions as listed for S corporations.Chapter 16, Exhibit 3 CCH Federal Taxation Basic Principles11 of 92
  12. 12. C Corporations—Accounting Methods Most corporations must use the accrual method. The cash method MAY be used by C corporations that have average annual gross receipts of $5 million or less in the three preceding years, or by PSCs.Chapter 16, Exhibit 4 CCH Federal Taxation Basic Principles12 of 92
  13. 13. C Corporations— Tax Formula Ord. and Cap. Income “From Whatever Source Derived” – Exclusions – Cost of Goods Sold = Gross Income – Deductions = Taxable Income (Loss) x Tax Rate = Gross Regular Tax Liability – Credits (If Any) = Net Regular Tax Liability + Alt. Minimum Tax (If Any) + FICA Taxes + Accumulated Earnings Tax (If Any) + Personal Holding Co. Tax (If Any) = Net Tax Due or RefundableChapter 16, Exhibit 5a CCH Federal Taxation Basic Principles13 of 92
  14. 14. C Corporations—Tax Formula AGI, standard deductions, personal exemptions, at- risk rules, and passive activity loss rules do not pertain to regular C corporations.Chapter 16, Exhibit 5b CCH Federal Taxation Basic Principles14 of 92
  15. 15. C Corporations—Comparison with Individual Taxpayers Income Similar Treatment Different Treatment Most items of gross income receive the Bond Redemptions – Discounts. same tax treatment. Sinking fund income. Cost of goods sold (actually, part of gross income) are similar. Exclusions Similar Tax Treatment Different Treatment Most exclusions receive the same tax Capital contributions. treatment. Gain/loss on sale of treasury stockChapter 16, Exhibit 6a CCH Federal Taxation Basic Principles15 of 92
  16. 16. C Corporations—Comparison with Individual Taxpayers Expenses Similar Tax Treatment Different Treatment  Travel, Meals and Entertainment  Organizational Expenditures  Insurance Premiums  Dividend Received Deduction  Research and Experimental  Charitable Contribution  Fines (not deductible)  Interest Expense  Bad Debts  Amortization of Original Issue  Worthless Securities  Bond Redemptions-Premiums  Casualty Losses (same as individuals’ business use  Stock Redemptions (not deductible) casualty losses)  Compensation  Taxes  Educational Expenses  Depreciation (except Sec. 1250 recapture)  Net Operating Losses  Amortization  Capital Gains and Losses  Depletion  Political Contributions & Lobbying  Business Investigation Expense  Business Start Up ExpenseChapter 16, Exhibit 6b CCH Federal Taxation Basic Principles16 of 92
  17. 17. Income Items Requiring Special Treatment Bond Repurchases. A corporation’s income INCLUDES the original issue price of its own bonds being repurchased, MINUS (i) The repurchase price, MINUS (ii) Any premium already recognized on the original issuance. PLUS (iii) Any discounts previously deducted. Sinking Fund Income. Interest or other income from property in a sinking fund established to satisfy an obligation IS INCLUDED, even if in the hands of a trustee (since both funded and nonforfeitable).Chapter 16, Exhibit 7 CCH Federal Taxation Basic Principles17 of 92
  18. 18. Exclusions Requiring Special Treatment Treasury Stock. No gain or loss is recognized by a corporation on the sale or exchange of its own stock.Chapter 16, Exhibit 8a CCH Federal Taxation Basic Principles18 of 92
  19. 19. Exclusions Requiring Special Treatment Capital Contributions. Gifts from nonshareholders are excluded. Noncash gifts. If a gift is property other than money, the corporation carries it with a zero basis. Cash gifts. When cash is contributed, reduce the basis of corporate property in the following order: (i) Property acquired within 1 year after the contribution; (ii) Then depreciable property in proportion to relative bases; (iii) Then, if there is a remaining balance, NON- depreciable property acquired over 1 year after the contribution.Chapter 16, Exhibit 8b CCH Federal Taxation Basic Principles19 of 92
  20. 20. Exclusions Requiring Special Treatment Pro rata contributions from shareholders are excluded. Whether voluntary or by assessment, shareholder contributions are excluded from corporate income. The corporation carries the property at the same basis as had been reported by the contributing shareholder. That shareholder gets no deduction, but does get an increase in stock basis, equal to the basis in the property contributed.Chapter 16, Exhibit 8c CCH Federal Taxation Basic Principles20 of 92
  21. 21. Deductions Requiring Special Treatment— Organizational Expenditures Amortizable expenditures. Organizational expenses qualify for amortization if: (a) = Incurred incidental to formation of the corporation (e.g., legal fees for drafting the charter, state incorporation fees, expenses for temporary directors and organizational meeting costs), and (b) = Incurred before the end of the tax year in which the corporation commences business. Amortization period must be over 180 months, starting with the month that the corporation commences business.Chapter 16, Exhibit 9a CCH Federal Taxation Basic Principles21 of 92
  22. 22. Deductions Requiring Special Treatment— Organizational Expenditures Nonamortizable expenditures. Organizational expenses DO NOT qualify for amortization if related to the transfer of assets to the corporation or the issuance and sale of stock (e.g., printing stock certificates, professional fees for issuing stock and broker’s commission on the sales of stock.) They are written off when the corporation completely liquidates.Chapter 16, Exhibit 9b CCH Federal Taxation Basic Principles22 of 92
