Chapter 2A.Corp. Tax Law

Howard Godfrey, Ph.D., CPAProfessor of Accounting

Copyright © 2011Edited December 28, 2010

C11-Chp-02-1A-Corp-Tax-Law-2011

A student should understand:1. Various business forms – corp. etc. [Pg. 2]2. Corporate tax (compare w/ individuals). [Pg. 8] 3. Fiscal years & accounting methods. [Pg 10]4. Cap. gains (losses). Deprec. recap. [Page 12]5. Passive Losses [Page 12]6. Charitable contributions. [Page 14]7. Domestic Production Activities [Page 16]8. Net operating losses. [Page 17] 9. Dividends received deduction. [Page 18]10.Organization & start-up expenses. [Page 20]11. Related Corporations [Page 22]12.Filing requirements, payments [23]13.Tax and book income. Acct. for Tax [Page 25] 14.Tax planning. Transactions w/ Owner. [Pg 36]

1. Compare Business Forms. [Page 2-2]Sec. 1, 1(h), 11, 1201, 63

Lecture OutlineA corporation is a separate taxpaying entity. This chapter discusses the rules for determining a corp's taxable income and tax liability. It also discusses how to file a corporate tax return. The corporations discussed in this chapter are regular corporations or C corporations. Corporations that are not classified as domestic -- are foreign corporations. Foreign corps are taxed somewhat like domestic corporations if they conduct a trade or business in the United States.

Sue owns 100% of Sue Corp. (C Corp), 50% of SueCorpS (S).

She is also a 50% partner in the Sue Partnership.

She receives a salary from the two corporations.

Her beginning tax basis is $65,000 for each entity.

Sue Corp. SueCorpS. Sue Ptship Answer

Revenue $100,000 $100,000 $100,000

Salary to Sue 40,000 40,000

Other Expenses 10,000 50,000 30,000

Taxable income 50,000

Taxable income 10,000

Taxable income 70,000

Total dividends paid 6,000

Total dividends paid $4,000

Total distribution $10,000

Sue's gross income from these three entities?

Sue owns 100% of Sue Corp. (C Corp), 50% of SueCorpS (S).

She is also a 50% partner in the Sue Partnership.

She receives a salary from the two corporations.

Her beginning tax basis is $65,000 for each entity.

Sue Corp. SueCorpS. Sue Ptship Answer

Revenue $100,000 $100,000 $100,000

Salary to Sue 40,000 40,000 $80,000

Other Expenses 10,000 50,000 30,000

Taxable income 50,000

Taxable income 10,000 $5,000

Taxable income 70,000 $35,000

Total dividends paid 6,000 $6,000

Total dividends paid $4,000

Total distribution $10,000

Sue's gross income from these three entities? $126,000

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FICA Rates for 2010A combined employee-employer social security tax rate of 15.30% applies in 2010.

Employers and employees are each liable for 6.20% of old age security and disability insurance tax or a total of 12.40% of the first $106,800 of wages in 2010.

Employers and employees also are each liable for a 1.45% Medicare hospital insurance tax for a total of 2.90% of all wages.

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You may find it helpful to get copies of the income tax returns for corporations, S corporations, partnerships and proprietorships, and enter the information on the following slides – on the tax forms. See Text-Appendix B

Study the worksheet on the next slide. Same basic data can be used to compute entity & individual tax with: (1), C Corporation (2) S Corporation and (3) Proprietorship. Owner (Jan) is single with no dependent. Jan has itemized deductions of $26,350.Jan invested $100,000 to start this business on January 1, 2010. With C or S Corp, Jan takes a salary of $70,000. For C or S Corp, payroll tax of $20,000 includes payroll tax for all salaries. With proprietorship, Jan withdraws $70,000. For proprietorship, payroll tax of $20,000 is applicable to salary for others. Self-Employment Tax: IRS Form 1040 SE.

