US Internal Revenue Service: p542--1997

8/14/2019 US Internal Revenue Service: p542--1997

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Contents

Introduction ........................................ 1

Important Changes for 1997 ............. 2

Important Changes for 1998 ............. 2

Important Reminders ......................... 2

Businesses Taxed as Corporations . 2

Forming a Corporation ...................... 3

Special Provisions ............................. 4

Below-Market Loan ......................... 4

Transfer of Stock to Creditor .......... 4

Golden Parachute Payments .......... 5

U.S. Real Property Interests ........... 5

Adjustments-Tax Preferences ........ 5

Dividends-Received Deduction ....... 5

Reduction in Basis of Stock ........... 6

Charitable Contributions ................. 6

Capital Losses ................................ 6

Related Taxpayers .......................... 7

Net Income or Loss ........................... 7

Figuring Tax ........................................ 7

Alternative Minimum Tax .................. 8

Estimated Tax ..................................... 13

Corporation Income Tax Returns ..... 14

Capital Contributions andRetained Earnings ....................... 15

Reconciliation Statements ................ 15

Schedule M1 ................................. 16

Schedule M2 ................................. 16

Earnings and Profits Computations 16

Distributions ....................................... 17

Sample Returns .................................. 20

Form 1120A .................................. 20

Form 1120 ...................................... 23

How To Get More Information .......... 29

Index .................................................... 30

IntroductionThis publication discusses the general taxlaws that apply to ordinary domestic corpo-

rations. It explains the tax law in plain lan-guage so that it will be easier to understand.However, the information provided does notcover every situation, replace the law, orchange its meaning.

If your corporation has a net operatingloss, see Publication 536, Net OperatingLosses. Also, some corporations may meetthe qualifications for electing to be S corpo-rations. For information on S corporations,see the instructions for Form 1120S.

See the sample filled-in Forms 1120 and1120A near the end of this publication.

Please note that you is usually used inthis publication to refer to the person or per-sons responsible for filing returns and makingtax payments for a corporation.

Departmentof theTreasury

InternalRevenueService

Publica tion 542Cat. No. 15072O

Corporations

For use in preparing

1997 Returns

Get f orms and other informat ion faster and easier by:COMPUTER

World Wide Web www.irs.ustreas.gov FTP ftp.irs.ustreas.gov IRIS at FedWorld (703) 321-8020

FAX From your FAX machine, dial (703) 368-9694See How To Get More Information in this publication.


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Important Changes for1997

Businesses taxed as corporations. Therules you must use to determine whether abusiness is taxed as a corporation changedfor businesses formed after 1996. However,a business formed before 1997 and taxed asa corporation under the old rules will generallycontinue to be taxed as a corporation. Formore information, see Businesses Taxed asCorporations, later.

Electronic deposit requirement. If yourtotal deposits of social security, Medicare,and withheld income taxes were more than$50,000 in 1995, you must make electronicdeposits for all depository tax liabilities thatoccur after June 30, 1997. However, no pen-alties for not making these electronic depositswill be imposed prior to July 1, 1998. Formore information, see How To Pay TaxunderCorporation Income Tax Returns, later.

New holding period for dividends-receiveddeduction. The holding period for the

dividends-received deduction has beenchanged. Generally, for dividends receivedor accrued after September 4, 1997, a cor-poration cannot take a deduction for divi-dends received from:

1) A corporation whose stock has beenheld less than 46 days during the 90-dayperiod beginning 45 days before thestock becomes ex-dividend with respectto the dividend, or

2) A corporation whose preferred stock hasbeen held less than 91 days during the180-day period beginning 90 days beforethe stock becomes ex-dividend with re-spect to the dividend, if the dividendsreceived on it are for a period or periods

totaling more than 366 days.

For more information about the dividends-received deduction, see Dividends-ReceivedDeduction, later.

Nonqualified preferred stock not treatedas stock. Generally effective for transfersmade after June 8, 1997, a person whotransfers property to a corporation and re-ceives nonqualified preferred stock must treatsuch stock as property or money (instead ofstock) received. This means that the personmay need to recognize at least part of anygain realized on the transfer of the propertyto the corporation even if that person controlsthe corporation. For more information, see

Forming a Corporation, later.

Important Changes for1998

Certain small corporations not subject toalternative minimum tax (AMT). For taxyears beginning after 1997, the tentativeminimum tax of certain small corporations willbe zero. A corporation is a small corporationfor this purpose if its average annual grossreceipts for the 3-tax-year period (or, ifshorter, the period of existence) ending with:

1) Its first tax year beginning after Decem-ber 31, 1996, are $5 million or less, and

2) Each later tax year up to and includingthe current tax year are $7.5 million orless.

For these tests, gross receipts for a short taxyear are annualized. For more informationabout the AMT, see Alternative Minimum Tax(AMT), later.

Electronic deposit requirement. If your

total deposits of social security, Medicare,and withheld income taxes were more than$50,000 in 1996, you must make electronicdeposits for all depository tax liabilities thatoccur after 1997. However, no penalties fornot making these electronic deposits will beimposed prior to July 1, 1998. For more in-formation, see How To Pay Tax under Cor-poration Income Tax Returns, later.

Important Reminders

Unresolved tax problems. The ProblemResolution Program (PRP), which is ad-ministered by the Taxpayer Advocate, is for

taxpayers who have been unable to resolvetheir problems with the IRS. If you have a taxproblem you cannot clear up through normalchannels, you can call the IRS at18008291040 for PRP assistance. If youprefer, you can write to the office that lastcontacted you (or your local district director)and ask for PRP assistance. If you have ac-cess to TTY/TDD equipment, you can call18008294059 to obtain this assistance.

Although the PRP office cannot changethe tax law or a technical tax decision, it canclear up problems that resulted from previouscontacts and ensure your case is given acomplete and impartial review. For more in-formation, see Publication 1546, The ProblemResolution Program of the Internal Revenue

Service.

Comments on IRS enforcement actions.The Small Business and Agricultural Regula-tory Enforcement Ombudsman and 10 Re-gional Fairness Boards were established toreceive comments from small business aboutfederal agency enforcement actions. TheOmbudsman will annually evaluate theenforcement activities and rate each agency'sresponsiveness to small business. If you wishto comment on the enforcement actions of theIRS, call 18887343247.

Useful ItemsYou may want to see:

Publication

535 Business Expenses

526 Charitable Contributions

544 Sales and Other Dispositions ofAssets

946 How To Depreciate Property

Form (and Instructions)

1120 U.S. Corporation Income Tax Re-turn

1120A U.S. Corporation Short-FormIncome Tax Return

1120W (WORKSHEET) Estimated Taxfor Corporations

1120XAmended U.S. Corporation In-come Tax Return

2220 Underpayment of Estimated Taxby Corporations

4626 Alternative MinimumTaxCorporations

7004 Application for Automatic Exten-sion of Time To File Corporation

Income Tax Return 8827 Credit For Prior Year Minimum

TaxCorporations

8832 Entity Classification Election

See How To Get More Information nearthe end of this publication for informationabout getting these publications and forms.

Businesses Taxed asCorporationsThe rules you must use to determine whethera business is taxed as a corporation changedfor businesses formed after 1996. However,a business formed before 1997 and taxed asa corporation under the old rules will generallycontinue to be taxed as a corporation.

Businesses formed before 1997. The fol-lowing businesses formed before 1997 aretaxed as corporations.

1) A business that is legally chartered as acorporation.

2) A joint-stock company.

3) An insurance company.

4) Any other business formed before 1997that has more than 2 of the followingcharacteristics:

a) Centralization of management.

b) Continuity of l ife.

c) Free transferability of interests.

d) Limited liabili ty.

Organizations of professional people. Or-ganizations of doctors, lawyers, and otherprofessional people organized under stateprofessional association acts are generallytaxed as corporations. A professional serviceorganization must be both organized andoperatedas a corporation to be classified asone. All states and the District of Columbiahave professional association acts.

Businesses formed after 1996. The follow-ing businesses formed after 1996 are taxedas corporations.

1) A business formed under a federal orstate law that refers to the business asa corporation, body corporate, or bodypolitic.

2) A business formed under a state law thatrefers to the business as a joint-stockcompany or joint-stock association.

3) An insurance company.

4) Certain banks.

5) A business wholly owned by a state orlocal government.

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6) A business specifically required to betaxed as a corporation by the InternalRevenue Code. (For example, certainpublicly traded partnerships.)

7) Certain foreign businesses.

8) Any other business formed after 1996, ifan election to be taxed as a corporationis filed for the business on Form 8832within 75 days of the date it is formed.

For more information, see the instructions forForm 8832.

Forming a CorporationA corporation is formed by a transfer ofmoney, property, or both by prospectiveshareholders in exchange for capital stock inthe corporation.

Issuance of StockIf one or more persons transfer money orproperty to a corporation solely in exchangefor stock of that corporation, and immediatelyafter the exchange they control the corpo-ration, neither the transferors nor the

transferee corporation recognizes gain orloss.