  23. 23. Dividends Received Deduction—Example 1 Dividends received from other corporations are included by both corporate and individual shareholders, but deductible only by corporate shareholders within limits explained below. Dividends Received Deduction (DRD) % Ownership Tentative* DRD: Tentative* DRD Limit: (Value and Voting) * (Subject to limit if DRD * (Does not apply if DRD would NOT create an NOL) would create an NOL) ≥ < --- 20% 70% div. received 70% ATI 20% 80% 80% div. received 80% ATI 80% & affiliated --- 100% div. received 100% ATI ATI = Revenue - COGS - Operating expenses + Other income (Another way to arrive at ATI is to start with taxable income and purge out three possible deductions: ATI = TI + (1) Actual DRD + (2) NOL carryover + (3) Capital loss carryover). “Affiliated” means owning ≥ 80% of both voting power and value of stock.Chapter 16, Exhibit 10a CCH Federal Taxation Basic Principles23 of 92
  24. 24. Dividends Received Deduction—Example 1 FACTS: C Corp. has the following income and expenses: Operating Revenue 800,000 COGS (300,000) Operating expenses (520,000) Other income (dividends received from a 25%-owned corp.) 100,000Chapter 16, Exhibit 10b CCH Federal Taxation Basic Principles24 of 92
  25. 25. Dividends Received Deduction—Example 1 Note: The relevant DRD % is 80% since C Corp. owned ≥20% and < 80% of stock. (a) Compute ATI (i.e., (a) = Rev. - COGS - ATI = $80,000 taxable income before Oper. exp. + Other inc. [= 800,000 - 300,000 - 520,000 + 100,000] special deductions) (b) Determine tentative (b) = 70% or 80% or Tentative DRD Limit = $64,000 DRD limit 100% x ATI [= 80% ATI = 80% x 80,000] (c) Compute tentative (c) = 70% or 80% or Tentative DRD = $80,000 DRD 100% x Div. Rec’d [= 80% x $100,000] (d) Determine actual (d) Actual DRD = $64,000 DRD If (a) - (c) ≥ 0, then (d) = $80,000 ATI - $80,000 tentative DRD is ≥ 0; therefore, DRD = the lesser of: the lesser of (b) or (c) $64,000 tentative DRD limit, or $80,000 tentative If (a) - (c) < 0, then (d) = DRD (c) (e) Compute TI (e) = (a) - (d) TI =$16,000 [= ATI - DRD = 80,000 - 64,000] (f) Compute tax (f) = (e) x appropriate tax Tax = $2,400 rates [From tax tables: 15% x $16,000 = $2,400]Chapter 16, Exhibit 10c CCH Federal Taxation Basic Principles25 of 92
  26. 26. Dividends Received Deduction—Example 2 FACTS: Same as Example 1 except operating expenses are $520,001, not $520,000. SOLUTION: ATI = $79,999 [= 800,000 - 300,000 - 520,001 + 100,000]  Tentative DRD Limit = $63,999 [= 80% ATI = 80% x 79,999 = 63,999]  Tentative DRD = $80,000 [= 80% x $100,000]  Actual DRD = $80,000 [Same as tentative DRD, since $79,999 ATI - $80,000 Tentative DRD is < 0.]  TI = $(1), an NOL [= ATI - DRD = 79,999 - 80,000]  Tax = $0Chapter 16, Exhibit 11a CCH Federal Taxation Basic Principles26 of 92
  27. 27. Dividends Received Deduction—Example 2 Note that in Example 1, the tentative DRD limit applies since the DRD does not create an NOL. In Example 2, where operating expenses are $520,001 instead of $520,000, the tax results are much more favorable. An additional $1 of operating expenses saves $2,400 of taxes!Chapter 16, Exhibit 11b CCH Federal Taxation Basic Principles27 of 92
  28. 28. Deductions Requiring Special Treatment— Charitable Contributions Charitable contributions. As with individuals, corporate charitable contributions are deductible if made to qualified organizations. [i.e., Code Sec. 501(c) organizations]. Also, as with individuals, corporate contributions in excess of deductions are carried forward 5 years. No carrybacks are allowed for corporations or individuals. The following DIFFERENCES distinguish corporate tax treatment from individual tax treatment.Chapter 16, Exhibit 12a CCH Federal Taxation Basic Principles28 of 92
  29. 29. Deductions Requiring Special Treatment— Charitable Contributions 10% ATI limitation. Deductions are limited to 10% ATI. What is ATI? ATI for Charitable Deduction Computations. = TI (i.e., after all deductions) Addback: + DRD + NOL carryback + Capital loss carryback + Charitable deductions Another way to compute ATI: = Rev. - COGS - Operating expenses + Other incomeChapter 16, Exhibit 12b CCH Federal Taxation Basic Principles29 of 92
  30. 30. Deductions Requiring Special Treatment— Charitable Contributions 2 1/2 Month Rule. If a charitable contribution is board-approved in the current year and paid within 2 1/2 months of the subsequent year, then a deduction is allowed in the current year. Not so for individuals. Inventory. Generally, as with individuals, corporations may deduct only the basis of inventory contributed. However, corporations may deduct 50 percent of market value if the inventory is donated solely for care of infants, the ill, or the needy.Chapter 16, Exhibit 12c CCH Federal Taxation Basic Principles30 of 92
  31. 31. Charitable Contributions—Example FACTS:  C Corp.’s taxable income BEFORE the charitable deduction was $410,000.  C Corp. contributed $40,000 to a qualified charitable organization.  Included in the $410,000 is a $20,000 DRD.  C Corp. also has a $5,000 carryover contribution from a prior year (not part of the $410,000). QUESTION: How much is the charitable deduction?Chapter 16, Exhibit 13a CCH Federal Taxation Basic Principles31 of 92
  32. 32. Charitable Contributions—Example SOLUTION: $43,000 1. ATI = $430,000 [410,000 + 20,000] 2. 10% ATI Limitation = $43,000 [10% x 430,000 = 43,000] 3. Contribution = $45,000 [40,000 current year + 5,000 carryover] 4. Deduction = $43,000 [ Lesser of 2. or 3. above]Chapter 16, Exhibit 13b CCH Federal Taxation Basic Principles32 of 92
  33. 33. Deductions Requiring Special Treatment Interest Expense. Interest expense on a corporation’s own debt is fully deductible, even if in connection with the repurchase of its own stock. Recall that individuals’ investment interest deductions are limited to net investment income. Not so with corporations.Chapter 16, Exhibit 14a CCH Federal Taxation Basic Principles33 of 92
