Upload
brook-stone
View
222
Download
2
Embed Size (px)
Citation preview
9 - 1©2004 Prentice Hall, Inc.
Taxation ofCorporations
Chapter 9
9 - 2©2004 Prentice Hall, Inc.
Corporation
A business entity created under the laws of state of incorporation
Owns property and can be sued directly Shareholder’s own part of corporation but no
interest in individual assets Shareholders have limited liability Corporation has unlimited life Free transferability of ownership interest Centralized management
9 - 3©2004 Prentice Hall, Inc.
Advantages
Easier to raise capital than other business forms
Corporations that reinvest their income rather than paying dividends could have lower tax bill than flow-through entities
Shareholder can be employee and participate in tax-free employee fringe benefits that are deductible by the corporation
Corporation can select calendar or fiscal year
9 - 4©2004 Prentice Hall, Inc.
Disadvantages
Double taxationMinimized by 2003 Tax Act reduction in tax
rate on dividend income to 15% (5% for individuals in 10% or 15% tax bracket)
C corporation cannot deduct losses of the corporationOffset NOL against operating incomeOffset capital losses against capital gains
9 - 5©2004 Prentice Hall, Inc.
Capital Structure
EquityCommon stock – shareholders have last claim
on income and assets in liquidation but no limit on sharing in income when profitable
Preferred stock – claims take precedence over claims of common stockholders for dividends (paid stated dividend rate first) and assets in liquidation
Debt Interest on debt is deductible (but dividends are
not deductible)
9 - 6©2004 Prentice Hall, Inc.
Dividend Received Deduction
To relieve burden of multiple taxation on corporate income
DRD based on percentage of ownership in the distributing corporation100% DRD for 80% or more owned affiliate80% DRD for ownership of 20% up to 80%70% DRD for ownership less than 20%
DRD limited to percentage times lesser of taxable income or dividend incomeUnless deducting DRD % x dividend income
creates or increases NOL
9 - 7©2004 Prentice Hall, Inc.
Charitable Contributions
Overall limit 10% of taxable income beforeCharitable contribution deductionDividend received deductionNOL or capital loss carrybacks
Excess carried forward up to 5 years Accrual basis corporation can deduct in year
accrued ifPayment authorized by board before year endPayment made by 15th day of 3rd month
following close of tax year in which accrued
9 - 8©2004 Prentice Hall, Inc.
Charitable Contributions
Deduction for ordinary income property usually limited to basis
Deduction for LTCG property is FMV Deduction for inventory (if donated for care of
infants, poor or ill) increased by 50% of difference between basis and FMV (not to exceed twice basis)Similar exception for gifts of scientific property
given to universities and research organizations
9 - 9©2004 Prentice Hall, Inc.
Capital Gains and Losses
All capital gains taxed as ordinary income Capital losses can only offset capital gains
Net loss carried back 3 years as short-term capital loss and forward up to 5 years in sequence
Losses not used in this period are lost
9 - 10©2004 Prentice Hall, Inc.
Net Operating Losses
NOLs incurred in 2001 and 2002 can be carried back 5 years
NOLs incurred after 2002 can be carried back 2 years
Remaining NOL carried forward 20 yearsCan elect to forgo carryback and carry
forward only
9 - 11©2004 Prentice Hall, Inc.
Computing Corporate Tax
Taxable revenuesLess: Deductible expenses
Equals: Taxable incomeTimes: Corporate tax rate
Equals: Corporate taxPlus: Additions to taxLess: Tax credits
Equals: Net corporate tax
9 - 12©2004 Prentice Hall, Inc.
Corporate Tax Rates
Corporate rates not affected by 2003 Tax Act 15% on first $50,000 25% on $50,001 - $75,000 34% on $75,001 - $100,000 39% (34% + 5% surtax) on $100,001 - $335,000 34% on $335,001 - $10,000,000 35% on $10,000,001 - $15,000,000 38% (35% + 3%) on $15,000,001 - $18,333,333 35% on over $18,333,333
9 - 13©2004 Prentice Hall, Inc.
PSC
Personal service corporation is a corporationProviding service in the field of accounting,
actuarial science, architecture, consulting, engineering, health, law, or performing arts and
Employees own substantially all of the corporation
Flat 35% tax rate applies on entire taxable income
Encourages owner-employees to take earnings out of corporation as salary
9 - 14©2004 Prentice Hall, Inc.
Reconciling Book/Tax Income
Form 1120 corporate tax returnSchedule L – beginning and ending
financial accounting balance sheetSchedule M-1 – reconciliation of after-tax
net income on books with taxable income before DRD and NOL carryover
Schedule M-2 – reports changes in unappropriated retained earnings
9 - 15©2004 Prentice Hall, Inc.