The transferors must be in control of thecorporation immediately after the exchange.To be in control, the transferors must, as agroup, own:

1) At least 80% of the total combined votingpower of all classes of stock entitled tovote, and

2) At least 80% of the total number ofshares of all other classes of stock.

Nonqualified preferred stock not treatedas stock. Generally effective for transfersmade after June 8, 1997, a person whotransfers property to a corporation and re-

ceives nonqualified preferred stock must treatsuch stock as property or money (instead ofstock) received. This means that the personmay need to recognize at least part of anygain realized on the transfer of the propertyto the corporation even if that person controlsthe corporation.

Preferred stock is stock that is limited andpreferred as to dividends and does not par-ticipate in corporate growth to any significantextent. Preferred stock is nonqualified if it hasanyof the following characteristics.

1) The holder of the stock can require theissuer or a related person to redeem orpurchase the stock.

2) The issuer or a related person is re-

quired to redeem or purchase the stock.

3) The issuer or a related person has theright to redeem or repurchase the stockand, as of the issue date, it is more likelythan not that that right will be exercised.

4) The dividend rate of the stock varies inwhole or in part (directly or indirectly)with reference to interest rates, com-modity prices, or other similar indices.

Transferor's loss. A transferor who has aloss from an exchange and who owns morethan 50% of the corporation's stock cannotdeduct the loss. This is true even if thetransferor does not control the corporation

(owns less than 80% of its stock). See Salesand Exchanges Between Related Partiesandits discussion Nondeductible Loss in chapter2 of Publication 544.

Transfer of services. Transfer of your ser-vices to a corporation in return for stock re-sults in taxable pay to you.

Property or money received. If you receiveproperty or money in addition to stock in ex-change for the property you transferred, any

gain may be taxable. Gain is taxable only tothe extent of the money and fair market value(FMV) of other property you receive. Propertyincludes securities of the corporation.

Fair market value (FMV). Fair marketvalue (FMV) is the price at which propertywould change hands between a buyer andseller, neither being required to buy or sell,and both having reasonable knowledge of allrelevant facts.

Transfer ofMortgaged PropertyIf you transfer mortgaged property to a cor-poration you control, you generally do notrecognize gain or loss. If the corporation as-

sumes your liabilities or takes property sub-ject to liability, you generally do not recognizegain or loss.

Gain if liability exceeds basis. If the cor-poration assumes or takes your propertysubject to an amount of liability that is morethan your adjusted basis of the transferredproperty, the excess amount is your taxablegain.

Liabilities you can exclude. To deter-mine the excess amount of liability describedin the preceding paragraph, you can excludecertain liabilities. These excludible liabilitiesare the type that would give rise to a de-duction if you had paid them. For example,you can exclude trade accounts payable, and

other liabilities such as interest and taxes thatrelate to a transferred trade or business. Yourbasis in this stock you receive from a corpo-ration is not reduced by the excluded liabil-ities.

Liabilities you cannot exclude. Youcannot exclude a liability if:

1) A deduction for it has already beenclaimed, or

2) When the liability was incurred it createdor increased the basis of any property.

For example, a cash basis taxpayer boughtsome small handtools on credit which areused in his business. However, before payingthe liability, he transfers the handtools and the

liability to a controlled corporation. This liabil-ity cannot be excluded because when it wasincurred, it created a basis in the asset for thetaxpayer which offsets the liability.

No gain for certain reorganizations.Even if your liability exceeds basis in thepreceding transfers, the excess liability rulefor recognizing gain does not apply to trans-fers you make as part of a:

1) Title 11 or similar plan of reorganizationunder section 368(a)(1)(G) of the Inter-nal Revenue Code, or

2) Reorganization that is a mere change inidentity, form, or place of organization,under section 368(a)(1)(F) of the Code.

Gain if transfer made for nonbusinesspurpose. Even if your liability exceeds basison a transfer to your controlled corporation,if you had no bona fide business purpose inmaking the transfer or you did so to avoidfederal income tax, you cannot use the ex-cess liability rule to figure any taxable gain.Instead, the gain is taxable to the extent ofall the liabilities you transferred or the corpo-ration assumed plus the fair market value ofany property (other than the corporation'sstock) you received in the exchange.

Gain or LossNot RecognizedA corporation does not recognize gain or lossif you transfer property and money to thecorporation in exchange for corporation stock(including treasury stock). A corporation doesnot recognize gain or loss on the acquisitionor lapse of an option to buy or sell its stock(including treasury stock).

Transfer toForeign CorporationsGenerally, you recognize gain on the transferof property to a foreign corporation. Ex-ceptions allow nonrecognition of gain on atransfer of certain property (see section367(a)(3) of the Internal Revenue Code).

Basis of StockThe basis of stock received for the propertytransferred to a corporation is the same as thebasis of property transferred with certain ad-

justments. The basis is decreasedby:

The FMV of any other property (exceptmoney) you receive,

Any money you receive, and

Any loss recognized on the exchange.

The basis is increasedby:

Any amount treated as a dividend, and

Any gain recognized on the exchange.

The basis of property received, other thanmoney or stock, is its FMV.

Assumption of liability. If, in return forstock, securities, or other property, youtransfer to a corporation property subject toa liability, treat the amount of the liability asmoney received by you for determining yourbasis. If the corporation assumes your liabil-ity, treat the amount of the liability as moneyreceived for determining your basis. This ruledoes not apply to any liabilities you excludedunder the excess liability rule discussed ear-lier in Gain if liability exceeds basis underTransfer of Mortgaged Property.

Basis of Property TransferredGenerally, the basis of property a corporationreceives from you in exchange for its stock:

1) In an 80% control transaction,

2) As paid-in surplus, or

3) As a contribution to capital

has the same basis you had in the propertyincreased by any gain you recognized on theexchange.

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Basis pursuant to reorganization. How-ever, the general rule discussed in the pre-ceding paragraph does not apply if the prop-erty is received in a reorganization andconsists of stock or securities in a corporationthat is a party to the reorganization unlessthat property is received in exchange for stockor securities of the transferee (or a corpo-ration that is in control of the transferee) asthe consideration in whole or in part for thetransfer.

Transferor not in control of corporation.If a corporation receives property by issuingstock for it, other than in an 80% controltransaction, its basis for the property is usu-ally the FMV of the stock at the time of theexchange. The corporation can use evidenceof the FMV of the transferred property to setthe value of the stock if:

1) The stock has no established value, and

2) It issues all outstanding stock in ex-change for that property.

Start-Up ExpensesA corporation may not take a deduction forstart-up expenses unless it chooses to treat

those expenses as deferred expenses andamortize them. When you amortize start-upexpenses, deduct them in equal amountsover a period of 60 months or more. Theamortization period starts in the month youstart or acquire the active business.

A start-up expense is one you pay or incurfor:

1) Creating an active trade or business, or

2) Investigating the possibility of creatingor acquiring an active trade or business.

However, to be amortizable, it must bedeductible if paid or incurred in the operationof an existing trade or business in the samefield.

Start-up expenses also include amountsyou pay or incur in any activity engaged in forprofit and for the production of income in an-ticipation of the activity becoming an activetrade or business. Start-up expenses aretreated differently than organizational ex-penses, discussed later.

Start-up expenses are those you havebefore you begin business operations. Theyinclude expenses both for investigating aprospective business and getting the busi-ness started. For example, they may includecosts for the following items:

A survey of potential markets,

An analysis of available facilities, laborsupply, etc.,

Advertisements for the opening of yourbusiness,

Salaries and wages for employees whoare being trained, and for their instruc-tors,

Travel and other necessary expenses forlining up distributors, suppliers, or cus-tomers, and

Salaries and fees for executives, con-sultants, or for other professional ser-vices.

Start-up expenses do not include interest,taxes, or research and experimental ex-penses allowable as deductions.

Choosing to amortize. If you want toamortize start-up expenses, complete PartVI of Form 4562. Attach it to the corporation'stax return for the tax year the amortizationperiod starts. Also, attach a statement to thereturn. It should show the total amount ofthose expenses, and describe what they werefor, date incurred, month the corporation be-gan business, and months in the amortizationperiod (not less than 60). File the return andstatement by the due date of the return (in-cluding extensions).

Organizational ExpensesA newly organized corporation may not cur-rently deduct its organizational expenses.However, it may choose to treat its organiza-tional expenses as deferred expenses andamortize them. To amortize, deduct the ex-penses in equal monthly amounts over a pe-riod of 60 months or more. The period startswith the first month the corporation activelyengages in business. If the corporation doesnot make this choice, capitalize and deductthese expenses only in the year the corpo-ration finally liquidates. However, this electiononly applies to expenditures incurred beforethe end of the tax year the corporation beginsbusiness (without regard to whether the cor-poration files its returns on an accrual or thecash method of accounting or whether theexpenses are paid in the tax year they areincurred).

Organizational expenses are those di-rectly for the creation of the corporation thatwould be chargeable to the capital account.These expenses are of a character which, ifspent for the creation of a corporation havinga limited life, would be amortizable over thatlimited life. They include expenses of tempo-rary directors, organizational meetings of di-rectors or shareholders, fees paid to a statefor incorporation, and accounting or legalservices incident to the organization. Theseservices include drafting the charter, the by-laws, minutes of organizational meetings, and

terms of the original stock certificates.