  34. 34. Deductions Requiring Special Treatment Original Issue Discounts. OID is deductible as interest expense. (1) Pre-7/1/82 issue bonds. Discount may be amortized using the straight-line method over the life of the bonds. (2) Post-6/30/82 issue bonds. For bonds issued on or after 7/1/82, discounts from face value must be amortized using the effective yield method.Chapter 16, Exhibit 14b CCH Federal Taxation Basic Principles34 of 92
  35. 35. Deductions Requiring Special Treatment Example on OID, Post-6/30/82 Bonds (Effective Yield Method) Facts:  3/1/x1: A corporation hired an investment banking firm to underwrite and sell 5- year, $10,000 bonds.  6/15/x1: The bonds were printed when the market yielded 10% on five-year bonds of comparable risk. Accordingly, the investment banking firm set the coupon rate at 10%.  6/15/x1 - 6/30/x1: The market yield on comparable five-year bonds rose to 12%.  6/30/x1: Five-year, $10,000, 10% bonds were issued to the public. Since the market then yielded 12%, the bonds had to be discounted to $9,250 to be saleable. Question: How much OID is deductible on one $10,000 bond in 20x1 and 20x2? Solution: 20x1: $55.00; 20x2: $120.10 (i.e., $120.10 = $58.30 + $61.80)Chapter 16, Exhibit 14c CCH Federal Taxation Basic Principles35 of 92
  36. 36. Deductions Requiring Special Treatment Solution (a) (b) = (a) x 12% (c) = (d) = (e) = (a) + (d) 10m x 10% (b) – (c) Year AIP, x 12% yield Less: Interest AIP, Beg Payment End. Bal. * Bal. * Deduction 20x1 9,250 555.00 500 55.00 9,305 (2nd half) [9,250 x (12% x 1/2)] [1,000 x 1/2] 9,250 + 55 = 9,305 20x2 9,305 558.30 500 58.30 9,363 (1st half) [9,305 x (12% x 1/2)] 9,305 + 58.30 = 9,363 20x2 9,363 561.80 500 61.80 9,425 (2nd half) [9,363 x (12% x 1/2)] 9,363 + 61.80 = 9,425 * AIP = Adjusted Issue Price, the original issue price increased by the OID deduction.Chapter 16, Exhibit 14d CCH Federal Taxation Basic Principles36 of 92
  37. 37. Deductions Requiring Special Treatment— Bond and Stock Redemptions at a Premium Repurchasing Bonds at a Premium. A corporation that repurchases its bonds may deduct as interest expense the excess of the repurchase price over the adjusted issue price. Repurchasing Stock at a Premium. Amounts paid to repurchase stock are not deductible. Both acquiring and target corporations may capitalize legal fees, invest banker fees and other cost associated with a takeover.Chapter 16, Exhibit 15a CCH Federal Taxation Basic Principles37 of 92
  38. 38. Deductions Requiring Special Treatment— Bond and Stock Redemptions at a Premium Example on Repurchasing Original Issue Bonds at a Premium FACTS:  ABC Corporation buys back one $10,000 bond on 1/1/x1 at a repurchase price of $9,800.  The adjusted issue price (AIP) on the bond is $9,425 as of 1/1/x1. QUESTION: How much of the payment premium is deductible in the year 20x1 as interest expense? SOLUTION: $375 (i.e., $9,800 payment, less $9,425 AIP balance)Chapter 16, Exhibit 15b CCH Federal Taxation Basic Principles38 of 92
  39. 39. Deductions Requiring Special Treatment— Compensation and Educational Reimbursement Compensation. Four independent rules: (1) Unreasonable compensation to a shareholder is generally treated as a dividend, to the extent of earnings and profits. (2) Informal short-term arrangements. Payments made by March 15 of the succeeding year may be accrued and expensed in the current year if related to services incurred in the current year.Chapter 16, Exhibit 16a CCH Federal Taxation Basic Principles39 of 92
  40. 40. Deductions Requiring Special Treatment— Compensation and Educational Reimbursement (3) Executive Compensation Limitations. Deductible compensation for the top five executives of publicly traded companies is limited to $1,000,000 for each executive unless performance based. (4) Restricted Stock. Compensation to an employee in the form of stock is deductible when the employee reports the amount as ordinary income. Employees must include the market value of stock received for services in GI when (i) it is not subject to a substantial risk of forfeiture, and (ii) its value is ascertainable.Chapter 16, Exhibit 16b CCH Federal Taxation Basic Principles40 of 92
  41. 41. Deductions Requiring Special Treatment— Compensation and Educational Reimbursement Example on Restricted Stock Compensation: FACTS:  20x1: Employee purchases restricted stock (FMV = $1,000) from employer-corporation for $500.  The stock is forfeitable until the employee serves the employer 6 years.  20x7: After 6 yrs., the restriction is lifted when the FMV = $2,000. QUESTION: What is the timing and amount of the employee’s taxable income & the corporate employer’s deduction? SOLUTION: 20x1: No TI to employee; no deduction to employer. 20x7: $1,500 ordinary income to employee; $1,500 corporate deduction 1,500 [2,000 - 500]Chapter 16, Exhibit 16c CCH Federal Taxation Basic Principles41 of 92
  42. 42. Educational Expenses An employer’s expenditures for employee education are deductible as business expenses. An individual, in contrast, may deduct only educational expenses required to maintain or improve skills in a present positionChapter 16, Exhibit 17 CCH Federal Taxation Basic Principles42 of 92