Schedule M-1
9 - 16©2004 Prentice Hall, Inc.
Tax Credits
Can reduce tax liability but not below zero General business credit – a group of credits
aggregated into one creditCannot exceed $25,000 plus 75% of tax
liability in excess of $25,000Unused credits carried back 1 year and
forward 20 years
9 - 17©2004 Prentice Hall, Inc.
Alternative Minimum Tax
AMT is a parallel tax that broadens the regular income tax base to ensure some taxes are paid
Small corporation are exemptAverage annual receipts less than $5 million
in each of prior taxable yearsRemain exempt until average annual gross
receipts exceed $7.5 million
9 - 18©2004 Prentice Hall, Inc.
Calculating AMT
Corporate taxable income
Plus/minus AMT adjustments
Plus: Preference items
Equals: AMT incomeLess: Exemption
Equals: AMTI baseTimes: AMT rate
Equals: Gross AMT
9 - 19©2004 Prentice Hall, Inc.
Calculating AMT
Gross AMTLess: Regular corporate tax
Equals: Alternative minimum taxLess: Credits
Equals: Net AMT
Corporation only pays AMT if gross AMT is greater that its regular corporate income tax
9 - 20©2004 Prentice Hall, Inc.
AMT Adjustments
Timing differencesDifference between regular tax depreciation
and AMT depreciationDifference between gain reported for AMT by
percentage-of-completion method over gain reported on completed contract method for regular tax
75% of difference between adjusted current earnings (ACE) and gross AMTI before this adjustment
9 - 21©2004 Prentice Hall, Inc.
AMT
$40,000 ExemptionPhased out at rate of $1 for every $4 AMTI
exceeds $150,000 (completely phased out at $310,000 AMTI)
Credit – equal to AMT paid in prior yearsCarried forward indefinitely but can only
offset regular tax in excess of AMT
9 - 22©2004 Prentice Hall, Inc.
Filing and Payment
Form 1120 due on 15th day of 3rd month following close of tax yearFile Form 7004 for 6 month automatic extension
Quarterly estimated tax payments due on 15th day of 4th, 6th, 9th, and 12th months of tax yearUnderpayment penalty assessed if liability $500
more than estimated payments If taxable income less than $1 million in each of 3
preceding years, no penalty if each estimated payment equals 25% of prior year’s tax liability
9 - 23©2004 Prentice Hall, Inc.
Consolidated Returns
Affiliated group – parent corporation must directly own 80% or more stock of subsidiaryCan have more than 2 corporations if 80% of
stock owned by one or more corporations that are part of affiliated group
Consolidated return reports combined results of operations of all corporations in the groupAll subsidiaries must consent and must have
or change to same tax year as parent
9 - 24©2004 Prentice Hall, Inc.
Consolidated Net Income
Affiliated corporations viewed as divisions of parent requiring modification for deferred intercompany transactions and intercompany dividends
Items subject to limitations and netting are determined on a consolidated basisCapital gains and lossesSection 1231 gains and lossesCharitable contributions deductions
9 - 25©2004 Prentice Hall, Inc.
Consolidated Tax Returns
AdvantagesIntercompany dividends are eliminated from
taxationGains on intercompany transactions are eliminatedDeductions subject to limitation may be allowed
when consolidatedLosses of one corporation can offset gains of
anotherIncome from one corporation can offset losses of
anotherLimitations based on consolidated income permit
greater use of deductions or credits
9 - 26©2004 Prentice Hall, Inc.
Corporate Distributions
Dividend – a distribution of corporate earnings and profits (E&P) that is taxable income to shareholders but not deductible by the corporation2003 Tax Act lowed rates on dividend
income to 15% (5% for individuals in 10% or 15% tax brackets) – same rates as LTCG
9 - 27©2004 Prentice Hall, Inc.
Dividends
Dividends in excess of E&PTax free return of capital to extent of
shareholder’s stock basis (reducing basis)Excess distribution is capital gain
E&P measures how much a corporation can distribute as dividends and leave contributed capital intactStarts with taxable income but is adjusted for
positive and negative adjustments
9 - 28©2004 Prentice Hall, Inc.
Computing Current E&P
DRD, loss carryovers, and tax-exempt income are added back
Federal income taxes paid are deductible Charitable contributions are deductible without
regard to the 10% limit 20% of Section 179 expensing allowed Also deductible for E&P are life insurance
premiums on key employees, capital losses in excess of capital gains, nondeductible expenses related to tax-exempt income, disallowed losses on related party sales, and nondeductible fines
9 - 29©2004 Prentice Hall, Inc.