Revenue 800,000$ Gross IncomeCost of Sales 500,000 Salary

Gross Margin 300,000 DividendsSaary-Others 100,000 Flow through - entitySalary -Owner 70,000 Total IncomePayroll Taxes 16,000 Deductions for AGI:Other Expenses 54,000 Total Expenses 240,000 Net Income 60,000 AGI [Adj. Gross Income]Income Tax Exemptions 3,650 After-Tax Income Itemized Deductions 26,350

Retained Earnings: Total deduct. from AGI 30,000 Beginning Balance -0- Taxable IncomeAfter-Tax Income Income TaxSubtotal Self-Employment Tax None Dividends PaidEnd. Retained Earn. Total tax before credits

C Corp. - 2010 [Fm 1120] Single Person - Form 1040- 2010

Revenue 800,000$ Gross Income

Cost of Sales 500,000 Salary 70,000$

Gross Margin 300,000 Dividends

Saary-Others 100,000 Flow through - entity

Salary -Owner 70,000 Total Income 70,000

Payroll Taxes 16,000 Deductions for AGI:

Other Expenses 54,000

Total Expenses 240,000

Net Income 60,000 AGI [Adj. Gross Income] 70,000

Income Tax 10,000 Exemptions 3,650

After-Tax Income 50,000 Itemized Deductions 26,350

Retained Earnings: Total deduct. from AGI 30,000

Beginning Balance -0- Taxable Income 40,000

After-Tax Income 50,000 Income Tax

Subtotal 50,000 Self-Employment Tax None

Dividends Paid

End. Retained Earn. 50,000 Total tax before credits

C Corp. - 2010 [Fm 1120] Single Person - Form 1040- 2010

Revenue 800,000$ Gross IncomeCost of Sales 500,000 SalaryGross Margin 300,000 DividendsPay-Others 100,000 Flow through - entityPay -Owner 70,000 Total IncomePayroll Taxes 16,000 Deductions for AGI:Other Expenses 54,000 Total Expenses 240,000

Net Income 60,000 Adjusted Gross IncomeIncome Tax None Exemptions 3,650

After-Tax Income 60,000 Itemized Deductions 26,350 Retained Earnings: Total ded. from AGI 30,000

Begin. Balance -0- Taxable IncomeAfter-Tax Income Income TaxSubtotal Self-Employment Tax NoneDividends Paid

End. Retained Earn. Total tax before credits

S Corp. - 2010 [Fm 1120S] Single Person - 1040- 2010

Revenue 800,000$ Gross IncomeCost of Sales 500,000 Salary 70,000$ Gross Margin 300,000 DividendsPay-Others 100,000 Flow through - entity 60,000 Pay -Owner 70,000 Total Income 130,000 Payroll Taxes 16,000 Deductions for AGI:Other Expenses 54,000 Total Expenses 240,000

Net Income 60,000 Adjusted Gross Income 130,000 Income Tax None Exemptions 3,650

After-Tax Income 60,000 Itemized Deductions 26,350 Retained Earnings: Total ded. from AGI 30,000

Begin. Balance -0- Taxable Income 100,000 After-Tax Income 60,000 Income TaxSubtotal 60,000 Self-Employment Tax NoneDividends Paid

End. Retained Earn. 60,000 Total tax before credits

S Corp. - 2010 [Fm 1120S] Single Person - 1040- 2010

Revenue 800,000$ Gross IncomeCost of Sales 500,000 Salary Not App.Gross Margin 300,000 DividendsSalary-Others 100,000 Flow through Salary -Owner Not App. Income-Schedule CPayroll Taxes 16,000 Total IncomeOther Expenses 54,000 Deductions for AGI:Total Expenses 170,000 One-half of SE Tax

Net Income 130,000 Adjusted Gross IncomeIncome Tax Not App. Exemptions 3,650

After-Tax Income Not App. Itemized Deductions 26,350 Capital Statement: Total ded. from AGI 30,000

Beginning Balance 100,000$ Taxable IncomeAfter-Tax Income Income TaxSubtotal Self-Employment TaxDrawing