Expenses for issuance or sale of stock.However, you cannot amortize:

1) Expenses of issuing or selling stock orsecurities, such as commissions, pro-fessional fees, and printing costs,

2) Expenses connected with the transferof assets to a corporation, or

3) Expenses connected with the reorgan-ization of the corporation, unless directlyincident to the creation of a corporation.

Time and manner of choosing. If a corpo-ration wants to amortize organizational ex-penses, it must choose to do so when it filesits return for the first tax year it actively en-gages in business. Make the choice by thedue date (including extensions) of the returnfor that tax year. The corporation completesPart VI of Form 4562 and attaches it to itsreturn. It must also attach a statement to itsreturn.

The statement should show the de-scription, amount of the expenses, date in-curred, month the corporation began busi-ness, and months (not less than 60) overwhich the corporation will deduct the ex-penses. The time over which the corporationchooses to amortize its organizational ex-penses is binding.

Start of business. Generally, a corporationstarts business when it starts the activities forwhich it was organized. A corporation has notbegun business merely by existing as a cor-poration or by conducting organizational ac-tivities. However, consider a corporation tohave begun business when its activities reachthe point necessary to establish the natureof its business operations. For example, if acorporation acquires the assets necessary tooperate its business, it may be considered tohave begun business activities.

Special ProvisionsRules on income and deductions that applyto individuals also apply, for the most part, tocorporations. However, some of the followingspecial provisions apply only to corporations.

Below-Market LoanIf a corporation issues a shareholder or anemployee a below-market loan, the corpo-ration reports additional income.

A below-market loan is a loan which pro-vides for no interest or interest at a rate belowthe federal rate that applies. Treat a below-market loan as an arm's-length transaction inwhich the lender is considered to have made:

1) A loan to the borrower in exchange fora note that requires payment of interestat the applicable federal rate, and

2) A payment to the borrower.

Treat the lender's payment to the borroweras a gift, dividend, contribution to capital,payment of wages, or other payment, de-pending on the substance of the transaction.

See Below-Market Interest Rate Loans inchapter 8 of Publication 535 for more infor-mation.

Transfer of Stockto CreditorIf a corporation transfers its stock in satisfac-tion of indebtedness and the fair market valueof its stock is less than the indebtedness itowes, the corporation has income (to the ex-tent of the difference) from the cancellationof indebtedness. After 1994, a corporationcan exclude all or a portion of the incomecreated by the stock for debt transfer if it is ina bankruptcy proceeding or, if it is not in abankruptcy proceeding, it can exclude the in-come to the extent it is insolvent. However,the corporation must reduce its tax attributes(to the extent it has any) generally by theamount of excluded income.

Stock for debt exception. The stock fordebt exception was repealed for transfersmade after 1994, unless the corporation filedfor bankruptcy (or similar court proceeding)before 1994. Generally, before 1995, a cor-poration did not realize income because ofthese stock for debt exchanges if it was inbankruptcy or to the extent it is insolvent.Consequently, there was no gross income toexclude and no reduction of its tax attributeswas necessary. The principal difference be-tween the stock for debt exception and thestock for debt exchange is that the corpo-ration does not reduce its tax attributes underthe stock for debt exception.

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Golden ParachutePaymentsCorporations may enter into goldenparachute contracts with key personnel. Un-der a typical golden parachute contract, thecorporation agrees to make payments to cer-tain officers, shareholders, or highly compen-sated individuals in certain events. The con-tract provides for payment when there is:

1) A change in the ownership or control ofthe corporation, or

2) A change in the ownership of a sub-stantial part of the corporation's assets.

The corporation's deduction is limited ifthe total present value of the payments to anyofficer, shareholder, or highly compensatedindividual equals or exceeds three times therecipient's base amount. It cannot deduct theexcess of any parachute payment over thepart of the base amount allocated to thepayment.

The base amount is the averageannualized includible pay that was payable tothe recipient by the corporation during the 5tax years ending before the date of thechange in ownership or control. The law im-

poses a nondeductible excise tax of 20% ofthese payments on the recipient in additionto regular income tax. For more information,see section 280G of the Internal RevenueCode.

U.S. Real Property InterestsIf a domestic corporation acquires a U.S. realproperty interest from a foreign person or firm,the corporation may have to withhold tax onthe amount it pays for the property. Theamount paid includes cash, the FMV of otherproperty, and any assumed liability. If a do-mestic corporation distributes a U.S. realproperty interest to a foreign person or firm,it may have to withhold tax on the FMV of theproperty. A corporation that fails to withhold

may be liable for the tax, penalties that apply,and interest. For more information, see U.S.Real Property Interestin Publication 515.

Adjustments-Tax PreferencesTax law gives special treatment to someitems of income and deduction called adjust-ments or tax preference items. They may re-sult in an additional tax called the alternativeminimum tax (discussed later). The corpo-ration adjusts the following items before ittakes them into account in determining itstaxable income:

Section 1250 capital gain treatment.Generally, for section 1250 property dis-posed of during the tax year, 20% of anyexcess of (a) the amount that would beordinary income if the property was sec-tion 1245 property over (b) the amounttreated as ordinary income under section1250, must be recognized as ordinaryincome under section 1250.

Section 1250 property. This includesall real property that is subject to an al-lowance for depreciation and that is notand never has been section 1245 prop-erty.

Section 1245 property. This includesany property that is or has been subjectto an allowance for depreciation, if the

property is either personal property orother section 1245 property described inchapter 4 of Publication 544.

Percentage depletion. For iron ore andcoal (including lignite), reduce the allow-able percentage depletion deduction by20% of any excess of (a) the percentagedepletion deduction allowable for the taxyear (determined without this adjust-ment), over (b) the adjusted basis of thedepletable property at the close of the taxyear (figured without the depletion de-

duction for the tax year). Pollution control facilities. Reduce the

amortizable basis of pollution control fa-cilities by 20% in determining the amorti-zation deduction for that property.

Mineral exploration and developmentcosts. Reduce the allowable deductionfor these costs by 30%. Special rulesapply to the amount not allowed becauseof this adjustment. This reduction alsoapplies to the intangible drilling costsof an integrated oil company. See section291(b) of the Internal Revenue Code formore information.

These adjustments apply to all corporations.However, they do not apply to an S corpo-ration unless it or a predecessor was a Ccorporation for any of the 3 immediately pre-ceding tax years.

Dividends-ReceivedDeductionA corporation can deduct a percentage ofcertain dividends received during its tax year.

Dividends from domestic corporations. Acorporation can deduct, with certain limits,70% of the dividends received if the corpo-ration receiving the dividend owns less than20% of the distributing corporation.

20%-or-more owners allowed 80% de-

duction. A corporation can deduct, withcertain limits, 80% of the dividends receivedor accrued if it owns 20% or more of thepaying domestic corporation. The payingcorporation is a 20%-owned corporation.

Ownership. Determine ownership, forthese rules, by the amount of voting powerand value of the paying corporation's stock(other than certain preferred stock) the re-ceiving corporation owns.

Dividends on debt-financed portfoliostock. For dividends received on debt-financed portfolio stock of domestic corpo-rations, reduce the 70% or 80% dividends-received deduction. Reduce the deduction bya percentage related to the amount of debtincurred to purchase the stock. This applies

to stock whose holding period begins afterJuly 18, 1984. For more information, seesection 246A of the Internal Revenue Code.

Small business investment companies.Small business investment companies candeduct 100% of the dividends received froma taxable domestic corporation.

Affiliated corporations. Members of an af-filiated group of corporations can deduct100% of the dividends received from a mem-ber of the same affiliated group if they meetcertain conditions. See section 243 of theInternal Revenue Code for the definition ofan affiliated group of corporations.

Dividends from regulated investmentcompany. Regulated investment companydividends received are subject to certain lim-its. Capital gain dividends do not qualify forthe deduction. For more information, seesection 854 of the Internal Revenue Code.

Dividends on preferred stock of publicutilities. A corporation can deduct 42% ofthe dividends it receives on certain preferredstock (issued before October 1942) of aless-than-20%-owned taxable public utility. A

corporation can deduct 48% of the dividendsit receives on certain preferred stock of a20%-or-more-owned taxable public utility. Formore information, see section 244 of theInternal Revenue Code.

Dividends from Federal Home LoanBanks. Certain dividends received fromFederal Home Loan Banks qualify for thedividends-received deduction. For more in-formation, see section 246 of the InternalRevenue Code.

Dividends from foreign corporations. Acorporation can deduct a percentage of thedividends it receives from 10%-owned foreigncorporations. For more information, see sec-

tion 245 of the Internal Revenue Code.

