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Chapter 11Chapter 11Corporate Income TaxCorporate Income Tax
2012 Cengage Learning
Income Tax Fundamentals 2012
Gerald E. Whittenburg Martha Altus-Buller
Learning ObjectivesLearning Objectives
This chapter pertains to corporationsCalculate tax liability using tax rates Compute basic capital gains/lossesAscertain how special deduction may affect taxable income Identify components of Schedule M-1Outline corporate tax return filing and estimated tax payment
requirementsUnderstand how S-Corporations operate and are taxedUnderstand basic tax rules when forming entityDescribe accumulated earnings and personal holding company
taxesDefine elements of alternative minimum tax calculation
2012 Cengage Learning
Corporate Tax RatesCorporate Tax Rates
Corporate rates are progressive ° Marginal rates are from 15% to 39%, depending on
taxable income° There are eight brackets° There are a number of ‘tax bubbles’ – these occur when
tax rate schedules recapture savings from prior brackets For corporations with large income (more than
$18.33 million) the rate is a flat 35% Qualified personal service corps taxed at flat 35%
◦ Architects, CPAs, consultants, etc.
2012 Cengage Learning
Example Corporate Tax RatesExample Corporate Tax Rates
ExampleJohnson & 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 to their clients?
2012 Cengage Learning
SolutionSolutionExample
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 to their clients?
Solution
Corporate tax = $100,250
$22,250 + (39%)($300,000 – 100,000)
If Johnson & Kelby is a qualified personal service corporation, corporate tax = $105,000 ($300,000 x 35%)
2012 Cengage Learning
Corporate Capital Gains Corporate Capital Gains
A corporation can choose from two alternative tax treatments on capital gains◦ Taxed at ordinary rates
or◦ Elect to pay an alternative tax (35%) on net long-
term capital gain (LTCG)Essentially equivalent to maximum regular
corporate tax (no tax benefit to LTCG)Bottom line: there is no difference in tax on
ordinary vs. capital income
2012 Cengage Learning
Dividends Received DeductionDividends Received Deduction
Corporations are allowed a deduction for a percentage of the dividends received from other corporations ◦ Attempt to alleviate triple taxation
Dividends received deduction is allowed based upon ownership
2012 Cengage Learning
Percentage Ownership Dividends Received % Deduction < 20% 70% 20% or more, less than 80% 80% > 80% 100%
Dividends received deduction is limited by % of corporate taxable income shown above
(calculated before certain deductions)
Organizational Expenditures & Organizational Expenditures & Start Up CostsStart Up Costs
Organizational expenditures pertain to LLCs, corporations and partnerships
Start up costs can be incurred by any organization, including a sole proprietorship and entities mentioned above
◦ Examples of these type of costs include◦ Investigatory costs to look at a business before deciding whether or
not to pursue it◦ Legal/accounting services incidental to organization, costs of a
temporary board of directors and state incorporation fees◦ Preopening costs such as advertising expenses, employee training
costs, etc.
2012 Cengage Learning
Amortization of Amortization of Organizational Expenditures & Organizational Expenditures &
Start Up CostsStart Up Costs
Organizational expenditures and start up costs are capitalized and then amortized over 180 months
However, can make election to deduct up to $5,000 of organization costs in the year corporation begins business◦ $5,000 amount is reduced $1 for each $1 that organizational
expenses exceed $50,000
2012 Cengage Learning
Charitable ContributionsCharitable Contributions Corporations are allowed a deduction for
charitable contributions◦ Cash basis taxpayers can deduct when paid◦ Accrual basis taxpayers have until the 15th day of
the third month following year-end to contribute, as long as pledge is made by year-end
Charitable contributions limited to 10% of taxable income*◦ Carry forward unused deduction for five years
*Calculated before any loss carry backs, net operating
losses (NOLs) or the dividend received deduction
2012 Cengage Learning
Example Example Charitable ContributionsCharitable Contributions
ExampleFerndale 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?
2012 Cengage Learning
SolutionSolution
ExampleFerndale 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?
SolutionThe charitable contribution deduction is $48,000($400,000 + 80,000) x 10% = $48,000 limit*Therefore, carry forward is $32,000 ($80,000 – 48,000)
*Note: had to add back DRD first!!
2012 Cengage Learning
Reconciliation of Income (Loss) Reconciliation of Income (Loss) per Books with Income Per Returnper Books with Income Per Return
Schedule M-1 of Form 1120 reconciles accounting (book) income to taxable income
Amounts added to book income (left column)◦ Federal tax expense◦ Capital losses◦ Income recorded on tax return but not on books◦ Expenses recorded on books but not on tax return
Amounts deducted from book income (right column) ◦ Income recorded on books but not on tax return ◦ Expenses recorded on tax return but not on books
See chapter for other items included on Schedule M-1
2012 Cengage Learning
Schedule UTP Now Required Schedule UTP Now Required
Schedule UTP (Uncertain Tax Position) is required beginning in 2010 for large corporations
It requires that the corporation disclose any tax positions taken on prior year’s returns that are uncertaino Allows the IRS to engage in more pointed and directed
audito Intended to generate additional revenue
2012 Cengage Learning
Filing Requirements Filing Requirements & Estimated Tax& Estimated Tax
Form 1120 filed for regular corporationForm 1120S filed for S Corporation
◦ Returns are due by the 15th day of the third month after year-end
◦ Can file Form 7004 and receive automatic 6-month extension
Corporations must make estimated tax payments in similar manner as self-employed taxpayers, in four installments
2012 Cengage Learning
S CorporationsS Corporations
Certain qualified small business corporations may elect to be taxed in a manner similar to partnerships
Qualified small business corporation may elect S Corporation status if several criteria apply◦ Operates as a domestic corporation◦ Has 100 or fewer shareholders
Shareholders may not be corporations or partnerships◦ Has only one class of stock◦ Has only shareholders that are U.S. citizens or resident
aliens
2012 Cengage Learning
S Corporations S Corporations
Corporation must make election of S status in a prior year ◦ Or within 2-1/2 months of the current tax year
S Corp status stays in effect until revocation*◦ Status can be voluntarily revoked by consent of shareholders
or◦ Involuntarily revoked
If corporation ceases to be a small business corporationor
If corporate passive income is 25% or more for three consecutive years and corporation has accumulated earnings and profits at the end of each of those years
*Election is terminated on the date status is revoked
2012 Cengage Learning
Example S Corporation ElectionExample S Corporation Election
ExampleSwannak Thermography Corporation is a
calendar year corporation that makes an S Corporation election on May 25, 2011. In which year may the corporation first be treated as an S Corporation?