  43. 43. Rules for Net Operating Losses (NOLs) Comparison of NOL Rules Between Corporations and Proprietorships Corporations Proprietorships Excess business exp. over bus income Definition of NOL Same general definition as corporate. Carryovers 2 years back, 20 years Same as corporate. [NOLs from tax years forward. [For pre-8/5/97 beginning after 8/5/97.]: NOLs: 3 yrs. back; 15 yrs. forward.] If carried backward: Prior taxable income (TI) is Same as corporate. recomputed, & taxpayer files for a refund with an amended return. If carried forward.: Deduction from gross income in Deduction for AGI in a a subsequent year. subsequent year. Election: May elect to forego Same as corporate. carrybacks.Chapter 16, Exhibit 18a CCH Federal Taxation Basic Principles43 of 92
  44. 44. Rules for Net Operating Losses (NOLs) Comparison of NOL Rules Between Corporations and Proprietorships Corporations Proprietorships Calculation TI (a negative amount) TI (a negative amount) + NOL Carryovers + NOL Carryovers + Alimony Deducted + IRA contributions + Charitable deductions + Nonbus. CLs in XS of nonbus. CGs = NOL + Std. or itemized deductions, except personal [Note that DRD is not added casualty. deductions are not added back. back; also net capital losses are + Personal exemptions not added back since they aren’t - Interest income deductible in the first place.] - Dividend income - Nonbus. CGs in XS of nonbus. CLs - Other nonbusiness inc. (except wages are not subtracted.) = NOL (Unlike individuals, corporations need not make adjustments to NOL for capital gains or losses. Also, corporations are permitted the full DRD in computing NOLs.)Chapter 16, Exhibit 18b CCH Federal Taxation Basic Principles44 of 92
  45. 45. Net Operating Losses (NOLs)—Example FACTS:  Fred Corporation had $100,000 sales and $135,000 expenses, plus a $(30,000) NOL carryover from 20 years ago.  Fred Corporation also had the following income and expenses:  $1,000 interest income on a savings account;  $70,000 dividends from a 30% - owned corporation;  $1,500 LTCG on the sale of business property;  $(10,000) STCL on the sale of stock;  $ 9,000 LTCG on the sale of a painting held for investment;  $ (6,000) charitable contributions. QUESTION: Compute Fred Corporation’s NOL.Chapter 16, Exhibit 19a CCH Federal Taxation Basic Principles45 of 92
  46. 46. Net Operating Losses (NOLs)—Example Taxable Income = $(53,150): Operating loss (35,000) 100,000 - 135,000 = (35,000) – NOL carryover (30,000) + Interest income 1,000 + Dividends received 70,000 – DRD (56,000) 80% x 70,000 + Net LTCG 500 1,500 - 10,000 + 9,000 – Charitable deduction (3,650) 10% ATI where ATI = The lesser of: (35,000) + 1,000+ 70,000 +500 (1) $6,000; or (2) 10% ATI = Taxable income (53,150)Chapter 16, Exhibit 19b CCH Federal Taxation Basic Principles46 of 92
  47. 47. Net Operating Losses (NOLs)—Example NOL = $(19,500): TI (53,150) + NOL carryover 30,000 + Charitable deduction 3,650 = NOL (19,500)Chapter 16, Exhibit 19c CCH Federal Taxation Basic Principles47 of 92
  48. 48. Capital Gains and Losses Comparison Between Corporations and Individuals Corporations Individuals Determining long/short- Requires netting from a Requires netting among term capital gains/losses: single “rate basket” several “rate baskets” Tax on net long-term Ordinary corporate tax rates Ord. ind’l rates, up to capital gains: 10%/15%/20%/28% Tax on net short-term Ordinary corporate tax rates Ord. ind’l tax rates, no limit capital gains: Net long-short-term capital Not deductible Deductible up to $3m losses: ($1.5m if married filing separately.) Carryovers: 3 yrs. back, 5 yrs. fwd. Carry forward (not back) (Unlike with NOLs, no indefinitely election allowed to forgo carrybacks.)Chapter 16, Exhibit 20a CCH Federal Taxation Basic Principles48 of 92
  49. 49. Capital Gains and Losses Comparison Between Corporations and Individuals Corporations Individuals Character of capital loss Long and short-term capital Long/short-term loss carryovers: losses carried over as short- carryovers retain their term character. Computing NOL: Net capital losses are never Net nonbusiness capital part of NOL since they are not losses are added back to deductible. Therefore, no taxable income (TI). addback to taxable income (Note that they are always ≤ (TI). $3,000); Net capital gains are not Net nonbusiness capital subtracted from TI (i.e., capital gains are subtracted from gains reduce NOLs). TI.Chapter 16, Exhibit 20b CCH Federal Taxation Basic Principles49 of 92
  50. 50. Depreciation Expense Depreciation Including Code Sec. 179. Generally, the rules for corporations are identical to the rules for proprietorships. However, for Code Sec. 1250 assets, an additional recapture amount is required under Code Sec. 291.Chapter 16, Exhibit 21a CCH Federal Taxation Basic Principles50 of 92
  51. 51. Depreciation Expense Code Sec. 291 Exception for Corporations. For corporations, realized gain must be characterized as Code Sec. 291 ordinary income (OI) to the extent of 20% of any excess of “pretend” Code Sec. 1245 OI over Code Sec. 1250 OI.Chapter 16, Exhibit 21b CCH Federal Taxation Basic Principles51 of 92
  52. 52. Code Sec. 291 Depreciation for Corporations— Example FACTS:  1/1/x1: ABC Corp. acquired an office building for $450,000.  1/1/x1 - 12/31/13: The building was depreciated using 15-year straight-line.  1/1/14: The building was sold 13 years later for $240,000. QUESTION: Compute Code Sec. 291 OI and Code Sec. 1231 gain.Chapter 16, Exhibit 22a CCH Federal Taxation Basic Principles52 of 92
  53. 53. Code Sec. 291 Depreciation for Corporations— Example SOLUTION: Formula: Description 000’s Computations: (a) Sales Price 240 Adjusted Basis: (b) Cost 450 (c) Accumulated 390 (450,000 ÷ 15 years) x 13 yrs, Depreciation (ignoring mid-month convention) (d)=(b)-(c) Adjusted Basis 60 (e)=(a)-(d) Realized gain 180 (f)= < of (c) or (e) “Pretend” Sec. 180 < of 390,000 or 180,000 1245 OIChapter 16, Exhibit 22b CCH Federal Taxation Basic Principles53 of 92