No deduction allowed for certain divi-dends. Corporations cannot take a deductionfor dividends received from:

1) A real estate investment trust,

2) A corporation exempt from tax either forthe tax year of the distribution or thepreceding tax year,

3) A corporation whose stock has beenheld less than 46 days (for dividendsreceived before September 5, 1997),

4) A corporation whose stock has beenheld less than 46 days during the 90-day

period beginning 45 days before thestock becomes ex-dividend with respectto the dividend (generally for dividendsreceived after September 4, 1997),

5) A corporation whose stock has beenheld less than 91 days, if the stock haspreference as to dividends and the divi-dends received on it are for a period orperiods totaling more than 366 days (fordividends received before September 5,1997), or

6) A corporation whose preferred stock hasbeen held less than 91 days during the180-day period beginning 90 days beforethe stock becomes ex-dividend with re-spect to the dividend if the dividends re-

ceived on it are for a period or periodstotaling more than 366 days (generallyfor dividends received after September4, 1997), or

7) Any corporation, if your corporation isunder an obligation (pursuant to a shortsale or otherwise) to make related pay-ments for positions in substantially simi-lar or related property.

Dividends on deposits. So-called dividendson deposits or withdrawable accounts in do-mestic building and loan associations, mutualsavings banks, cooperative banks, and simi-lar organizations are interest. They do notqualify for this deduction.

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Limit on deduction for dividends. The totaldeduction for dividends received or accruedis generally limited (in the following order) to:

1) 80% of the difference between taxableincome and the 100% deduction allowedfor dividends received from affiliatedcorporations, or by a small business in-vestment company, for dividends re-ceived or accrued from 20%-owned cor-porations, and

2) 70% of the difference between taxable

income and the 100% deduction allowedfor dividends received from affiliatedcorporations, or by a small business in-vestment company, for dividends re-ceived or accrued fromless-than-20%-owned corporations (re-ducing taxable income by the total divi-dends received from 20%-owned corpo-rations).

Figuring limit. In figuring this limit, de-termine taxable income without:

1) The net operating loss deduction,

2) The deduction for dividends received,

3) Any adjustment due to the part of anextraordinary dividend that is not taxable(see Reduction in Basis of Stock, later),

4) The deduction for contributions to aCapital Construction Fund (CCF), and

5) Any capital loss carryback to the taxyear.

Effect of net operating loss. If a corpo-ration has a net operating loss for a tax year,the limit of 80% (or 70%) of taxable incomedoes not apply. To determine whether a cor-poration has a net operating loss, figure thedividends-received deduction without the 80%(or 70%) of taxable income limit.

Example 1. A corporation loses $25,000from operations. It receives $100,000 in divi-

dends from a 20%-owned corporation. Itstaxable income is $75,000 before the de-duction for dividends received. If it claims thefull dividends-received deduction of $80,000($100,000 80%) and combines it with theoperations loss of $25,000, it will have a netoperating loss of $5,000. The 80% of taxableincome limit does not apply. The corporationcan deduct $80,000.

Example 2. Assume the same facts asin Example 1 except that the corporationloses $15,000 from operations. Its taxableincome is $85,000 before the deduction fordividends received. However, after claimingthe dividends-received deduction of $80,000($100,000 80%), its taxable income is$5,000. But because the corporation will nothave a net operating loss after a fulldividends-received deduction, its allowabledividends-received deduction is limited to80% of its taxable income, or $68,000($85,000 80%).

Reduction in Basis of StockIf a corporation receives an extraordinarydividendon stock held 2 years or less beforethe dividend announcement date, it reducesits basis in the stock by the nontaxed part ofthe dividend. Do not reduce the basis of thestock below zero. The total nontaxed part ofdividends on stock that did not reduce thebasis of the stock, due to the limit on reducing

basis below zero, is generally treated as gainfrom the sale or exchange of the stock for thetax year the dividend is received. For distri-butions made before May 4, 1995, this partwas treated as gain from the sale or ex-change of the stock for the tax year you sellor exchange the stock. For more informationabout this change, see section 1011 of theTaxpayer Relief Act of 1997 (Public Law10534).

An extraordinary dividend is any divi-dend on stock that equals or exceeds a cer-tain percentage of the corporation's adjustedbasis in the stock. The percentages are:

1) 5% for stock preferred as to dividends,or

2) 10% for other stock.

Treat all dividends received that have ex-dividend dates within an 85-consecutive-dayperiod as one dividend. Treat all dividendsreceived that have ex-dividend dates withina 365-consecutive-day period as extraor-dinary dividends if the total of the dividendsexceeds 20% of the corporation's adjustedbasis in the stock. Do not include qualifyingdividends, discussed earlier under Affiliatedcorporations, in the definition of extraordinarydividends.

A corporation can elect to determinewhether the dividend is extraordinary by usingthe FMV of the stock rather than its adjustedbasis. To make this election, the corporationmust establish to the satisfaction of the IRS,the FMV of the stock as of the day before theex-dividend date. (See Revenue Procedure8733 in the Cumulative Bulletin, Volume19872, on page 402.)

The nontaxed part is any dividends-received deduction allowable for the divi-dends.

The dividend announcement dateis thedate the corporation declares, announces, oragrees to either the amount or the paymentof the dividend, whichever is earliest.

Disqualified preferred stock. Any dividendon disqualified preferred stock is treated asan extraordinary dividend regardless of theperiod the corporation held the stock.

Disqualified preferred stock is any stockpreferred as to dividends if:

1) The stock when issued has a dividendrate that declines (or can reasonably beexpected to decline) in the future,

2) The issue price of the stock exceeds itsliquidation rights or stated redemptionprice, or

3) The stock is otherwise structured toavoid the rules for extraordinary divi-dends and to enable corporate share-

holders to reduce tax through a combi-nation of dividends-received deductionsand loss on the disposition of the stock.

These rules apply to stock issued afterJuly 10, 1989, unless issued under a writtenbinding contract in effect on that date andthereafter before the issuance of the stock.

Charitable ContributionsA corporation can claim a limited deductionfor any charitable contributions made in cashor other property. The contribution is deduct-ible if made to or for the use of a qualifiedorganization. For more information on qual-ified organizations, see Publication 526.

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You can ask any organization whetherit is a qualified organization, and mostwill be able to tell you. Or you can

check IRS Publication 78, Cumulative List ofOrganizations, which lists most qualified or-ganizations. You may find Publication 78 inyour local library's reference section. If not,you can call the IRS tax help telephonenumber shown for your area in your taxpackage to find out if an organization isqualified.

You cannot take a deduction if any of thenet earnings of an organization receivingcontributions benefit any private shareholderor individual.

Cash method corporation. A corporationusing the cash method of accounting candeduct contributions only in the tax year paid.

Accrual method corporation. A corporationusing an accrual method of accounting canchoose to deduct unpaid contributions for thetax year the board of directors authorizesthem if it pays them within 21/2 months afterthe close of that tax year. Make the choiceby reporting the contribution on the corpo-ration's return for the tax year. A copy of theresolution authorizing the contribution and adeclaration stating the board of directors

adopted the resolution during the tax yearmust accompany the return. An officer au-thorized to sign the return must sign the dec-laration under penalties of perjury.

Limit. A corporation cannot deduct as chari-table contributions for a tax year more than10% of its taxable income. Figure taxable in-come for this purpose without the following:

Deduction for contributions,

Deductions for dividends received anddividends paid,

Any net operating loss carryback to thetax year, and

Any capital loss carryback to the tax year.

Carryover of excess contributions. Youcan carry over (with certain limits) any chari-table contributions made during the year thatare more than the 10% limit to each of thefollowing 5 years. You lose any excess notused within that period. For example, if acorporation has a carryover of excess contri-butions paid in 1996 and it does not use allthe excess on its return for 1997, it can carrythe rest over to 1998, 1999, 2000, and 2001.Do not deduct a carryover of excess contri-butions in the carryover year until after youdeduct contributions made in that year (sub-

ject to the 10% limit). You cannot deduct acarryover of excess contributions to the extentit increases a net operating loss carryover to

a succeeding tax year.

Capital LossesA corporation can deduct capital losses onlyup to its capital gains. In other words, if acorporation has a net capital loss, it cannotdeduct the loss in the current tax year. Itcarries the loss to other tax years and deductsit from capital gains that occur in those years.

First, carry a net capital loss back 3 years.Deduct it from any total net capital gain whichoccurred in that year. If you do not deduct thefull loss, carry it forward 1 year (2 years back)and then 1 more year (1 year back). If anyloss remains, carry it over to future tax years,1 year at a time, for up to 5 years. When you

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carry a net capital loss to another tax year,treat it as a short-term loss. It does not retainits original identity as long term or short term.

Example. In 1997, a corporation has anet short-term capital gain of $3,000 and anet long-term capital loss of $9,000. Theshort-term gain offsets some of the long-termloss, leaving a net capital loss of $6,000. Ittreats this $6,000 as a short-term loss whencarried back or forward.

The corporation carries the $6,000 short-term loss back 3 years to 1994. In 1994, the

corporation had a net short-term capital gainof $8,000 and a net long-term capital gain of$5,000. It subtracts the $6,000 short-term lossfrom 1997 first from the net short-term gain.This results in a net capital gain for 1994 of$7,000. This consists of a net short-termcapital gain of $2,000 ($8,000 $6,000) anda net long-term capital gain of $5,000.