E&P
Current earnings and profits (CE&P) - the current year’s taxable income (as adjusted)
Accumulated earnings and profits (AE&P) – accumulations of CE&P for all prior years that has not been distributed as dividends
Dividends are first paid from CE&P then AE&P Property distributions – corporation recognizes
gain on distribution of appreciated property (but not loss)Value of distribution is net FMV (net of any liabilities
assumed) and basis to shareholder is FMV
9 - 30©2004 Prentice Hall, Inc.
Stock Dividends and Rights
Stock dividend – distribution of stock giving shareholder a greater number of sharesNontaxable if proportionate distribution (unless
given choice of cash or stock)Shareholder allocates basis among all shares
of stock Stock rights – if value of rights is less than
15% of value of stock, then no basis need be allocated to rights
9 - 31©2004 Prentice Hall, Inc.
Redemptions
Redemption – a repurchase of stock from a shareholder by the issuing corporation If treated as sale, shareholder recognizes capital
gain on difference between FMV received and basis of stock surrenderedSale treatment if complete termination of
interest or if substantially disproportionate (ownership after redemption less than 80% of before redemption ownership and less than 50% ownership)
If not a sale, then taxed as dividend on full amount received (to extent of E&P) and basis transfers to other shares of stock owned
9 - 32©2004 Prentice Hall, Inc.
Redemptions
Attribution rules apply in determining ownershipFamily attribution – includes stock owned by
spouse, parent, child, grandchildEntity to owner – proportionately from partnership
to partners, from estate or trust to beneficiaries, from corporation to 50% or greater shareholders
Owner to entity – from partner to partnership, from beneficiary to estate or trust, from 50% or greater shareholder to corporation
9 - 33©2004 Prentice Hall, Inc.
Partial Liquidation
Partial liquidation – similar to redemption when corporation significantly reduces its operations or terminates one of its qualifying businessesCorporation recognizes gain on distribution of
appreciated property (but not loss)Sale treatment for noncorporate shareholdersDividend to corporate shareholders (eligible
for DRD)
9 - 34©2004 Prentice Hall, Inc.
Liquidating Distributions
Corporations can recognize loss as well as gain on distribution of property in liquidation
Shareholders recognize gain or loss on difference between FMV received and basis of stock surrenderedBasis of property to shareholders is FMV
Parent corporation can liquidate a subsidiary tax free (but basis of assets carries over)
9 - 35©2004 Prentice Hall, Inc.
Constructive Dividends
Shareholders receiving informal economic benefits Examples include rents in excess of property’s
FMV, use of corporate property for personal use, loans to shareholder at no interest, payment of personal expenses by corporation, and excessive compensation
Benefit reclassified by IRS as dividend is taxable to shareholder and not deductible by corporationBenefits to related parties can also be reclassified
as dividend to shareholder
9 - 36©2004 Prentice Hall, Inc.
Penalty Taxes
Penalty taxes to encourage payment of dividends to shareholdersPersonal holding company – closely held corporation
with more than 60% AOGI from passive sourcesAccumulated earnings tax – assessed when
corporation accumulates more than $250,000 ($125,000 if service business) without valid business needs
2003 Tax Act lowed these penalty tax rates to 15%
9 - 37©2004 Prentice Hall, Inc.
Controlled Groups
Controlled groups must apportion lower tax rates to members of group
Parent-subsidiary group – 2 or more corporations with a common parentParent directly owns 80% of stock of subsidiary80% or more of stock must be jointly or separately
owned of all other corporations by parent and subsidiaries
Brother-sister group2 or more corporations have 80% of more of each
corporation’s stock owned by 5 or few individuals and sum of lowest common ownership of each shareholder is 50% or more
9 - 38©2004 Prentice Hall, Inc.
Exempt Organizations
Appendix 9A
9 - 39©2004 Prentice Hall, Inc.
Exempt Organizations
Organizations whose purpose is to serve the public are classified as tax-exempt organizations
Persons who donate to exempt organizations may be permitted a charitable contribution deduction
Exempt organizations do not pay tax on their income if they qualify under Section 501(c)
If it fails to meet the requirements on a continuing basis, it may either lose its status or be assessed an income or excise tax
9 - 40©2004 Prentice Hall, Inc.
Exempt Organizations
Exempt organizations normally operate as corporations or as trusts
An exempt organization can be assessed taxes when it engages in prohibited transactionsUnrelated businessesTransactions that benefit disqualified
persons
9 - 41©2004 Prentice Hall, Inc.
