Chapter 3 presentation


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Chapter 3 presentation

  1. 1. Chapter 3 Corporations: Special Situations
  2. 2. The Big Picture (slide 1 of 2) <ul><li>Determining DPGR for the Domestic Production Activities Deduction </li></ul><ul><li>Mocha, Inc., produces and sells its ice cream to food stores and restaurants. </li></ul><ul><ul><li>Mocha also operates snack shops next to its facilities where it sells ice cream, coffee, and other snacks to the general public. </li></ul></ul><ul><li>Mocha has gross receipts of $42 million from the wholesale sale of its ice cream and $5 million from the operation of the snack shops. </li></ul><ul><ul><li>What receipts are considered to be domestic production gross receipts (DPGR) for the domestic production activities deduction (DPAD)? </li></ul></ul><ul><li>What planning tip might you give to Mocha? </li></ul><ul><ul><li>Read the chapter and formulate your response. </li></ul></ul>
  3. 3. The Big Picture (slide 2 of 2) <ul><li>Who Pays the alternative minimum tax (AMT)? </li></ul><ul><li>Carmine, Inc., has a tentative minimum tax base of $7 million and average gross receipts for this year and the prior 3 years of < $7.5 million. </li></ul><ul><li>Taupe, Inc., has a tentative minimum tax base of $7.1 million and average gross receipts for this year and the prior 3 years of < $7.5 million. </li></ul><ul><li>Carmine is not subject to the AMT, but Taupe is. </li></ul><ul><li>How can this happen? </li></ul><ul><ul><li>Read the chapter and formulate your response. </li></ul></ul>
  4. 4. Domestic Production Activities Deduction (slide 1 of 5) <ul><li>The American Jobs Creation Act of 2004 created a new deduction, the domestic production activities deduction (DPAD) </li></ul><ul><ul><li>Based on income from manufacturing activities </li></ul></ul><ul><ul><li>Calculated using the following formula: </li></ul></ul><ul><ul><ul><li>9% × Lesser of </li></ul></ul></ul><ul><ul><ul><ul><li>Qualified production activities income </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Taxable income (or modified AGI) or AMTI </li></ul></ul></ul></ul><ul><ul><li>The deduction cannot exceed 50% of an employer’s W–2 wages properly allocable to domestic production gross receipts </li></ul></ul>
  5. 5. Domestic Production Activities Deduction (slide 2 of 5) <ul><li>A phase-in provision increased the applicable rate for the production activities deduction as follows: </li></ul><ul><li>Rate Years </li></ul><ul><li>3% 2005-2006 </li></ul><ul><li>6% 2007-2009 </li></ul><ul><li>9% 2010 and thereafter </li></ul>
  6. 6. Domestic Production Activities Deduction (slide 3 of 5) <ul><li>Eligible taxpayers include: </li></ul><ul><ul><li>Individuals, partnerships, S corporations, C corporations, cooperatives, estates, and trusts </li></ul></ul><ul><ul><ul><li>For a pass-through entity (e.g., partnerships, S corporations), the deduction flows through to the individual owners </li></ul></ul></ul><ul><ul><ul><li>For sole proprietors, a deduction for AGI results </li></ul></ul></ul><ul><ul><ul><li>For C corporations, the deduction is included with other expenses in computing corporate taxable income </li></ul></ul></ul>
  7. 7. Domestic Production Activities Deduction (slide 4 of 5) <ul><li>Qualified production activities income is the excess of domestic production gross receipts over: </li></ul><ul><ul><li>Cost of goods sold (CGS) </li></ul></ul><ul><ul><li>Direct costs </li></ul></ul><ul><ul><li>Allocable indirect costs </li></ul></ul>