S corporation status. A corporation maynot carry a capital loss from, or to, a year forwhich it is an S corporation.

Rules for carryover and carryback. Whencarrying a capital loss from one year to an-other, the following rules apply:

When figuring this year's net capital loss,you cannot use any capital loss carriedfrom another year. In other words, youmay only carry capital losses to years thatwould otherwise have a total net capitalgain.

If you carry capital losses from 2 or moreyears to the same year, deduct the lossfrom the earliest year first. When you fullydeduct that loss, deduct the loss from thenext earliest year, and so on.

You cannot use a capital loss carriedfrom another year to produce or increasea net operating loss in the year to whichyou carry it.

Refunds. When you carry back a capital loss

to an earlier tax year, refigure your tax for thatyear. If your corrected tax is less than youoriginally owed, you may apply for a refund.File Form 1120X.

Related TaxpayersThe related party rules apply to:

1) An individual and a corporation the indi-vidual controls,

2) Two corporations that are members ofthe same controlled group,

3) A partnership and a corporation con-trolled by the same person, and

4) An S corporation and a C corporation if

controlled by the same persons.These rules deny the deduction of losses

on the sale or exchange of property betweenrelated parties. They also deny the deductionof certain unpaid business expenses and in-terest on transactions between the parties.Losses on the sale or exchange of propertybetween members of the same controlledgroup of corporations are deferred rather thandenied. Under certain conditions, the IRS mayreallocate income and deductions betweentwo or more businesses directly or indirectlycontrolled by the same interests.

For an explanation of these tax rules, seechapters 2 and 8 of Publication 535, andPublication 544.

Table 1. Tax Rate ScheduleIf taxable income (line 30, Form 1120, or line 26, Form 1120-A) on page 1 is:

Over

$050,000

75,000100,000335,000

10,000,00015,000,000

18,333,333

But not over

$50,000

75,000100,000335,000

10,000,00015,000,000

18,333,333

Tax is:

15%$7,500 + 25%13,750 + 34%

22,250 + 39%113,900 + 34%

3,400,000 + 35%

5,150,000 + 38%

35%

Of the amountover

$050,000

75,000100,000

335,00010,000,00015,000,000

0

Accrual basis corporation. An accrual ba-sis taxpayer cannot deduct expenses owedto a related cash basis person until paymentis made, and the amount is includible in thegross income of the person paid. This ruleapplies even if the relationship ceases beforethe amount is includible in the gross incomeof the person paid.

Complete liquidations. The disallowanceof losses from the sale or exchange of prop-erty between related parties does not applyto liquidating distributions. It does not applyto any loss of either the distributing corpo-ration or a distributee for a distribution incomplete liquidation.

Interest paid to related parties. A corpo-ration's deduction for interest expense maybe limited if it paid (or accrued) interest torelated parties not subject to tax on the in-terest received. The deduction for this inter-est is disallowed for any tax year that thecorporation has:

1) Excess interest expense, and

2) A debt to equity ratio greater than 1.5 to1 at the end of that tax year.

However, the deduction is disallowed only tothe extent of the corporation's excess interest

expense. The corporation can carry the dis-allowed interest to later years.Not subject to tax on the interestmeans

that the related party is not subject to U.S.income tax on the interest income. For ex-ample, the related party may be a foreignparent corporation not subject to U.S. tax.

Excess interest expense. Excess inter-est expense is the excess of the corporation'snet interest expense over the sum of 50% ofits adjusted taxable income plus any excesslimitcarryforward.

Excess limit. Excess limit means theexcess of 50% of the corporation's adjustedtaxable income over its net interest expense.

If a corporation has an excess limit for atax year, that amount becomes an excesslimit carryforward to the next tax year. Whenthe corporation does not use it up in the nexttax year, it can carry it forward to the following2 tax years.

More information. For more information,including the definition of adjusted taxableincome, see section 163(j) of the InternalRevenue Code.

Net Income or LossAt the end of each tax year, a corporationfigures its net income or loss. To do this,subtract the operating expenses and otherallowable deductions from gross income.

Figure the corporation's tax as explained un-der Figuring Tax.

The at-risk rules apply to closely heldcorporations that engage in any activity as atrade or business or for the production of in-come. These rules limit a corporation's loss.

The at-risk rules generally do not apply toa qualifying business that is an active busi-ness of a qualified corporation. For more in-formation on the at-risk rules, see Publication925.

Figuring TaxCorporate taxable income is subject to the taxrates shown in Table 1.

Controlled group of corporations. A con-trolled group of corporations gets only oneapportionable $50,000, $25,000, and$9,925,000 (in that order) amount for eachtaxable income bracket. For more informa-tion, see the instructions for Schedule J ofForm 1120.

Personal service corporations. The tax ratefor qualified personal service corporations is35% of taxable income. These corporationscannot use the graduated tax rates that applyto other corporations.

A corporation is a qualified personalservice corporationif:

1) At least 95% of the value of its stock isheld by employees, retired employees,their estates, or (for a limited time) thebeneficiaries of such estates, and

2) Its employees perform services at least95% of the time in any of the followingfields:

a) Health,

b) Law,

c) Engineering,

d) Architecture,

e) Accounting,f) Actuarial science,

g) Veterinary services,

h) Performing arts, or

i) Consulting.

CreditsA corporation decreases its tax liability bycredits, such as the:

1) Credit for fuels used for certain purposes(see Publication 378),

2) Foreign tax credit (use Form 1118),

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3) General business credit (see Generalbusiness credit, below),

4) Possessions tax credit (use Form 5735),

5) Credit for fuel produced from a noncon-ventional source, and

6) Qualified electric vehicle credit (useForm 8834).

General business credit. Your generalbusiness credit consists of your carryforwardof business credits from prior years plus your

total current year business credits. Currentyear business credits include the:

Alcohol used as fuel credit (Form 6478),

Contributions to selected community de-velopment corporations credit (Form8847),

Disabled access credit (Form 8826),

Employer social security and Medicaretaxes paid on certain employee tips credit(Form 8846),

Empowerment zone employment credit(Form 8844),

Enhanced oil recovery credit (Form8830),

Indian employment credit (Form 8845), Investment credit (Form 3468),

Low-income housing credit (Form 8586),

Orphan drug credit (Form 8820),

Renewable electricity production credit(Form 8835),

Research credit (Form 6765),

Welfare-to-work credit (For wages paidto qualified long-term family assistancerecipients who began work after 1997.)(Form 8861), and

Work opportunity credit (Form 5884).

In addition, your general business credit forthe current year may be increased later by thecarryback of business credits from later years.

To claim the general business credit, youwill first need to get the form or forms youneed to claim your current year businesscredits. The above list contains a list of cur-rent year business credits. The form you needto claim a credit is shown in parentheses. Inaddition to the credit form, you may also needto file Form 3800, General Business Credit.

Who must file Form 3800. You must fileForm 3800 if any of the following apply:

1) You have more than one of the creditslisted earlier (other than theempowerment zone employment credit).

2) You have a carryback or carryforwardof any of these credits (other than the

empowerment zone employment credit).

3) Any of these credits (other than the low-income housing credit or theempowerment zone employment credit)is from a passive activity. (For informa-tion about passive activity credits, getForm 8582CR.)

The empowerment zone employmentcredit is subject to special rules. The credit isfigured separately on Form 8844 and is notcarried to Form 3800. For more information,see the instructions for Form 8844.

See the instructions to Form 3800 formore information about the general businesscredit.

Other TaxesA corporation increasesits tax liability by the:

1) Personal holding company tax (attachSchedule PH (Form 1120)),

2) Investment credit recapture (Form 4255),

3) Low-income housing credit recapture(Form 8611),

4) Qualified electric vehicle credit recap-ture,

5) Indian employment credit recapture, and

6) Alternative minimum tax.

AlternativeMinimum Tax (AMT)The tax law gives special treatment to somekinds of income and allows special de-ductions and credits for some kinds of ex-penses. This special treatment could sub-stantially reduce or eliminate a corporation'sincome tax. Corporations that benefit from thelaw in these ways may have to pay at least

a minimum amount of tax, through an addi-tional tax. This tax is called the alternativeminimum tax (AMT).

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For tax years beginning after 1997,the tentative minimum tax of certainsmall corporations will be zero. This

means that they will no longer be subject toAMT. A corporation is a small corporation forthis purpose if its average annual gross re-ceipts for the 3-tax-year period (or, if shorter,the period of existence) ending with:

1) Its first tax year beginning after Decem-ber 31, 1996, are $5 million or less, and

2) Each later tax year up to and includingthe current tax year are $7.5 million or

less.

For these tests, gross receipts for a short taxyear are annualized.

The AMT rate for corporations is 20%.There is an exemption of up to $40,000. Thisamount is reduced (but not below zero) by25% of the amount by which alternative min-imum taxable income (AMTI) exceeds$150,000.

You can apply a minimum tax creditagainst your regular tax liability in later yearsfor the AMT caused by certain preferencesand adjustments. For more information, seeMinimum Tax Credit, later.