  54. 54. Code Sec. 291 Depreciation for Corporations— Example SOLUTION: Formula: Description 000’s Computations: (g)= Excess accel OI under Sec. 1250 0 “$0” since ACRS (i.e., accelerated depr. over S/L depreciation) was not used. depreciation. (h) = (f) - (g) Excess “pretend” 180 Sec. 1245 OI (i) = (h) x 20% Sec. 291 OI 36 180,000 x 20% (j) = (e) - (i) Sec. 1231 cap. gain 144 180,000 - 36,000Chapter 16, Exhibit 22c CCH Federal Taxation Basic Principles54 of 92
  55. 55. Reconciling Book and Taxable Income Form 1120. A corporation files its federal return on Form 1120. Schedule M-1. Reconciling accounting and tax income is done on Schedule M-1 of Form 1120. M-1 addresses differences, both permanent and temporary, between accounting and tax income. The differences are caused by using different accounting and tax methods to report income and expenses. In addition to tax reporting, the M-1 is also useful for tax planning.Chapter 16, Exhibit 23a CCH Federal Taxation Basic Principles55 of 92
  56. 56. Reconciling Book and Taxable Income Example on M-1 Reconciling Items FACTS: ABC Corp. reports the following results of operations: Net income per books, after taxes 88,000 Rent received in advance (booked as a liability) 11,000 Federal income taxes 13,750 Tax-exempt interest on Municipal bonds 3,000 Net capital loss (in XS of CGs) 1,250 Premium paid on life insurance for key employees (ABC = 1,000 Beneficiary) Life ins. proceeds received due to death of key employee 10,000 XS MACRS over S/L depreciation (S/L is used for accounting 5,000 purposes.) Charitable contribution carryover 7,000Chapter 16, Exhibit 23b CCH Federal Taxation Basic Principles56 of 92
  57. 57. Reconciling Book and Taxable Income Example on M-1 Reconciling Items: Prepare an M-1 reconciliation and compute taxable income. Net income per books 88,000 + Expenses per books that are not deductible: Federal income tax expense (not tax deductible) 13,750 XS capital losses over capital gains (not tax deductible) 1,250 Insurance premiums (not deductible since ABC is a beneficiary) 1,000 – Deductible expenses not booked for accounting purposes: XS MACRS depr. per tax return over S/L depreciation per books (5,000) Charitable contribution carryover (7,000) – Income per books not taxable: Tax-exempt interest on municipal bonds (3,000) Life insurance proceeds received on death of key employee (10,000) Taxable income not booked for accounting purposes + Future rent received in advance. 11,000 = Taxable income 90,000Chapter 16, Exhibit 23c CCH Federal Taxation Basic Principles57 of 92
  58. 58. Corporate Tax Rates Computing Regular Income Tax. Corporations are subject to the 4-bracket graduated tax rate structure below. Tax Rates on Corporate Taxable Income At Least: But Not Over: Marginal Tax Rate: $ 0 $ 50,000 15% (1st bracket) 50,000 75,000 25% (2nd bracket) 75,000 100,000 34% (3rd bracket) 39% (3rd + 5% surc harge ) 100,000 335,000 335,000 10,000,000 34% (3rd bracket) 10,000,000 15,000,000 35% (4th bracket) 15,000,000 18,333,333 38% (4th + 3% surcharge) Over 18,333,333 35% (4th bracket)Chapter 16, Exhibit 24a CCH Federal Taxation Basic Principles58 of 92
  59. 59. Corporate Tax Rates Surtaxes imputed in the table from the previous slide.  A 5% surtax is charged on TI between $100,000 and $335,000, which eliminates the “tax savings” on the first $100,000 of TI.  A 3% surtax is charged on TI between $15,000,000 and $18,333,333, which recaptures the “tax savings” from $335,000 to $10,000,000. Capital gain rates. Same as ordinary rates. No rate breaks as with individual tax rates. Capital losses. Not deductible as with individuals, offset only against capital gains. Personal Service Corporations. Taxed at a flat rate of 35% on all taxable income (TI).Chapter 16, Exhibit 24b CCH Federal Taxation Basic Principles59 of 92
  60. 60. Corporate Tax Rates Controlled group of corporations. Rates are applied to the aggregate TI of the group as if it were a single corporation. A controlled group a parent corporation and one or more subsidiaries in which the parent owns EITHER: (a) 80% total voting power of Subsidiary, or (b) 80% total value of Subsidiary’s stock. Any additional corporation with an 80% connection to any member of the controlled group becomes part of the controlled group.Chapter 16, Exhibit 24c CCH Federal Taxation Basic Principles60 of 92
  61. 61. Corporate Tax Credits General Availability of Credits. Most tax credits available to individuals are available to corporations. Exceptions include: • Earned income credit; • Child and dependent care credit; • Elderly and disabled credit; • Hope credit; • Lifetime Learning credit; • Adoption credit. Foreign Tax Credit (FTC) or Deduction (FTD). A U.S. citizen or resident alien may elect either a credit or a deduction “FOR” AGI, on taxes paid to other countries or U.S. possessions. The maximum amount credited or deducted is determined from the following table.Chapter 16, Exhibit 25 CCH Federal Taxation Basic Principles61 of 92
  62. 62. Template for Computing the Foreign Tax Credit/Deduction (a) U.S. income tax before the foreign tax credit or deduction. (b) Foreign source taxable income (TI). (c) Worldwide taxable income. (d) = (a) x [(b) ÷ (c)] Allocation amount. (e) Foreign taxes actually paid on worldwide TI. (f) = < (d) or (e) Foreign tax credit or deduction.  FTCs are credited against gross tax liability before all other credits. • FTDs are deductible from gross income. • FTC’s usually result in greater tax benefits than FTDs. • Unused foreign tax credits or deductions are carried back 2 years and then carried forward 5 years. • For nonresident aliens, FTC is allowed to reduce U.S. tax on U.S. income but only to the extent that foreign taxes have been paid on U.S. income.Chapter 16, Exhibit 26 CCH Federal Taxation Basic Principles62 of 92