  8. 8. Domestic Production Activities Deduction (slide 5 of 5) <ul><li>Domestic production gross receipts (DPGR) include receipts from: </li></ul><ul><ul><li>Lease, rental, license, sale, exchange, or other disposition of qualified production property (QPP) that was manufactured, produced, grown, or extracted in the U.S. </li></ul></ul><ul><ul><li>Qualified films largely created in the U.S. </li></ul></ul><ul><ul><li>Production of electricity, natural gas, or potable water </li></ul></ul><ul><ul><li>Construction performed in the U.S. </li></ul></ul><ul><ul><li>Engineering and architectural services for domestic construction </li></ul></ul>
  9. 9. Disallowed Production Activities-Preparation of Food & Beverages <ul><li>DPGR does not include gross receipts from the sale of food & beverages prepared by a taxpayer at a retail establishment </li></ul><ul><ul><li>There is a 5 percent de minimis safe harbor </li></ul></ul>
  10. 10. The Big Picture – Example 20 DPGD – 5% De Minimis Rule <ul><li>Return to the facts of The Big Picture on p. 3–2. </li></ul><ul><li>Suppose that Mocha has the following sales: </li></ul><ul><ul><li>$42 million from the wholesale sale of its ice cream, and </li></ul></ul><ul><ul><li>Only $2 million from the snack shops next to its facilities where it sells ice cream to the general public. </li></ul></ul><ul><li>The full $44 million is DPGR </li></ul><ul><ul><li>The $2 million falls under the de minimis safe-harbor exception </li></ul></ul><ul><ul><li>$2 million is less than 5% of $44 million ($42 million + $2 million). </li></ul></ul>
  11. 11. Alternative Minimum Tax (slide 1 of 3) <ul><li>Designed to ensure that corporations with substantial economic income pay at least a minimum amount of federal taxes </li></ul><ul><li>Essentially, a separate tax system with a quasi-flat tax rate applied to a corporation’s economic income </li></ul>
  12. 12. Alternative Minimum Tax (slide 2 of 3) <ul><li>If tentative alternative minimum tax > regular corporate income tax, corporation must pay regular tax plus the excess, the alternative minimum tax (AMT) </li></ul>
  13. 13. Alternative Minimum Tax (slide 3 of 3) <ul><li>For tax years beginning after 1997, many small corporations are not subject to AMT </li></ul><ul><ul><li>A small corporation has average annual gross receipts of $5 million or less for the preceding three-year period </li></ul></ul><ul><ul><li>Small corporation continues to qualify as long as average gross receipts for the preceding three-year period do not exceed $7.5 million </li></ul></ul>
  14. 14. The Big Picture – Example 25 Small Corporation Exemption <ul><li>Return to the facts of The Big Picture on p. 3–2. </li></ul><ul><li>Suppose that Carmine, Inc., had gross receipts of $3.7 million, $4.8 million, and $4.6 million for tax years 2008, 2009, and 2010, respectively, for an average of $4.37 million. </li></ul><ul><ul><li>For 2011 AMT purposes, Carmine is considered to be a small corporation . </li></ul></ul>
  15. 15. AMT Formula for Corporations
  16. 16. AMT Adjustments (slide 1 of 2) <ul><li>The starting point for computing AMTI is taxable income before any NOL deduction </li></ul><ul><ul><li>Certain adjustments must be made to this amount </li></ul></ul><ul><li>Tax preference items are always additions to taxable income </li></ul><ul><li>AMT adjustments may either positive or negative </li></ul><ul><ul><li>Positive adjustments result from timing differences </li></ul></ul><ul><ul><ul><li>Added to taxable income in computing AMTI </li></ul></ul></ul><ul><ul><li>When AMT adjustments reverse, they are deducted from taxable income to arrive at AMTI </li></ul></ul>