The adjustment and preference items forAMT purposes are listed in Table 2 with abrief description for each item. However, eachadjustment and preference item is discussedin more detail separately. These adjustmentand preference items are reported on Form4626 in figuring AMT.

Form 4626. Use Form 4626 to figure yourcorporation's AMT. File this form if your cor-poration's taxable income or (loss) before anynet operating loss deduction plus its adjust-ments and preferences total more than$40,000 or, if smaller, its allowable exemptionamount. The easiest way to determinewhether you must file the form is to fill it out.If line 3 is more than line 9, you will need toattach Form 4626 to your corporation's in-come tax return.

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Before you can fill out Form 4626, youmust fill out most of your corporation'sincome tax return. For more informa-

tion on the income tax return, seeCorporationIncome Tax Returns, later.

How to figure AMT. Before you can figureyour corporation's AMT, you must figure itsalternative minimum taxable income. The fol-lowing section contains general informationthat may help you figure your corporation's

AMTI. The next section explains how to useAMTI to figure AMT. For more detailed infor-mation, see Form 4626 and its instructions.

Figuring AlternativeMinimum Taxable Income(AMTI)

To figure your corporation's AMTI, youmust refigure its taxable income using specialAMT rules to figure its:

1) Adjustments and preferences,

2) Adjusted current earnings (ACE) adjust-ment, and

3) Alternative tax net operating loss de-duction (ATNOLD).

AMTI is figured on page 1 of Form 4626.

Adjustments and PreferencesTo figure AMT, you make certain adjustmentsto the taxable income on the return. Theseadjustments eliminate the tax advantages ofcertain items that receive preferential taxtreatment. These items are called adjust-ments and preferences. The adjustment forthese items is the difference between the re-computed item for AMT purposes and theamount on the return. They can be either in-creases or decreases (entered as negativeamounts on Form 4626).

If an expense or loss claimed for regulartax purposes is more than the recomputedAMT expense or loss, the difference is an in-crease to taxable income. If the expense orloss claimed for regular tax purposes is lessthan the recomputed AMT expense or loss,the difference is a decrease to taxable in-come.

If income or gain reported for regular taxpurposes is less than the recomputed AMTincome or gain, the difference is an increaseto taxable income. If the income or gain re-ported for regular tax purposes is more thanthe recomputed AMT income or gain, the dif-ference is a decrease to taxable income.

Depreciation of post-1986 property. Thisadjustment applies to property placed in ser-vice after 1986. The depreciation deductionused for AMT is the amount calculated underthe alternative depreciation system (ADS)under the modified accelerated cost recoverysystem (MACRS). For real property, use thestraight line method with a 40-year recoveryperiod and the mid-month convention. Formost property other than real property, usethe 150% declining balance method, switch-ing to the straight line method when it givesa larger allowance. For more information ondepreciation, see Publication 946.

This adjustment applies to property placedin service after 1986, other than transitionproperty not subject to MACRS. It also ap-plies to property placed in service after July

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Table 2. Adjustments and Preferences

Special AMT rules(Also see Adjustments and Preferences, earlier.)

Adjustment and preference items(Items subject to special AMT rules.)

Accelerated depreciation of leased personal property (pre-1987)(personal holding companies only)

Accelerated depreciation of real property (pre-1987)

Refigure using SL method.

Refigure using SL method.

This easy to scan table may help you determine whether your corporation is likely to owe AMT.

Adjusted gain or loss Refigure gain or loss on the disposition of assets using AMT basis.

Amortization of certified pollution control facilities (post-1986facilities)

Do not reduce the basis by 20%

Use the SL method over the class life.

Amortization of circulation expenditures (personal holdingcompanies only)

Amortization of mining exploration and development costs

Use the optional 3-year writeoff.

Do not reduce the basis by 30%

Use the optional 10-year writeoff.

Charitable contributions

Depletion

Depreciation of post-1986 property

Installment sales

Intangible drilling costs

Long-term contracts

Loss limitations

Merchant marine capital construction funds

Passive activities (closely held corporations and personal servicecorporations only)

Section 833(b) deduction (Blue Cross, Blue Shield, and similar typeorganizations only)

Tax-exempt interest from specified private activity bonds

Tax shelter farm activities (personal service corporations only)

Other adjustments

Refigure taxable income limit using AMT rules.

Refigure using AMT rules.

Use the alternative depreciation system with special rules.

Do not use installment method for certain dispositions of property.

See Form 4626 instructions.

Use percentage-of-completion method if over 2 years and nothome construction.

Refigure gains and losses from at-risk activities and partnershipsusing AMT adjustments and preferences.

Do not exclude or deduct deposits or earnings.

Refigure passive activity gains and losses using special rules.

Do not take this deduction.

Generally include excluded interest in income.

Refigure all gains and losses using special AMT rules.

Do not include possession tax or alcohol fuel credits in income.Use AMTI instead of taxable income to figure deductions (such asthe section 179 deduction) limited by taxable income.

31, 1986, and before 1987, if you elected touse MACRS.

Do not consider the following types ofproperty in figuring this adjustment item.

Property you elect to exclude fromMACRS that is depreciated under theunit-of-production method or most othermethods of depreciation not expressed interms of years,

Certain public utility property,

Any motion picture film or video tape, or

Any sound recording.

The adjustment is the difference betweenthe total depreciation for all property for al-ternative minimum tax purposes and the totaldepreciation for regular income tax purposes.

The effect of using two different types ofdepreciation (one for regular income tax andone for alternative minimum tax) is that a

corporation will have a different basis in theproperty for alternative minimum tax. Thismeans, for example, that if a corporation sellsthe property, the gain will be different for al-ternative minimum tax purposes. See the laterdiscussion of Adjusted gain or loss.

Accelerated depreciation of pre-1987

property. For property placed in service be-fore 1987, accelerated depreciation is a pref-erence item. Continue to treat depreciationon that property as a preference item. SeeAccelerated depreciation of real property(pre-1987) and Accelerated depreciation ofleased personal property (pre-1987), dis-cussed later.

Amortization of certified pollution controlfacilities. For the AMT, determine youramortization deduction for a certified pollutioncontrol facility using the alternative depreci-ation system under MACRS (see Publication946).

Amortization of mining exploration anddevelopment costs. If you did not choosethe Optional Write-Off, discussed later, re-compute your regular tax deduction for miningexploration and development costs by amor-tizing it ratably over a 10-year period. Theadjustment is the difference between the de-

duction claimed for regular tax and the de-duction allowed for AMT.

If you have a loss for mining property, infiguring AMT, deduct all mining explorationand development costs for the property thathave not been written off. A loss occurs whenyou abandon a worthless mine.

Amortization of circulation expenses. Thisadjustment is for personal holding companiesonly. If you did not choose the OptionalWrite-Off, discussed later, this adjustmentapplies. In figuring AMT, amortize circulationcosts over 3 years beginning with the tax yearyou make the expenditures. The adjustmentis the difference between the amount de-

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ducted for regular tax purposes and theamortized amount.

Adjusted gain or loss. If a corporation soldproperty during the year, refigure the gain orloss from the sale using the corporation'sadjusted basis for AMT purposes. The fol-lowing AMT adjustments require changes tothe corporation's regular tax basis.

Depreciation,

Circulation expenses,

Mining exploration and developmentcosts, and

Certified pollution control facilities.

The adjustment is the difference between thegain (or loss) reported for regular tax pur-poses and the recomputed gain (or loss) forAMT purposes.

Long-term contracts. For any long-termcontract you enter into after February 28,1986, apply the percentage of completionmethod (as modified by the rules for long-term contracts under section 460(b) of theInternal Revenue Code) in determining AMTfor that contract.

The adjustment is the difference between

income determined using the method of ac-counting used for regular tax purposes andincome determined using the percentage ofcompletion method of accounting.

Home construction contracts. Therules for long-term contracts do not apply toany home construction contract you enteredinto in a tax year beginning after September30, 1990, regardless of whether you meet thesmall home construction contract require-ments.

For a construction contract not describedabove, determine the percentage of the con-tract completed using the simplified proce-dures for allocating costs.

Installment sales. For any disposition of in-

ventory or stock in trade, the installmentmethod of accounting does not apply for theAMT. Because of this, a corporation recog-nizes all gain realized on the disposition in theyear of sale. The adjustment for AMT is thedifference between the recognition of all gainin the year of disposition and the gain recog-nized under the installment method of ac-counting. However, this adjustment does notapply to certain dispositions of timeshares orresidential lots for which you elected to payinterest.

Merchant marine capital constructionfunds. Deposits into a capital constructionfund (CCF) established under section 607 ofthe Merchant Marine Act of 1936 are notdeductible in figuring AMT. Also, the earnings(including gains and losses) on amounts inthe fund are not excludable in determiningAMT. The adjustment is the total of thesedeposits deducted or earnings excluded fromincome. Do not make any reduction in basisrequired by section 607(g) of the MerchantMarine Act of 1936 for amounts withdrawnfrom the fund if you included the amounts forpurposes of AMT.

Section 833(b) deduction. This deductionis not allowed for AMT purposes. If a corpo-ration (Blue Cross or Blue Shield or similarhealth insurance providers) took this de-duction for regular tax purposes, the adjust-ment is to add back the amount deducted.

