Double taxation occurs when both a corporation and its shareholders are taxed on the same income. Corporations pay tax on their income, and shareholders also pay tax when they receive dividends from the corporation. This can be avoided by using a pass-through entity like a partnership or S corporation, where the income "flows through" to the shareholders without double taxation. Alternatively, a C corporation can retain earnings and treat distributions as deductible payments to avoid double taxation.

1. Corporate Taxation What is double taxation?

2. Corporations Corporation is a separate “TP” from shareholders (owners) Shareholders must pay tax on dividends received This results in double taxation

3. Double Taxation A and B are shareholders of XYZ Corp., A and B are equal shareholders , each have a basis of $250 in XYZ stock. In Y1, XYZ has an income of $10,000 and distributes $100 to each shareholder. What will happen?

4. Alternatives What will happen is XYZ is a sole proprietorship? What will happen is XYZ is a partnership? An LLC? A Sub S Corporation?

5. A Sub S Corporation? Same facts: $10,000 income? $5,000 OI each A & B will each reduce their basis by $100 (the distribution)

6. Why incorporate? Raising capital is easier (price of shares reflects the PV of Future Prospects) Multiple classes of stock are possible Limited liability to investors

7. Lenders may REQUIRE incorporation (usury laws) Shareholders can be employees (fringes are excludable from income—deductible for corporation Pension flexibility (historically—not since 1982) Why incorporate?

8. Avoiding Double Taxation Avoid C Form Retain Earnings Treat distributions as deductible payments (particularly in a closely held corp, where shareholders can be employees or creditors of the corporation)

9. Avoid the corporate form, instead use Partnership LLC To Avoid Double Taxation

10. 1. Partnership “Flow Through” paradigm BUT there are limitations on “pass through” expense, which must be allocated to keep the expenses from being used by partners to whom they would be particularly beneficial

11. 2. LLCs Partnership Taxation (default) Vs. Corporation Taxation To distinquish, use “Kintner Regulations”

12. Kintner Regulations US v. Kintner (1954) Associates Carry on business/ divide gains Continuity of life Centralization of management Liability for corporate debts limited to corporate property Free transferability of interests

13. If entity had 3 or more like a corporation, it was TAXED as a corporation If it lacked 2 it was taxed as a partnership Kintner Regulations

14. “Check the box” rules LLCs then began to flourish Under “check the box” rules, a business entity with 2 or more “members’ is either a corporation or a partnership.

15. If one “member” it can be a corporation or a sole proprietorship (maybe branch or division of its owner) “Check the box” rules

16. Entity is taxed as a corporation if Organized as corporation under state law, and Associations, under Tres. Reg 301.7701-3 Joint stock companies (joint ventures) Insurance companies State chartered banks Those wholly owned by a state (or political subdivision) Certain foreign entities If not above, entity can CHOOSE tax treatment “Check the box” rules

17. Introduction of Sub S All shareholders must consent No more than 75 shareholders All SHs must be (basically) individuals No nonresident aliens One class of stock

18. Avoiding Subchapter C—Corporation as Agent Where a real estate partnership formed corporation to comply with usury laws, but all parties regarded the partnership as owner, and: Corp had no employees, assets, Contract specified agency, in form and substance

19. Disguised Dividends IRS has tests and techniques for closely held corporations to recharacterizing salary as dividends. For example, the salary must be “reasonable” and “purely for services. “

20. Distinguishing Capital Gains and OI in Corporate Tax Many Issues in Corporate Tax involve characterization of a transaction as either a distribution taxable as a dividend or a sale or exchange

21. Distinguishing Capital Gains versus Ordinary Income Which would you rather have? CG are defined by exclusion, only “capital assets” etc. Capital Losses are disfavored—limited on their deductibility

22. Need “appreciation event” Eisner v. Macomber (1920) For example: a sale—”profit” is taxed at CG rates How is appreciation of stock taxed?

23. Backstops to Planning Substance-Over-Form—avoids abusive transactions that do not quality for the beneficial treatment sought. This requires that TPs think carefully when setting up a corporate form Courts are hesitant to disregard the form the TP chooses, because it is the TPs choice

24. The Step-Transaction Doctrine—are steps indeed separate or part of an integrated whole that forms one transaction? “ binding commitment test” a plan to engage in several step simultaneously will collapse transactions to one “ mutual-interdependence” test— are steps so interdependent that the legal relations created by one would have been fruitless without the other steps? “ end-result” test-are steps prearranged components of a single transaction in which parties from the beginning intended to reach a particular result? Backstops