UBIT
An exempt organization is assessed the unrelated business income tax if it regularly carries on a trade or business that is substantially unrelated to the organization’s exempt purposeA business is substantially unrelated to the
exempt purpose if the sales of goods or services do not make a significant contribution to its exempt purpose
9 - 42©2004 Prentice Hall, Inc.
UBIT
UBIT is assessed when the exempt organization regularly carries on a business that competes with for-profit businesses
UBIT is assessed on the net unrelated business income at the regular corporate tax rates$1,000 exemption is allowed
9 - 43©2004 Prentice Hall, Inc.
UBIT
Gross unrelated business income
Less: Deductions
Plus/minus: ModificationsLess: $1,000 exemption
Equals: Unrelated business incomeTimes: Corporate tax rates
Equals: Unrelated business income tax
9 - 44©2004 Prentice Hall, Inc.
Filing
Form 990: Return of Organizations Exempt from Income Tax is due on the 15th day of the 5th month after the close of the organization’s tax year
If UBIT must be paid, then it must also file Form 990-T: Exempt Organization’s Business Income Tax Return
9 - 45©2004 Prentice Hall, Inc.
Excise Taxes
An excise tax is levied on any excess benefit transaction in which a disqualified person participates (bargain purchase or personal use of assets)Disqualified person – anyone who can
substantially influence the activities of an exempt organization
Excise tax is 25% of the excess benefit (up to $10,000 maximum) for the disqualified person (200% if they fail to correct the transaction) and 10% for the exempt organization’s manager
9 - 46©2004 Prentice Hall, Inc.
Private Foundation
Exempt organizations are classified as private foundations if they are not supported by or operated for the general public as a whole but have a more narrow focus for their activities
Private foundations exclude 501(c)(3) organizations that receive a major part of their support from the public or governmentTo be excluded, an external support test and
internal support test must be met
9 - 47©2004 Prentice Hall, Inc.
Private Foundations
External support test – must receive more than one-third of annual support from the general public, governments, or other exempt organizationsSupport includes membership fees,
contributions, and grants Internal support test – limits interest,
dividends, rent, royalty, and unrelated business income (net of tax) to one-third of the total support
9 - 48©2004 Prentice Hall, Inc.
Private Foundations
Subject to taxes on investment income, for failure to distribute its income, for excess business holdings, for investing in speculative assets, and for participating in transactions with disqualified personsExcise tax on investment income is 2%Taxes on other activities range from 5% to 15%Second round of excise taxes of up to 200% if
corrective actions are not taken
9 - 49©2004 Prentice Hall, Inc.
Multistate Issues
Appendix 9B
9 - 50©2004 Prentice Hall, Inc.
Income Taxes
46 states assess some type of income tax on corporationsFranchise tax – an excise tax based on the
right to do business or own property in the state
Rates typically range from 4% to 10% Most states piggyback on the federal system
by beginning their computations with the corporation's federal taxable income
9 - 51©2004 Prentice Hall, Inc.
Income Taxes
Typical modifications of federal taxable income includeState and local income taxesInterest income earned on state and local
bondsInterest income on federal notes or bondsDividends received deductionNet operating losses
9 - 52©2004 Prentice Hall, Inc.
Income Taxes
Nexus – the connection between a state and the business that the state is seeking to taxNexus can be established through physical
presence of corporate property or employees in the state
When there is nexus in several states, each state can tax only the percentage of income based on the business allocated to that stateMost states use the three-factor allocation
formula of sales, payroll costs, and tangible property
9 - 53©2004 Prentice Hall, Inc.
Income Taxes
Nonbusiness income (interest, dividends, rent) is taxed in one state only Usually where corporation is domiciled or where
property is located or used Income tax planning usually involves shifting
income from high-tax states to low-tax states by outsourcing some functions to eliminate nexus in a state or shifting assets
A few states subject S corporations to their corporate income tax
9 - 54©2004 Prentice Hall, Inc.
Sales Taxes
45 states charge sales taxes that typically range from 3% to 7%Many local governments impose local sales
taxes resulting in more than 7,400 different taxing jurisdictions
Sales taxes are imposed on gross receipts from retail sales or leases of tangible personaltyRetailer is responsible for collecting
9 - 55©2004 Prentice Hall, Inc.
Sales Taxes
Multistate retailers must determine not only the appropriate tax rate but also which items are subject to tax in each locationExempt items typically include food,
prescription drugs, realty, intangible property, and most services
A state can require an out-of-state business to collect sales tax only if it has nexus with the state
9 - 56©2004 Prentice Hall, Inc.
Sales Taxes
Use tax – imposed on the use of property brought into a state when sales tax was not paid in the state of purchaseA use tax is self-assessed and usually has
the same rate as the sales tax
9 - 57©2004 Prentice Hall, Inc.
The End