Tax shelter farm activities. This adjustmentapplies only to personal service corporations.Refigure all gains and losses from a taxshelter farm activity that is not a passive ac-tivity by taking into account all AMT adjust-ment and preference items. Determine theAMT gain or loss using the same rules usedfor the regular tax with the following modifi-cations:

1) No loss is allowed except to the extentthe personal service corporation is in-solvent, and

2) Do not use a loss in the current tax yearto offset gains from other tax shelter farmactivities. Instead, suspend any loss andcarry it forward until the corporation hasa gain in a later tax year from that sameactivity, or it disposes of the activity.

A corporation is insolvent to the extent its li-abilities exceed the FMV of its assets. Theadjustment is the difference between the gainor loss for AMT purposes and the amount thatwas reported for regular tax purposes.

CAUTION

!To avoid duplication, do not includeany AMT adjustment or preferenceitem that is included as a gain or loss

in the computation for a passive activity loss,

discussed next.

Passive activities. This adjustment appliesonly to closely held and personal servicecorporations. To determine the adjustment fora passive activity, refigure all gains andlosses by taking into account the corpo-ration's AMT adjustments, preferences, andAMT prior year unallowed losses. You do thisby determining the corporation's passive ac-tivity gain or loss for AMT using the samerules used for regular tax purposes. You re-duce the loss disallowed by the amount acorporation is insolvent. The adjustment is thedifference between the allowable loss re-ported for regular tax and the refigured AMTloss.

CAUTION

!To avoid duplication, do not includeany AMT adjustment or preferenceitem that is taken into account in this

passive activity computation in the amountsto be entered on any other line of Form 4626.

Loss limitations. You must take into ac-count the corporation's AMT adjustments andpreferences before you apply certain lossdeferral rules.

The loss deferral rules include limits onlosses due to:

A partner's basis in the partnership inter-est, and

The at-risk limits.

The adjustment is the excess of the lossamount that is not allowable for AMT pur-poses over the loss amount that is not allow-able for regular tax purposes. If the lossamount that is not allowable for regular taxpurposes is more than the loss amount thatis not allowable for AMT purposes, the differ-ence is entered on line 2l of Form 4626 as anegative amount.

Depletion. If a corporation's depletion de-duction for the year is more than its adjustedbasis in the property at the end of the year(figured before reducing the basis by the de-pletion deduction), the difference is a prefer-ence item. You figure this item separately for

each separate piece of property being de-pleted. Depletion figured using the small pro-ducer's and royalty owner's exemption is nota preference item.

In computing the year-end adjusted basis,do not add the unrecovered cost of machineryand other depreciable equipment to the ad-

justed depletable basis of mineral property. Ifyou added these costs to the adjusted basis,deduct them before figuring the depletionpreference.

Percentage depletion of coal and ironore. Figure a corporation's (other than an Scorporation's) preference for the percentagedepletion of coal (including lignite) and ironore as follows:

1) Subtract the corporation's basis in theproperty at the end of the year (beforeadjusting it for the year's depletion) fromthe year's percentage depletion on theproperty.

2) Reduce the corporation's percentagedepletion by 20% of the amount figuredin (1). This is the most the corporationcan deduct for percentage depletion onthe property.

3) Subtract the corporation's basis in theproperty (before adjusting it for the year's

depletion) from the amount figured in (2).The result is the corporation's preferenceitem for percentage depletion on theproperty.

Tax-exempt interest from specified privateactivity bonds. This preference item is thetax-exempt interest on specified private ac-tivity bonds reduced by any deduction thatwould have been allowable if the interest hadbeen included in gross income for regular taxpurposes. A specified private activity bond isone issued after August 7, 1986, or, on orafter September 1, 1986, for bonds satisfyingpre-Tax Reform Act of 1986 definitions ofgovernmental bonds.

For this preference item, a private activity

bond does not include:1) A qualified section 501(c)(3) bond, or

2) Any refunding bond (whether a currentor advance refunding) if the refundedbond (or for a series of refundings, theoriginal bond) was issued before August8, 1986.

Treat any exempt-interest dividends a corpo-ration receives from a mutual fund as intereston a specified private activity bond to the ex-tent of its proportionate share of the intereston the bonds received by the company payingthe dividend.

Charitable contributions. Refigure thecharitable contributions deduction for theAMT. Use only income and deductions al-lowed for the AMT when refiguring the limitbased on taxable income. Also, any AMTcarryover of charitable contributions is limitedto the cost or other basis (instead of fairmarket value) for any contribution of capitalgain or section 1231 property for which thepreference for charitable contributions ap-plied.

Intangible drilling costs (IDCs). If youelected the optional 60-month write-off forIDCs, discussed later, these costs are not apreference item. If you do not elect the60-month write-off, this preference item is theamount by which excess IDCs paid or in-

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curred during the year on a corporation's oil,gas, and geothermal properties are morethan 65% of the net income from theseproperties.

Excess IDCs. These are costs incurredor paid for oil, gas, and geothermal wells overthe amount allowable if the costs had beenamortized using a 120-month period or anypermitted cost depletion method.

Net income. Net income from oil, gas,and geothermal properties for this purpose isthe gross income received or accrued fromall these properties less the deductions allo-cated to these properties. Deductions do notinclude excess IDCs or costs for nonproduc-tive wells. Nonproductive wells are thoseplugged and abandoned without producingoil, gas, or geothermal energy in commercialquantities for any substantial period of time.A well that is temporarily shut in is not anonproductive well.

Special rule. Excess IDCs for any oil orgas well are a preference item only for inte-grated oil companies. However, if you are notan integrated oil company, the reduction inyour alternative minimum taxable income(AMTI) cannot exceed 40% of your AMTI forthe year figured by taking into account thisitem, but without regard to the alternative taxNOL deduction, discussed later, under Other

adjustments.

Accelerated depreciation of real property(pre-1987). This preference item is the de-preciation or amortization a corporation tookduring the tax year on real property placed inservice before 1987, minus straight line de-preciation. Figure this amount separately foreach separate item of property. Generally,each building (or its component) is a separateitem of property. Do not figure this amount foran item of property you dispose of during thetax year.

For property depreciated as 15-year realproperty under the accelerated cost recoverysystem (ACRS), figure straight line depreci-ation using a recovery period of 15 years.

For property depreciated as 18-year realproperty under ACRS, figure straight line de-preciation using a recovery period of 18years.

For property depreciated as 19-year realproperty under ACRS, figure straight line de-preciation using a recovery period of 19years.

For low-income housing property depreci-ated under ACRS, figure straight line depre-ciation using a recovery period of 15 years.

For property a corporation placed in ser-vice between July 31, 1986, and 1987, andelected to depreciate under MACRS, seeDepreciation of post-1986 property, earlier.

You do not have a preference item if youuse a recovery period longer than these pe-riods.

For property depreciated under anothermethod, figure straight line depreciation usingthe same basis, useful life, and salvage valueyou first used to depreciate the property. If thecorporation did not use a useful life or salvagevalue, figure straight line depreciation as if ithad taken depreciation using that method.

Accelerated depreciation of leased per-sonal property (pre-1987). This item appliesonly if the corporation is a personal holdingcompany. This preference item is the depre-ciation a corporation took during the tax yearon personal property it leased to others minusthe depreciation using the straight linemethod.

Other adjustments. You must make an ad-justment as a negative amount for certain in-come reported for regular tax purposes in-cluding:

1) Income eligible for the possession taxcredit, and

2) Income from the alcohol fuel credit.

Also, the adjustment can be either a positiveor negative amount for:

1) Any minimum taxable income adjust-ment from Schedule K1 (Form 1041),line 8, if the corporation is the beneficiaryof a trust,

2) Any AMT adjustment from a cooperative,or

3) Any related adjustment, discussed next.

Related adjustments. AMT adjustmentsand preferences may affect deductions thatare based on an income limit. You must re-figure these deductions using the income limitas modified for AMT purposes. You includethis adjustment on line 2s of Form 4626 forthe total difference between the regular taxand AMT amounts for all items not taken into

account on any other line on Form 4626. If theAMT deduction is more than the regular taxdeduction, enter the difference as a negativeamount. See the instructions for Form 4626for more information.

Optional Write-OffA corporation can choose an optional60-month, 3-year, or 10-year write-off of cer-tain adjustments and preference items in fig-uring its regular income tax. If it does, do notconsider these items as adjustments or pref-erence items for the alternative minimum tax.A corporation may choose the following op-tional write-off periods.

60-month write-off. A corporation canchoose to deduct intangible drilling and de-velopment costs in equal installments over a60-month period beginning with the month thecosts were paid or incurred.

3-year write-off. The cost a corporation canchoose to deduct, in equal installments overa 3-year period, is the cost of increasing thecirculation of a newspaper or periodical.

10-year write-off. The costs a corporationcan choose to deduct in equal installmentsover 10 years are: mining exploration costs;development expenses; and research andexperimental expenses.