2012 Cengage Learning
SolutionSolution
ExampleSwannak Thermography Corporation is a calendar year
corporation that makes an S Corporation election on May 25, 2011. In which year may the corporation first be treated as an S Corporation?
SolutionSince 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 2011. It will become an S Corporation for tax year 2012.
2012 Cengage Learning
Income ReportingIncome Reporting
Must report all elements of income and expense separately on Form 1120S
Then each shareholder reports his/her share of these items of corporate income/expense on personal return◦ K-1 takes total shareholder income/expenses and
allocates each item to each shareholder based upon his/her ownership percentage
If shareholder dies, his/her portion of S Corp items
will be included in shareholder’s final return
2012 Cengage Learning
Loss ReportingLoss Reporting
Each shareholder of an S Corp may also report his/her respective share of loss◦ Individual taxpayer cannot take a loss in
excess of adjusted basis in stock◦ If loss exceeds adjusted basis in stock plus
loans, shareholder can carry it forward If shareholder entered/departed S Corp
mid-year, must allocate losses on a daily basis
2012 Cengage Learning
S Corporation S Corporation Pass Through ItemsPass Through Items
Many items retain tax character when passing through to the S Corporation’s shareholders on individual K-1
Examples of such items include◦ Capital gains/losses◦ §1231 gains/losses◦ Dividend Income◦ Charitable contributions◦ Tax-exempt interest◦ Most credits
2012 Cengage Learning
Special TaxesSpecial Taxes
S Corporations, in general, do not pay corporate taxes on their taxable income
Certain exceptions exist such as:◦ Built-in gains tax (paid on appreciated assets that
were held by corporation prior to S Corp election)◦ Certain tax imposed if corporation has large
amount of passive income, such as dividends and income
These rules are complex and will not be covered in this text
2012 Cengage Learning
Corporate FormationCorporate Formation
Shareholders often transfer high-value low-basis assets to a corporation in exchange for stock in company
No tax is due on gain from transfer of appreciated assets if following conditions met◦ Shareholder transferred cash or property
and◦ Shareholder made transfer solely in exchange for stock*
Shareholder is not providing a service and all taxpayers together own at least 80% of stock after transaction
*If shareholder receives boot in addition to stock, transaction may qualify for partial nonrecognition of gain
2012 Cengage Learning
Shareholder Basis in StockShareholder Basis in Stock A shareholder’s initial basis in his/her stock is calculated
as follows Basis of property transferred
Less Boot received*Plus Gain recognizedLess Liabilities transferred Equals Basis in stock
The corporation has a carry-over basis in the property contributed equal to the basis in the hands of the shareholder, increased by any gain recognized by shareholder on the transfer
*Boot is any property other than stock
2012 Cengage Learning
Note: generally, corporate assumption of shareholder liabilities that are attached to property are not
considered boot received
Accumulated Earnings Tax (AET)Accumulated Earnings Tax (AET)
Penalty tax designed to prevent a corporation from avoiding tax by retaining earnings
15% AET imposed on “unreasonable” accumulation of earnings; this is in addition to corporate income taxo Corporation may accumulate up to $250,000 a year
that is exempt from AET tax or $150,000 for a service corporation
o May accumulate more if can prove a valid business purpose
2012 Cengage Learning
Example Example Accumulated Earnings TaxAccumulated Earnings Tax
ExampleXinix 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?
2012 Cengage Learning
SolutionSolution
ExampleXinix 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?
SolutionXinix’ AET = $45,000($800,000 – 500,000) x 15%Note: this is paid in addition to regular tax
2012 Cengage Learning
Personal Holding Company TaxPersonal Holding Company Tax
Penalty tax designed to encourage Personal Holding Companies to distribute earnings to shareholders◦ Tax is 15% on undistributed earnings
Corporation is not liable for both the personal holding company tax and the AET in the same year
2012 Cengage Learning
Corporate AMTCorporate AMT Corporate AMT - calculated similar to the individual AMT AMT is 20% of Alternative Minimum Taxable Income (defined
below)
Taxable Income +/- Adjustments + Preferences - Exemption*
Alternative Minimum Taxable Income (AMTI)
Small corporations are not subject to the AMT◦ Defined as having average annual gross receipts < $7.5 million
over a three-year period
*Exemption is $40,000, but is phased out when AMTI > $150,000
2012 Cengage Learning
You’re Done with Chapter 11You’re Done with Chapter 112012 Cengage Learning
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