  63. 63. Foreign Tax Credits—Example FACTS: U.S. Corp. has worldwide TI of $500,000, and a tentative U.S. tax liability of $170,000. From its Chinese operations, U.S. Corp. had $100,000 of TI on which a $45,000 Chinese tax was paid. QUESTION: What is U.S. Corp.’s FTC or FTD? SOLUTION: ( U.S. income tax before the FTC or FTD. a ) $170,000 (b) Foreign source TI 100,000 (c) Worldwide taxable income 500,000 (d) = (a) x [(b) ÷ (c)] Allocation amount. 34,000 (e) Foreign taxes actually paid on worldwide TI. 45,000 (f) = < (d) or (e) Foreign tax credit or deduction. 34,000Chapter 16, Exhibit 27 CCH Federal Taxation Basic Principles63 of 92
  64. 64. Formation of Corporations—Overview of Code Sec. 351 What is the general rule on transferring property to a corporation in exchange for stock? Code Sec. 351 requires that no gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in the corporation and immediately after the exchange, such person or persons control the corporation. This nonrecognition treatment is mandatory, not elective. Note that Code Sec. 351 protects only the transfer of property. It does not protect the transfer of services. Also, Code Sec. 351 applies even after a corporation has been formed.Chapter 16, Exhibit 28a CCH Federal Taxation Basic Principles64 of 92
  65. 65. Formation of Corporations—Overview of Code Sec. 351 What was Congress thinking when it enacted Code Sec. 351? There are two reasons for Code Sec. 351. First, as the stockholders receive only stock, they may not have the wherewithal to pay taxes. Second, the incorporation of a going concern is not an economic transaction but rather a change in legal form only.Chapter 16, Exhibit 28b CCH Federal Taxation Basic Principles65 of 92
  66. 66. Formation of Corporations—Overview of Code Sec. 351 What is “control”? Control is ownership by all transferors of property of 80% or more of BOTH the voting power AND the value of all classes of stock. Do not include the % ownership of transferors of services in this determination.Chapter 16, Exhibit 28c CCH Federal Taxation Basic Principles66 of 92
  67. 67. Formation of Corporations—Overview of Code Sec. 351 What is “property”? Consistent with Code Sec. 351(d) “property” includes just about everything except services. (i.e., cash, inventory, receivables, land, other tangible assets, nonexclusive licenses, and industry know-how.)Chapter 16, Exhibit 28d CCH Federal Taxation Basic Principles67 of 92
  68. 68. Formation of Corporations—Overview of Code Sec. 351 Why are “services” NOT “property’? Under Code Sec. 351(d)(1), services are NOT property to ensure that a person who provides ONLY services to a corporation (1) will be taxed immediately (on the FMV of stock received); and (2) will NOT be included in the 80% control computation.Chapter 16, Exhibit 28e CCH Federal Taxation Basic Principles68 of 92
  69. 69. Formation of Corporations—Overview of Code Sec. 351 How does Code Sec. 351 apply if a person contributes both property and services? The receipt of stock attributable to services will generally be treated as a separate transaction outside the scope of Code Sec. 351. [However, the stock received in exchange for part property, part services will ALL be included in the 80% control computation!]Chapter 16, Exhibit 28f CCH Federal Taxation Basic Principles69 of 92
  70. 70. Code Sec. 351 Contribution of Part Property/Part Services—Example FACTS: A transfers land worth $50,000, and B transfers land worth $15,000 and contributes services worth $35,000 to X Corp. in exchange for all of the stock of X. QUESTION 1: Has the 80% control requirement been met under Code Sec. 351? SOLUTION 1: Yes, B’s stock attributable to services counts in the “control” computation—and control by A and B after the exchange is 100%. Since control immediately after the exchange ≥ 80%, the exchange qualifies as a Code Sec. 351 exchange.Chapter 16, Exhibit 29a CCH Federal Taxation Basic Principles70 of 92
  71. 71. Code Sec. 351 Contribution of Part Property/Part Services—Example FACTS: A transfers land worth $50,000, and B transfers land worth $15,000 and contributes services worth $35,000 to X Corp. in exchange for all of the stock of X. QUESTION 2: What would be the result if B contributed ONLY services? SOLUTION 2: Then B’s stock would not count in the control computation, and control immediately after the exchange would be limited to A’s 50%. Since 50% < 80%, this would not have been a Code Sec. 351 exchange.Chapter 16, Exhibit 29b CCH Federal Taxation Basic Principles71 of 92
  72. 72. Code Sec. 351 Contribution of Part Property/Part Services—Example FACTS: A transfers land worth $50,000, and B transfers land worth $15,000 and contributes services worth $35,000 to X Corp. in exchange for all of the stock of X. QUESTION 3: Can B get Code Sec. 351 tax free treatment for the $35,000 services contributed? SOLUTION 3: No, services are not property under Code Sec. 351(d)(1). Therefore, B will recognize $35,000 OI as compensation for his services.Chapter 16, Exhibit 29c CCH Federal Taxation Basic Principles72 of 92