End. Capital Balance Total tax before credits

Schedule C on 1040 - 2010 Single Person-Form 1040- 2010

Revenue 800,000$ Gross IncomeCost of Sales 500,000 Salary Not App.Gross Margin 300,000 DividendsSalary-Others 100,000 Flow through Salary -Owner Not App. Income-Schedule C 130,000 Payroll Taxes 16,000 Total Income 130,000 Other Expenses 54,000 Deductions for AGI:Total Expenses 170,000 One-half of SE Tax 8,363

Net Income 130,000 Adjusted Gross Income 138,363 Income Tax Not App. Exemptions 3,650

After-Tax Income Not App. Itemized Deductions 26,350 Capital Statement: Total ded. from AGI 30,000

Beginning Balance 100,000$ Taxable Income 108,363 After-Tax Income Income TaxSubtotal 100,000 Self-Employment Tax 16,725 Drawing

End. Capital Balance 100,000 Total tax before credits

Schedule C on 1040 - 2010 Single Person-Form 1040- 2010

Tax Year - 2010Sch. C Net Income $130,000

92.35%

Net. SE Income $120,055 2.90% $3,482

$106,800 12.40% $13,243

15.30%

Self-Employment Tax (1040-Line 57) $16,725

50%

Income Tax Deduction (1040-Line 30) $8,362

Tax Year - 2010 - Alternate ApproachSch. CNet Income $130,000

92.35%

Net. SE Inc. $120,055

$106,800 15.30% $16,340$13,255 2.90% $384

$120,055

Self-Employment Tax (1040-Line 57) $16,72550%

Income Tax Deduction (1040-Line 30) $8,362

Gross Income - Sec. 61Less: Deductible expenses Equals: Taxable income Times: Corporate tax rate Equals: Corporate income tax Plus: Additions to tax Less: Tax credits Equals: Net corporate tax

Corp-Big Picture

Corporate Tax Rates15% on first $50,00025% on $50,001 - $75,00034% on $75,001 - $100,00039% (34% + 5% surtax) on $100,001 - $335,000

34% on $335,001 - $10,000,00035% on $10,000,001 - $15,000,00038% (35% + 3%) on $15,000,001 - $18,333,333

35% on over $18,333,333

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Double Taxation

The following slide shows the impact of double taxation of corporate earnings.

The corporation has taxable income of $1,500,000 and distributes all after-tax income to shareholders. See Sec 301.

Corporation Distributes All After-tax IncomeShareholders are individualsWhat is combined effective tax rate?

Corp. taxable income $1,500,000Tax rate

Corp. after-tax incomeShareholder tax rate

Total income tax0.00%Total Tax as % of T.I. above

Corporation Distributes All After-tax IncomeShareholders are individualsWhat is combined effective tax rate?

Corp. taxable income $1,500,000Tax rate 34%

$510,000Corp. after-tax income $990,000Shareholder tax rate 15%

148,500Total income tax 658,500

43.90%Total Tax as % of T.I. above

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Corporation Distributes All After-tax IncomeAssume 15% dividend rate expires.Shareholders are individualsWhat is combined effective tax rate?

Corp. taxable income $1,500,000Tax rate 34%

$510,000Corp. after-tax income $990,000Shareholder tax rate 35%

346,500Total income tax 856,500

57.10%Total Tax as % of T.I. above

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2. Corporate tax law (compare with individuals). [Page 2-8]Sec. 1, 1(h), 11, 1201, 63

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2. Fiscal years

and accounting methods. [Pg 2-10]

Sec. 441, 451

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Corporate Year.When a corp. is formed there are certain elections that must be made.A. Choosing a Calendar or Fiscal Year. A new corp. may select either a calendar or fiscal year by filing its first tax return for the selected period. The corp's tax year must be the same as its annual accounting period that is used for financial accounting purposes.

Corporate Year.A corp's first tax year may not cover a full 12-month period. In that case, a short-period tax return must be filed. A corp's final year may also cover a short period.