  17. 17. AMT Adjustments (slide 2 of 2) <ul><li>AMT adjustments may either increase or decrease taxable income </li></ul><ul><ul><li>e.g., The deduction for domestic manufacturing activities (DPAD) is available for AMT purposes </li></ul></ul><ul><ul><ul><li>DPAD for AMT is limited to the smaller of qualified production income as determined for the regular income tax or for AMTI before the manufacturing deduction </li></ul></ul></ul>
  18. 18. Adjustments for AMT (slide 1 of 2) <ul><li>A portion of depreciation on property placed in service after 1986 </li></ul><ul><li>Difference between gain (loss) on sale of property for regular tax and AMT purposes </li></ul><ul><li>Passive activity losses of certain closely held corporations and personal service corporations </li></ul><ul><li>Mining exploration and development costs in excess of allowed AMT 10 year amortization </li></ul>
  19. 19. Adjustments for AMT (slide 2 of 2) <ul><li>Difference between percentage of completion and completed contract income </li></ul><ul><li>Amortization claimed on certified pollution control facilities </li></ul><ul><li>Difference between installment gain and total gain on certain dealer sales </li></ul><ul><li>A portion of the difference between “ACE” and unadjusted AMTI </li></ul>
  20. 20. Tax Preference Items <ul><li>Accelerated depreciation on real property in excess of straight-line for property placed in service before 1987 </li></ul><ul><li>Tax-exempt interest on “private activity bonds” </li></ul><ul><ul><li>Interest on such bonds issued in 2009 and 2010 is not treated as a tax preference </li></ul></ul><ul><li>Percentage depletion in excess of the adjusted basis of property </li></ul><ul><li>Certain intangible drilling costs for “integrated oil companies” </li></ul>
  21. 21. ACE Adjustment (slide 1 of 3) <ul><li>Ace adjustment = 75% of difference between unadjusted AMTI and ACE </li></ul><ul><ul><li>Can be positive or negative </li></ul></ul><ul><ul><li>Negative adjustment is limited to aggregate positive adjustments less previous negative adjustments </li></ul></ul>
  22. 22. ACE Adjustment (slide 2 of 3) <ul><li>Starting point for determining ACE is AMTI </li></ul><ul><ul><li>AMTI is defined as regular taxable income after AMT adjustments and tax preferences (other than the NOL and ACE adjustments) </li></ul></ul>
  23. 23. ACE Adjustment (slide 3 of 3) <ul><li>AMTI is adjusted to arrive at ACE </li></ul><ul><ul><li>These adjustments include: </li></ul></ul><ul><ul><ul><li>Exclusion items—Income items that will never be included in regular taxable income or AMTI </li></ul></ul></ul><ul><ul><ul><li>Disallowed items – e.g., dividends received deduction of 70% (less than 20% ownership) </li></ul></ul></ul><ul><ul><ul><li>Other adjustments items including, for example, intangible drilling costs, circulation expenditures, organization expense amortization, LIFO inventory adjustments, installment sales, other items </li></ul></ul></ul>
  24. 24. Impact of Certain Transactions on ACE
  25. 25. Exemption <ul><li>Exemption amount for a corp = $40,000 </li></ul><ul><ul><li>Reduced by 25% of excess of AMTI over $150,000 </li></ul></ul><ul><ul><li>Exemption is totally phased-out when AMTI reaches $310,000 </li></ul></ul>
  26. 26. Minimum Tax Credit (slide 1 of 2) <ul><li>AMT paid in one year can be used as a credit against future regular tax liability that exceeds its tentative minimum tax </li></ul><ul><ul><li>Indefinite carryforward </li></ul></ul><ul><ul><li>Cannot be carried back </li></ul></ul><ul><ul><li>Cannot offset any future minimum tax liability </li></ul></ul>
  27. 27. Minimum Tax Credit (slide 2 of 2) <ul><li>Small corporations (no longer subject to AMT) with unused minimum tax credits after 1997 may use them against regular tax liability </li></ul><ul><li>Limit = regular tax – [25% × (regular tax – $25,000)] </li></ul>