  73. 73. Code Sec. 351 Contributions— Tax Effect on Shareholders What is the recognized gain of shareholders in a Code Sec. 351 transfer of property for stock? Code Sec. 351(b) provides that a shareholder’s recognized gain will be the smaller of (1) boot received or (2) realized gain. (Students should not confuse Code Sec. 351 boot with Code Sec. 1031 “net boot received”—that term applied to like-kind exchanges under Code Sec. 1031.) Here, boot is money and the FMV of property other than the common stock of the corporation received in the exchange. Also, under Code Sec. 358(c), a shareholder liability assumed by the corporation is boot if it exceeds the AB of all property contributed by the shareholder. If not, then it’s not boot.Chapter 16, Exhibit 30a CCH Federal Taxation Basic Principles73 of 92
  74. 74. Code Sec. 351 Contributions— Tax Effect on Shareholders How is the basis of the stockholder in the stock determined? Code Sec. 358 provides the following formula (referred to as the “front-in” approach): AB in contributed property – FMV of boot received, including liabilities assumed by corporation that ARE boot – Liabilities of shareholder assumed by corporation that are NOT boot. Code Sec. 358(d) + Gain recognized by the shareholder – Loss recognized by the shareholder = SHAREHOLDER BASIS OF STOCK.Chapter 16, Exhibit 30b CCH Federal Taxation Basic Principles74 of 92
  75. 75. Code Sec. 351 Contributions— Tax Effect on Shareholders How is a shareholder’s holding period in the stock determined? The holding period of the property contributed tacks on to the stock received. If several properties have been contributed, the stock will have a split holding period! What is a shareholder’s basis and holding period in the boot received? The shareholder’s basis in boot received is generally the corporation’s basis (not FMV). The holding period of boot received does not tack on as does stock received. Instead, it begins on the day AFTER receipt.Chapter 16, Exhibit 30c CCH Federal Taxation Basic Principles75 of 92
  76. 76. Code Sec. 351 Contributions— Tax Effect on Corporations What is the corporation’s basis in the assets transferred by shareholders? Code Sec. 362 provides that the basis of assets received by a corporation in a Code Sec. 351 transfer will be (a) + (b), where: (a) = Shareholder’s basis in contributed property (b) = Gain recognized by the shareholder, allocated using relative FMVs. (a) = (a) + (b) = Corporation’s basis in assets contributed by S/H.Chapter 16, Exhibit 31a CCH Federal Taxation Basic Principles76 of 92
  77. 77. Code Sec. 351 Contributions— Tax Effect on Corporations What is the corporation’s holding period in the assets contributed by a shareholder? Same as the holding period of the shareholder. Does the corporation recognize gain or loss on the exchange of its stock for property under Code Sec. 351? No, never. What about property other than stock transferred by the corporation? If a corporation transfers other property to shareholder, then YES, it generally recognizes gain (but not loss) based on [FMV - AB].Chapter 16, Exhibit 31b CCH Federal Taxation Basic Principles77 of 92
  78. 78. Code Sec. 351 Contributions—Example 1 Facts: On 12/31/x1, Dennis forms a new corporation and receives 100% of the corporation’s stock after contributing the following property: Land Building Holding period Began 3/21/97 Began 8/19/x1 FMV, 12/31/x1 1,000,000 14,000,000 Basis, 12/31/x1 2,000,000 3,000,000 Bldg. mtg.assumed by corporation 6,000,000Chapter 16, Exhibit 32a CCH Federal Taxation Basic Principles78 of 92
  79. 79. Code Sec. 351 Contributions—Example 1 Question: Compute the following items:  Dennis’ realized gain.  Dennis’ boot received.  Dennis’ recognized gain.  Dennis’ postponed gain.  Dennis’ basis in the stock received.  Dennis’ holding period in the stock received.  The corporation’s basis in the land and building contributed by Dennis.  The corporation’s holding period in the land and building.Chapter 16, Exhibit 32b CCH Federal Taxation Basic Principles79 of 92
  80. 80. Code Sec. 351 Contributions—Example 1 Solution: Formula Computation 000’s (a) Dennis’ (a) = Amt. Realized Note: Dennis’ stock is not publicly 4 realized gain - Basis of traded. However, its value may be assumed to be equal to the net value contributed of assets received by the corporation: property FMV of land........................... 1 = Realized gain + FMV of bldg......................+ 14 - Mtg. assumed by corp....... (6) (Similar to rules for any = Net value of assets .(i.e., disposition) Dennis’ amt. realized)........... 9 - Basis of contributed property (2mm land + 3mm bldg)..... 5 = Dennis’ realized gain.......... 4Chapter 16, Exhibit 32c CCH Federal Taxation Basic Principles80 of 92
  81. 81. Code Sec. 351 Contributions—Example 1 Solution: Formula Computation 000’s (b) Dennis’ (b) = Excess debt Dennis’ debt relief.................... 6 1 boot relief (i.e., debt relief - Basis of contributed property received: —AB of assets (2mm land + 3mm bldg)...... (5) contributed) = Excess debt relief..........…... 1 + FMV of other boot received + FMV of other boot received.. 0 = Dennis’ total boot received.. 1Chapter 16, Exhibit 32d CCH Federal Taxation Basic Principles81 of 92
  82. 82. Code Sec. 351 Contributions—Example 1 Solution: Formula Computation 000’s (c) Dennis’ (c) = Lesser of (a) or (a) = 4,000,000 1 recognized gain (b) (b) = 1,000,000 (Similar to “like-kind” (c) = 1,000,000 (the lesser exchange rules) amount) (d) Dennis’ (d) = (a) - (c) (d) = 4,000,000 – 1,000,000 = 3 postponed gain: 3,000,000Chapter 16, Exhibit 32e CCH Federal Taxation Basic Principles82 of 92