Some corporations may be restricted in their ability to select a tax year. A member of an affiliated group of corps that files a consolidated return must use the same tax year as the group's parent corporation.

A PSC may elect to use certain fiscal years even when there is no business purpose.

A new PSC may elect to use a September 30, October 31, or November 30 year-end provided that it meets minimum distribution requirements to employee-owners during the deferral period.

Corporate Year.

A personal service corporation (PSC) is defined for this purpose as a corporation whose principal activity is the performance of personal services.

A corporation is not a PSC unless its employee-owners own more than 10% of the stock (by value) on any day of the year and the personal services are substantially performed by the employee-owners.

Corporate Year.

A corporation wishing to change its accounting period must secure the prior approval of the IRS unless a change is specifically authorized under the Regulations. A request for change is filed on Form 1128 on or before the fifteenth day of the second calendar month following the close of the short period.

The change will be granted if there is a substantial business purpose.

Corporate Change of Year.A corporation may change its tax year without the prior

approval of the IRS if:1. the corporation has not changed its accounting period

within the last ten years;2. the resulting short period does not have a net operating

loss.3. the taxable income of the short period is, if annualized, at

least 80% of the corporation's taxable income for the tax year preceding the short period.

4. the corporation had a special status (i.e. personal holding company or exempt status) for the short period or the tax year prior to the short period, it has the same status for both tax years; and

5. the corporation does not elect S corporation status in the year following the short period.

Accounting Methods. A new corp. must select the method of accounting it will use to keep its books and records.

The same method must be used to compute financial accounting income and taxable income. (At least that is what Sec. 446(a) says, but….)

Accrual Method. Income is reported when earned and expenses are reported when incurred. C corporations are accrual except:

a. A family farming business.

b. A qualified personal service corp. where substantially all of its activities involve the performance of services in the fields of health, law, engineering, architecture, accounting, …; and where substantially all of the stock is held by current (or retired) employees performing the services, their estates, or certain persons who inherited their stock.

c. Corps with gross receipts of $5 million or less.

d. S corporations.

Cash Method. Income is reported when received and expenses are reported when paid. This method may not be used if inventories are a material income-producing factor.

Hybrid Method. The corporation uses the accrual method of accounting for sales, cost of goods sold, inventories, accounts receivable, and accounts payable. The cash method of accounting is used for all other income and expense items.

Cash and Accrual Method. On 5-1-10, Tom, (Cash basis), leased an office from Downtown Plaza (Cash basis) for 5 years starting on 6-1-10, for $1,000 per month. On 6-1-10, Tom paid $30,000, half of the lease amount, to Downtown (for 30 months). Tom made no payment during 2010.

Tom’s rent deduction (in 2010):a. $‑0‑ b. $6,000 c. $12,000 d. $30,000

Downtown (an accrual basis taxpayer reports rental income (in 2010):a. $‑0‑ b. $6,000 c. $12,000 d. $30,000

What if Downtown is on the Accrual Basis?Sec. 451, 1.451-1

§1.451-1., General rule for taxable year of inclusion(a) General rule. –…..Under an accrual method …, income is includible in gross income when all the events have occurred which fix the right to receive such income and

the amount thereof can be determined with reasonable accuracy.

§1.451-1., General rule for taxable year of inclusion (a) General rule. …Under the cash receipts and disbursements method .., such an amount is includible in gross income when actually or constructively received. Where an amount of income is properly accrued on the basis of a reasonable estimate and the exact amount is subsequently determined, the difference, if any, shall be taken into account for the taxable year in which such determination is made.

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Nare, an accrual‑basis taxpayer, leased a building to Pine under a five‑year lease on 11-1-2010. Pine paid Nare $10,000 rent for 2 months of November and December, 2010, and $5,000 for the last month's rent. How much should Nare report as rental income for 2010?a. $10,000 b. $15,000 c. $40,000 d. $45,000Sec. 451, 1.451-1

Nare, Cont’d

The answer is $15,000.