Choosing the optional write-off. Choose

the optional write-off by the due date (includ-ing extensions) of the corporation's incometax return for the year for which you aremaking the choice. Attach a statement to thecorporation's return that includes:

The corporation's name, address, andemployer identification number,

The specific write-off you are choosing,

A note that states you make this choiceunder section 59(e) of the Internal Reve-nue Code, and

The year for which you make the choiceand the preference item to which it ap-plies.

You can use Form 4562 to choose theoptional write-off. Once you select the op-tional write-off for any qualified expense, youcan revoke it only with IRS consent.

Adjusted Current Earnings (ACE)Increase AMTI by 75% of any excess of thecorporation's ACE for the tax year over pre-adjustment AMTI. Preadjustment AMTI is thecorporation's AMTI for the tax year deter-mined without the adjustment for ACE andwithout the alternative tax net operating lossdeduction. Make a negative (reduction) ad-

justment for 75% of any excess preadjust-ment AMTI over ACE to the extent of the netpositive adjustments for ACE in prior taxyears.

ACE is the corporation's preadjustmentAMTI for the tax year determined by takinginto account certain specified adjustments.You can determine the ACE by completingthe Adjusted Current Earnings Worksheet.This worksheet is provided in the instructionsfor Form 4626. The worksheet lists all of theadjustments that may affect the ACE.

Some of these adjustments are brieflydiscussed next.

ACE depreciation adjustment. The adjust-

ment is the excess of AMT depreciation overACE depreciation. If ACE depreciation ex-ceeds AMT depreciation, the adjustment is anegative amount. The ADS system ofMACRS is used for property placed in serviceafter 1989 and before 1994. This system re-quires use of the straight line method over aspecified recovery period. For property placedin service after December 31, 1993, the ACEdepreciation expense is the same as the AMTdepreciation expense discussed earlier inDepreciation of post-1986 property underAdjustments and Preferences.

Inclusion in ACE of items included inearnings and profits (E & P). These areitems that are not taken into account in de-

termining the corporation's preadjustmentAMTI but that are included in determining E& P. An adjustment must be made to includethem in ACE. These items are listed on theAdjusted Current Earnings Worksheet onlines 3a through 3e.

Disallowance of items not deductible fromE & P. These are items that are not takeninto account in figuring E & P. No deductionis allowed for them when figuring ACE. Theseitems will generally increase ACE to the ex-tent they were deductible in figuring the pre-adjustment AMTI. However, there are someexceptions to this rule discussed in the in-structions for Form 4626. These items arelisted on the Adjusted Current Earnings

Worksheeton lines 4a through 4e.

Circulation expenses. For purposes of fig-uring ACE, the amortization provisions do notapply to expenses paid or incurred after 1989.You must treat the expenses in accordancewith the case law in effect before theenactment of section 173 of the InternalRevenue Code (IRC). The adjustment is theresult of subtracting the ACE expense (if any)from the expense claimed for regular taxpurposes (or for personal holding companies,from the expense refigured for AMT purposesin figuring the adjustment for line 2d of Form4626). If the ACE expense exceeds the reg-ular tax expense (or AMT expense for a per-

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sonal holding company), the adjustment is anegative amount. You enter any adjustmenton line 5b of the worksheet.

Organizational expenses. For purposes offiguring ACE, the amortization provisions donot apply to expenses paid or incurred after1989. All organizational expenses are capi-talized and are not taken into account until thecorporation is sold or otherwise disposed of.You enter any adjustment on line 5c of theworksheet.

LIFO inventory adjustments. The adjust-ments outlined in section 312(n)(4) of the IRCapply in computing the ACE. You enter anyadjustment on line 5d of the worksheet. Formore information on figuring this adjustment,see Income Tax Regulation 1.56(g)1(f)(3).

Installment sales. For any installment salethat occurs in a tax year beginning after 1989,you figure the ACE as if the corporation didnot use the installment method. However, thisdoes not apply to the IRC section 453A per-centage of the gain from an installment saleto which that section applies. The adjustmentis the result of subtracting the installment saleincome for AMT purposes from the ACE in-

come. If the ACE income is less than the AMTincome, the adjustment is a negative amount.You enter any adjustment on line 5e of theworksheet.

Basis adjustments in determining gain orloss from sale or exchange of pre-1994property. For purposes of ACE, if a corpo-ration disposed of property during a tax yearfor which it is making or has made any of theACE adjustments described in section 56(g)of the IRC, you must refigure the property'sadjusted basis for ACE purposes. The differ-ence is a negative amount if:

1) The ACE gain is less than the AMT gain,

2) The ACE loss is more than the AMT loss,

or

3) You have a loss for ACE and a gain forAMT.

See the instructions to line 4 of Form 4626 formore information on the ACE computation.

Alternative Tax Net OperatingLoss Deduction (ATNOLD)The ATNOLD replaces any net operating loss(NOL) deduction your corporation is allowedon Form 1120, line 29a (Form 1120A, line25). If your corporation has an NOL de-duction, you will add it back to taxable income

on line 1 of Form 4626. You will replace it withthe ATNOLD.

Figuring an ATNOLD after 1986. For AMTpurposes, figure an NOL for a tax year be-ginning after 1986 in generally the samemanner as for regular tax purposes, except:

Make the AMT adjustments, undersections 56 and 58 of the IRC, to thatyear's NOL that you figured for regulartax purposes, and

Reduce that year's NOL by the prefer-ence items under section 57 of the IRC,to the extent they increased the NOL forthe tax year.

Carrybacks and carryovers. After makingthe above calculations, determine the NOLyou can deduct in a carryback or carryoveryear. It cannot exceed 90% of the corpo-ration's AMTI for that year figured before theNOL deduction.

You can carry the NOL back or carry itforward using the regular NOL rules. How-ever, if you elect not to use the carryback ofan NOL for regular tax purposes, you cannotcarry it back for AMT purposes. For more in-formation, see Publication 536, Net OperatingLosses.

In years that a corporation does not havean AMT liability, you still reduce the NOL de-duction. Use Form 4626 to figure AMTI eventhough the corporation does not have an AMTliability.

Figuring the amount of pre-1987 carry-overs. The NOL carryforward from tax yearsbeginning before 1987 that you can carry totax years beginning after 1986 is the amountof your regular NOL carryover. Adjust theNOL carryforward if the corporation had adeferred add-on minimum tax liability for ayear before 1987. See section 701(f)(2)(B) ofPublic Law 99514 (10/22/86).

Figuring AlternativeMinimum TaxAfter you arrive at AMTI, you figure the tax.First, you subtract an exemption amountfrom the corporation's AMTI. Next, you multi-ply the balance by the AMT rate of 20%. Thisresult is the tentative minimum tax. Now yousubtract the corporation's regular tax liabilityfrom the tentative minimum tax. The result isthe corporation's AMT liability.

Exemption Amount

The AMT does not apply to corporations inthe lower tax brackets with small amounts of

adjustments or preference items. This is ac-complished by subtracting the exemptionamount from the corporation's AMTI beforefiguring the tentative minimum tax. The ex-emption amount phases out as the AMTI in-come gets higher.

The maximum exemption is $40,000.However, you must reduce it by $0.25 forevery dollar that the corporation's AMTI ex-ceeds $150,000. This reduction causes theexemption to be zero when the corporation'sAMTI is $310,000 or more.

Tentative Minimum Tax

Figure the tentative minimum tax by multiply-ing the corporation's AMTI, minus the ex-

emption amount, by 20%. This is the corpo-ration's tentative minimum tax unless thecorporation has an AMT foreign tax credit. Ifthe corporation has an AMT foreign tax credit,subtract it to arrive at the tentative minimumtax.

AMT foreign tax credit. Figure the AMTforeign tax credit in the same manner as theregular tax foreign tax credit, with certainmodifications. These include treating pre-credit tentative minimum tax as the taxagainst which the credit is taken and applyingthe section 904 foreign tax credit limits on thebasis of AMT income, instead of taxable in-come.

TIP

For tax years beginning after 1997,you may choose to use a new simpli-fied method to figure the AMT foreign

tax credit. For more information, see Publi-cation 553.

Limit. The AMT foreign tax credit cannotbe more than the amount on Form 4626, line11, less 10% of the amount that would be onthat line if Form 4626 were refigured usingzero on line 6 and if the exception for intan-gible drilling costs under section 57(a)(2)(E)of the IRC does not apply. This 90% limitdoes not apply to certain corporations thatmeet the requirements of section 59(a)(2)(C)of the IRC.

CAUTION

!For tax years beginning after August5, 1997, the 90% limit will also applyto corporations that meet the require-

ments of section 59(a)(2)(C) of the IRC.

Regular TaxAfter you figure the corporation's tentativeminimum tax, subtract its regular tax to getthe AMT. Regular tax is the corporation's in-come tax shown on page 2, line 1, Part I,Form 1120A; or line 3, Schedule J, Form1120, minus any foreign tax credit or pos-sessions tax credit (lines 4a and 4b, ScheduleJ, Form 1120).

Credits. If a corporation pays AMT, it will notget any tax benefit from certain credits (li

Documents

US Internal Revenue Service: p542--1997