  28. 28. AMT Example (slide 1 of 4) <ul><li>Moreland Co. has the following income, etc. in 2011: </li></ul><ul><li>Taxable income $100,000 </li></ul><ul><li>Depreciation adjustment 18,000 </li></ul><ul><li>Installment gain (not on inventory sale) 80,000 </li></ul><ul><li>Federal income tax provision on </li></ul><ul><li>financial stmts. 75,000 </li></ul><ul><li>Penalties and fines 2,000 </li></ul><ul><li>Private activity bond interest income </li></ul><ul><li>(issued 2008) 25,000 </li></ul><ul><li>Other tax-exempt interest 20,000 </li></ul><ul><ul><li>The depreciation adjustment is an AMT adjustment and the private activity bond interest is a tax preference for AMTI. </li></ul></ul>
  29. 29. AMT Example (slide 2 of 4) <ul><li>Calculation of AMTI before ACE: </li></ul><ul><li>Taxable income $100,000 </li></ul><ul><li>Plus: private activity bond income 25,000 </li></ul><ul><li>Plus: depreciation adjustment 18,000 </li></ul><ul><li>AMTI $143,000 </li></ul>
  30. 30. AMT Example (slide 3 of 4) <ul><li>Calculation of ACE Adjustment: </li></ul><ul><li>AMTI before ACE $143,000 </li></ul><ul><li>Plus: deferred installment gain 80,000 </li></ul><ul><li>Plus: other tax-exempt income 20,000 </li></ul><ul><li>Adjusted current earnings $243,000 </li></ul><ul><li>Less: AMTI 143,000 </li></ul><ul><li>Base amount for Ace Adjustment $100,000 </li></ul><ul><li>Times rate: 75% </li></ul><ul><li>ACE Adjustment (positive) $75,000 </li></ul>
  31. 31. AMT Example (slide 4 of 4) <ul><li>Calculation of AMT: </li></ul><ul><li>AMTI before ACE $143,000 </li></ul><ul><li>Plus: ACE Adjustment 75,000 </li></ul><ul><li>AMTI $218,000 </li></ul><ul><li>Less: Exemption 23,000 </li></ul><ul><li>Tentative minimum tax base $195,000 </li></ul><ul><li>20% rate × 20% </li></ul><ul><li>Tentative minimum tax $ 39,000 </li></ul><ul><li>Less: regular tax (22,250) </li></ul><ul><li>AMT(TMT-Regular tax) $ 16,750 </li></ul><ul><li>Total cash paid = Regular tax + AMT = $ 39,000 </li></ul>
  32. 32. Accumulated Earnings Tax (slide 1 of 5) <ul><li>Penalty tax designed to discourage the retention of corporate earnings unrelated to the business needs of the company </li></ul>
  33. 33. Accumulated Earnings Tax (slide 2 of 5) <ul><li>Tax of 15% is imposed on accumulated taxable income (ATI), determined as follows: </li></ul><ul><li>ATI = Taxable income ± Adjustments - Dividends paid - Accumulated earnings credit </li></ul><ul><li>Adjustments to taxable income generally pertain to a corporation’s ability to pay a dividend </li></ul><ul><ul><li>Thus, deductions include the corporate income tax and excess charitable contributions, while additions include the NOL and dividends received deductions </li></ul></ul>
  34. 34. Accumulated Earnings Tax (slide 3 of 5) <ul><li>An accumulated earnings credit is allowed even when accumulations are beyond reasonable business needs </li></ul>
  35. 35. Accumulated Earnings Tax (slide 4 of 5) <ul><li>The accumulated earnings credit is the greater of: </li></ul><ul><ul><li>Current E&P needed to meet “reasonable needs” of the business, or </li></ul></ul><ul><ul><li>Amount by which $250,000 ($150,000 for service companies) exceeds Accumulated E&P as of close of preceding tax year (the minimum credit) </li></ul></ul>
  36. 36. Accumulated Earnings Tax -Reasonable Needs Of The Business (slide 5 of 5) <ul><li>Legitimate reasons </li></ul><ul><ul><li>Business expansion </li></ul></ul><ul><ul><li>Capital asset replacement </li></ul></ul><ul><ul><li>Working capital needs </li></ul></ul><ul><ul><li>Product liability loss </li></ul></ul><ul><ul><li>Loans to suppliers or customers </li></ul></ul><ul><li>Invalid Reasons </li></ul><ul><ul><li>Loans to shareholders </li></ul></ul><ul><ul><li>Unrealistic contingencies </li></ul></ul><ul><ul><li>Investment in unrelated business assets </li></ul></ul>