An accrual basis taxpayer recognizes income with all events have occurred to establish the right to receive the income.

Nare has the right to receive $15,000, even though only $10,000 has been earned during the taxable year.

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On March 1, 2008, Sharon, a cash basis sole proprietor, leased a dance studio from Shelby Rentors for 3 years at $1,200 per month. In 2008, Sharon paid $28,800 and in 2009 she paid $6,000 on the lease. She paid the remainder of the lease payment in 2010. What is Sharon’s deduction for 2009?a. $6,000 b. $11,600 c. $14,400 d. $20,400

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Sharon must capitalize the payments for rent for future years and write off the cost on a monthly basis.

Answer: $14,400

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A consulting firm started in 2010 and adopted the accrual method.

The firm had gross income of $90,000 and expense payments of $60,000 for 2010.

The firm owed salaries payable of $5,000 to employees (non-owners) for December, which were not recorded at 12-31-10. These salaries were paid to employees in January, 2011. How much is taxable income for 2010?a. $25,000 b. $30,000 c. $35,000 d. Other (CPA)

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A consulting firm- continued.The firm reported net income of $30,000, but failed to deduct an expense for salaries earned but not paid. On the accrual basis, such salaries will be deducted for the year in which the employees earned those salaries, if paid early in next year.

This reduces net income to $25,000.

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Mark, who gives music lessons, is a calendar year taxpayer using the accrual method of accounting. On 11-2-2011, he received $10,000 for a one-year contract beginning on that date to provide 10 lessons. He gave 2 lessons in 2011. How much should Mark include in income in 2011?a. $--0-- b. $2,000 c. $8,000 d. $10,000

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Mark-Continued.

This is income received in advance and would normally be reported entirely in the year of receipt.

However, this qualifies as an exception, and the taxpayer can report the income as earned, not when payment is received in advance.

Hall Co., (accrual basis) leases offices with rent received in advance on the first day of each month. Not all tenants make timely payments. Hall's records at end of its first year show :

Cash from Tenants 40,000$ Expenses Paid 10,000 Net Income 30,000$ Rental Receivable 6,000$

Net income should Hall report for the year?a. $24,000 b. $30,000 c. $36,000 d. Other (CPA)How would your analysis change if thisis not the first year of operations?

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Accounting MethodsHall Co., -ContinuedThe rent receivable of $6,000 must be included in revenue – using the accrual method. Corrected computations:Revenue $46,000Expenses $10,000Taxable Income $36,000(Before Depreciation)

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Timing of Deductions

• Accrual method – expenses deductible when:– “All events” have occurred that fix liability

and– “Economic performance” occurs (property

or services provided or used)

• Cash basis taxpayer - expenses deductible when paid:

– Date check is mailed

– Date charged on credit card

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Accrual Accounting-1 Reg §1.446-1. ..methods of accounting

…a liability is incurred, …, [when] all events have occurred that establish the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.

Accrual Accounting-1

• Automobile manufacturer sells an auto to dealer for a wholesale price of $30,000.

• Dealer sells it later that year for $40,000.

• Manufacturer warrants the auto for five years and estimates that the warranty cost over five years will be $4,000 per auto.

• Is the manufacturer permitted to recognize an expense in the year of sale and set up a “reserve” for future warranty costs (equal to $4,000 per auto sold this year)? See Reg earlier.

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Accrual Accounting-2 Manufacturer provides a 3-year warranty. Financial statement for its first year:

Sales $1,000,000Cost of sales 600,000Expenses 300,000Net income before taxes $100,000

Expenses include a reserve of $20,000[Reserve for future repair costs on units sold in the current year.]What is taxable income for current year?a. $100,000 b. $80,000 c. $120,000

Accrual Accounting-3Manufacturer provides a 3-year warranty. Financial statement for its first year:

Sales $1,000,000Cost of sales 600,000Expenses 300,000Net income before taxes $100,000

Accrued warranty liability $20,000Taxable Income $120,000

What is taxable income for current year?a. $100,000 b. $80,000 c. $120,000

Accrual Accounting-4Manufacturer provides a 3-year warranty. Financial statement for its first year:

Sales $1,000,000Cost of sales 600,000Expenses 300,000Net income before taxes $100,000

Expenses include a reserve of $20,000

What is the balance in the deferred taxasset or liability account at end of Year 1?