  83. 83. Code Sec. 351 Contributions—Example 1 Solution: Formula Computation 000’s (e) Dennis’ stock Front-in approach: Back-in approach: 0 Dennis’ basis can be (Here, the stock’s FMV basis in determined two ways: Stock basis: must first be “plugged” the stock  Using the Sec. from amount realized): received: + AB in cont’d 358 formula, i.e., FMV of stock: property....... 5 the “front-in” Amt realized........ 9 approach (shown - Boot rec’d... (1) above) - Debt relief.......... (6) - Debt relief,  Using the nonboot ....... (5) = Stock FMV........ 3 “back-in” Stock basis: approach, as was + Gain recog’d.. 1 Stock FMV......... 3 done for like- - Loss recog’d.. 0 kind property -Postponed gain....(3) = Stock basis ... 0 received = Stock basis......... 0Chapter 16, Exhibit 32f CCH Federal Taxation Basic Principles83 of 92
  84. 84. Code Sec. 351 Contributions—Example 1 Solution: Formula Computation 000’s (f) Dennis’ (f) = Same as holding period of holding the contributed property  HP of 1/15 share begins period in the Note 1. Since more than one on 3/21/97; stock property was contributed for the  HP of 14/15 share begins received: stock, each share will have a on 8/19/x1. split holding period (HP). (Thus, as of 12/31/x1, 1/15 of each share is deemed to Note 2. The HP rules for Sec. be long-term, and 14/15 351 stock is similar to HP rules short-term!) for like-kind assets received under Sec. 1031.Chapter 16, Exhibit 32g CCH Federal Taxation Basic Principles84 of 92
  85. 85. Code Sec. 351 Contributions—Example 1 F Solution: Computation 000’s o r m u l a (g) The The corporation’s Land Bldg. corporation’s basis in the land Dennis’ asset basis 2,000,000 3,000,000 basis in the and building can + Alloc. of recog. gain: assets be determined 1 mm x [ 1 ÷ (1 + 14)] 66,667 received: using the Sec. 362 1 mm x [14 ÷ (1 + 14)] 933,333 above. Corporation’s basis 2,066,667 3,933,333 (h) The (h) = Same as Land Bldg. corporation’s shareholder’s HP HP beginning date 3/15/97 8/19/x1 holding period in assets received: (Same as Dennis’ HP)Chapter 16, Exhibit 32h CCH Federal Taxation Basic Principles85 of 92
  86. 86. Code Sec. 351 Contributions—Example 2 FACTS: Anu, Ellsworth, and Tebessum decided to pool their efforts and form a corporation. They made the following contributions to the corporation: Stockholder Asset FMV AB to S/H # shares issued Anu Services $ 30,000 $ 0 30 Ellsworth Land 70,000 20,000 60 Tebessum Equipment 10,000 11,000 10 TOTALS $110,000 100 The FMV of the stock is $1,000 per share. Ellsworth’s land is subject to a $10,000 mortgage which the corporation assumed.Chapter 16, Exhibit 33a CCH Federal Taxation Basic Principles86 of 92
  87. 87. Code Sec. 351 Contributions—Example 2 QUESTION 1: Does this transfer of assets qualify for Code Sec. 351 treatment? SOLUTION 1: No, Anu is not a transferor of property. Only Ellsworth and Tebessum can be included in the control computation. Since their combined control is only 70% [(60 + 10) ÷100], the ≥ 80% control requirement has not been met. What would be the result if Anu had also contributed $1.00?Chapter 16, Exhibit 33b CCH Federal Taxation Basic Principles87 of 92
  88. 88. Code Sec. 351 Contributions—Example 2 QUESTION 2: Assuming the previous transaction did qualify under Code Sec. 351, fill in the blanks below. (Answers provided.) SOLUTION 2: Stockholder Realized G/L Recog. Gain/Loss Basis of stock (FMV - AB) (< Real gain or boot (AB - debt relief + recog’d rec’d) gain - recog’d loss) Anu 30,000 (30m - 0) 30,000 (services 30,000 (0 - 0 + 30m) income) Ellsworth 50,000 (70m - 20m) 0 ($0 boot received) 10,000 (20m - 10m + 0) Tebessum (1,000) (10m - 11m) 0 ($0 boot received) 11,000 (11m -0 + 0) Basis of the land to the corporation: $20,000. (Ellworth’s AB of $20m + $0 gain recognized by Ellsworth)Chapter 16, Exhibit 33c CCH Federal Taxation Basic Principles88 of 92
  89. 89. Code Sec. 351 Contributions—Example 2 QUESTION 3: Assuming the previous transaction did NOT qualify under Code Sec. 351, fill in the blanks below. (Answers provided.) SOLUTION 3: Stockholder Realized G/L Recog. G/L Basis of stock (FMV – AB) (FMV – AB) (AB – debt relief + recog’d gain – recog’d loss) Anu 30,000 30,000 30,000 (0 - 0 + 30,000) Ellsworth 50,000 50,000 60,000 (20,000 – 10,000 + 50,000) Tebessum (1,000) (1,000) 10,000 (11,000 – 0 – 1,000)Chapter 16, Exhibit 33d CCH Federal Taxation Basic Principles89 of 92
  90. 90. Nonstock Distributions— Effect on Shareholder of C Corporation What is the amount of “distributions other than stock”? The amount of distribution other than stock of the corporation is: (a) - (b), where (a) = The fair market value of all property received (other than the common stock of the distributing corporation). (b) = Liabilities of the distributing corporation, both recourse and nonrecourse, assumed by the shareholder.Chapter 16, Exhibit 34a CCH Federal Taxation Basic Principles90 of 92
  91. 91. Nonstock Distributions— Effect on Shareholder of C Corporation Do shareholders of C corporations recognize income on nonstock distributions? Yes, then yes, then no, then yes. That is, when a corporation distributes property other than its own stock to shareholders, the tax treatment to shareholders moves in different directions, according to the following pecking order:Chapter 16, Exhibit 34b CCH Federal Taxation Basic Principles91 of 92
  92. 92. Nonstock Distributions— Effect on Shareholder of C Corporation Tier Distributions Other Than Stock, to the Extent Tax Treatment to S/H: of: 1st Current earnings and profits (E&P) Ordinary income based on FMV 2nd Accumulated E&P Ordinary income based on FMV 3rd S/H’s basis in the stock Nontaxable return of capital Any balance remaining Capital gain What is a shareholder’s basis in the non-stock property distributed by the C corporation? Basis = FMV of the asset. The assumption of a liability does not affect basis.Chapter 16, Exhibit 34c CCH Federal Taxation Basic Principles92 of 92