  37. 37. Personal Holding Company Tax <ul><li>Personal Holding Company (PHC) tax is designed to discourage sheltering of certain types of passive income in corporations </li></ul><ul><ul><li>Like the accumulated earnings tax, the purpose is to force the distribution of corporate earnings to shareholders </li></ul></ul>
  38. 38. Definition of PHC <ul><li>A company is a PHC if: </li></ul><ul><ul><li>More than 50% of the value of stock is owned by 5 or fewer individuals during the last half of the year </li></ul></ul><ul><ul><ul><li>Broad constructive ownership rules apply in determining stock ownership </li></ul></ul></ul><ul><ul><li>60% or more of gross income (as adjusted) must consist of personal holding company income (PHCI) </li></ul></ul><ul><ul><ul><li>Examples are dividends, interest, rents, royalties, and certain personal service income </li></ul></ul></ul><ul><ul><ul><li>Rents or royalties may be excluded if they are significant in amount (i.e., comprise more than 50% of the adjusted gross income) </li></ul></ul></ul>
  39. 39. Calculation of PHC Tax <ul><li>Once classified as a PHC, the tax base must be calculated </li></ul><ul><ul><li>Penalty tax rate = 15% </li></ul></ul><ul><ul><li>Tax base is undistributed Personal Holding Company income (UPHC income) </li></ul></ul><ul><ul><ul><li>Amount is taxable income plus or minus certain adjustments, minus the dividends paid deduction </li></ul></ul></ul>
  40. 40. Dividends Paid <ul><li>Dividend payments reduce both ATI and undistributed PHCI </li></ul><ul><ul><li>As these are the bases on which the § 531 tax or the § 541 tax is imposed, either tax can be completely avoided by paying sufficient dividends </li></ul></ul>
  41. 41. Refocus On The Big Picture (slide 1 of 4) <ul><li>Determining DPGR for the DPAD </li></ul><ul><li>The $42 million gross receipts from the wholesale sale of Mocha’s ice cream are considered DPGR. </li></ul><ul><ul><li>However, the de minimis safe-harbor 5% exception does not apply to include the gross receipts from the snack shops </li></ul></ul><ul><ul><ul><li>$5 million ÷ $47 million = 10.6%. </li></ul></ul></ul>
  42. 42. Refocus On The Big Picture (slide 2 of 4) <ul><li>The sales from the snack shops could qualify as DPGR if Mocha were to restrict snack shop sales. </li></ul><ul><ul><li>For example, keeping snack sales at around $2.2 million would satisfy the 5 % exception. </li></ul></ul><ul><li>Thus, Mocha will have to decide whether the 9 % DPAD is worth forgoing the profit on the snack sales. </li></ul><ul><li>Keep in mind that the DPAD is allowed for the AMT. </li></ul>
  43. 43. Refocus On The Big Picture (slide 3 of 4) <ul><li>Who Pays the AMT? </li></ul><ul><li>Carmine, Inc., has met several gross receipts tests, including initially qualifying as a ‘‘small corporation.’’ </li></ul><ul><li>To qualify as a ‘‘small corporation,’’ the business must have had average gross receipts of $5 million or less in the preceding 3 years. </li></ul>
  44. 44. Refocus On The Big Picture (slide 4 of 4) <ul><li>Once qualified as a ‘‘small corporation’’ it will continue to be exempt from the AMT as long as its average gross receipts for the 3 preceding taxable years do not exceed $7.5 million. </li></ul><ul><li>Unfortunately, Taupe, Inc., did not meet the initial $5 million test, so it does not fall within the $7.5 million exemption. </li></ul>
  45. 45. <ul><li>If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: </li></ul><ul><li>Dr. Donald R. Trippeer, CPA </li></ul><ul><li>trippedr </li></ul><ul><li>SUNY Oneonta </li></ul>