[Reserve for future repair costs on unitssold in the current year.] Tax Rate 40%.

Accrual Accounting-5Manufacturer provides a 3-year warranty. Financial statement for its first year:

Sales $1,000,000Cost of sales 600,000Expenses 300,000Net income before taxes $100,000

Accrued warranty liability $20,000Taxable Income $120,000Timing difference $20,000Tax rate 40%Deferred tax asset $8,000

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Hurd, Inc. reported for year: Info. ReturnBook income before taxes $900,000 $900,000

Records show:Interest on municipal bonds 70,000

Depreciation on tax return in excess of deprec. per books 130,000 Warranty exp.- accrual basis 40,000 Actual warranty expenditures 60,000Taxable incomeTax Rate 40% 40%Tax liability

Compute taxable income for Hurd, Inc.

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Hurd, Inc. reported for year: Info. Return

Book income before taxes $900,000 $900,000

Records show: Interest on municipal bonds 70,000 ($70,000)

Depreciation on tax return in excess of deprec. per books 130,000 ($130,000)

Warranty exp.- accrual basis 40,000 40,000

Actual warranty expenditures 60,000 ($60,000)

Taxable income 680,000

Tax Rate 40% 40%

Tax liability $272,000

Compute taxable income for Hurd, Inc.

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Formula For Corporate Tax Liability.

Each year a corporation computes its regular tax liability. A corporation may owe the alternative minimum tax, AMT, and possibly the accumulated earnings tax or personal holding company tax, PHC. The total tax liability equals the sum of the two primary corporate tax liabilities plus the amount of any special levies that are owed.

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Corporate Taxable Income• In defining gross income, Section 61 does not explicitly distinguish between individuals and corporations.

• What “individual types” of income are rarely if ever realized by a corporation? (e.g. alimony, etc.)

• What “individual types” of exclusions from income are rarely if ever realized by a corporation? (gift)

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Similarities with IndividualsGross Income of a corporation and individual are very similar

Includes compensation for services, income from trade or business, gains from property, interest, dividends, etc.Corp taxpayers have fewer exclusions.Nontaxable exchange treatment is similarDepreciation recapture applies to both but corp may have added recapture under §291.

Dissimilarities with Individuals–Different tax rates apply

–All deductions of corp are business deductions

• Corp does not calculate AGI

• Corp does not deduct standard deduction, itemized deductions, or personal and dependency exemptions

• Corp does not reduce casualty and theft loss by $100 statutory floor and 10% of AGI.

4. Capital gains (losses) & depreciation recapture.

[Page 12]Sec. 11, 1201, 1211, 1212

Indiv. Capital Gains & LossesNet short-term gains

subject to regular tax rates.Net long-term gains have

maximum tax rate 15%.Net capital losses

deductible up to $3,000& remainder carried forward.

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Corp. Capital Gains & LossesCapital 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.

Losses not used in carryover periods are lost.

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Corporation had taxable incomefrom business operations: $36,000Corporation also had: Short term capital gain $8,600 Short term capital loss ($9,600) Long term capital gain $1,500 Long term capital loss ($3,500)What is taxable income? a. $35,000 b. $33,000 c. $36,000d. $35,500 CPA - Nov. 1995

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Corporation had taxable incomefrom business operations: $36,000Corporation also had: Short term capital gain $8,600 Short term capital loss ($9,600) Long term capital gain $1,500 Long term capital loss ($3,500)What is taxable income? a. $35,000 b. $33,000 c. $36,000d. $35,500 CPA - Nov. 1995

$100,000

Big had the following:

$3,000

($9,000)

$100,000 Taxable income?

Big Corp's taxable income before

Long-term capital gain

Short-term capital loss

capital gains & losses

Carryover of Corp. Capital LossesCorp. had these capital gains & (losses):

2006 2007 2008 2009 2010$30,000 ($20,000) $15,000 ($30,000) $60,000

($20,000) $20,000

$10,000 ($10,000) ($15,000) $25,000

($5,000)$5,000 ($5,000)

$0

Net capital gain for 2010 is: $55,000

Asset - Section 1245 Machine

Owner Individual

Selling Price $290,000Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB -

Adjusted Basis

Gain

Section 1245 GainSection 1231 gain (CG?)

Asset - Section 1245 Machine

Owner Individual

Selling Price $290,000Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB

Adjusted Basis 240,000

Gain 50,000

Section 1245 Gain 50,000 Section 1231 gain (CG?)

Asset - Section 1245 Machine

Owner Individual

Selling Price $320,000Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB

Adjusted Basis

Gain

Section 1245 GainSection 1231 gain (CG?)

Asset - Sec. 1245 Machine

Owner Individual

Selling Price $320,000Cost 300,000Accum. Deprec. (S/L) (60,000) Additional Dep. DDB

Adjusted Basis 240,000

Gain 80,000

Section 1245 Gain 60,000 Section 1231 gain (CG?) 20,000

Asset - Section 1250 Apartment

Owner Individual

Selling Price 250,000$ Cost 300,000Accum. Deprec. (S/L) (80,000) Additional Dep. DDB 0

Adjusted Basis 220,000

Gain 30,000

Section 1245 GainSection 1250 gain - Section 1231 gain (CG?) 30,000

Unrecaptured 1250 gainHow is answer different for a corporation?

Asset - Section 1250 Apartment

Owner Individual

Selling Price 250,000$ Cost 300,000Accum. Deprec. (S/L) (80,000) Additional Dep. DDB (40,000)

Adjusted Basis 180,000

Gain 70,000

Section 1245 GainSection 1250 gain 40,000 Section 1231 gain (CG?) 30,000

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Corp. Income Tax Gross receipts of $450,000Cost of goods sold of 145,000 Deductible bus. expenses 276,000 Gain on sale of machine 20,000 Interest on Virginia bonds 500 What is its tax liability? a. $4,900 b. $7,350 c. $10,000 d. None of these

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A corporation has Facts Return

Gross receipts $450,000 $450,000Cost of goods sold $145,000 $145,000

Deductible bus. exp. $276,000Gain-sale of machine $20,000Interest- VA bonds $500Taxable IncomeFed. income tax liability at 15%

Corporate Income Tax - Problem

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A corporation has Facts Return

Gross receipts $450,000 $450,000Cost of goods sold $145,000 $145,000

$305,000Deductible bus. exp. $276,000 ($276,000)Gain-sale of machine $20,000 $20,000Interest- VA bonds $500Taxable Income $49,000Fed. income tax liability at 15% $7,350

Corporate Income Tax - Solution

Computing a Corporation's Taxable Income.If Sec. 1250 property is sold at a gain, the gain will be reported as ordinary income to the extent that accelerated depreciation exceeds straight-line depreciation. This is known as "Sec. 1250 depreciation recapture." (The recognition of Sec. 1250 gain has been almost eliminated since the MACRS rules were introduced in 1987 that restricted depreciation on realty to the straight-line method.)

Corp. must recapture as ordinary income an additional amount equal to 20% of the additional ordinary income that would have been recognized on a sale, exchange, or other disposition of the property if it had been Sec. 1245 property rather than Sec. 1250 property.

6. Charitable contributions. [Page 13]

Sec. 17077

Less: Deductions: Except: charity, Div. Rec.,

NOL & C-Loss Carryback

Equals Taxable Income- For Charity Limit [170(b)(2)]

Less: Charitable Cont. < = 10% of Tax.Inc. Above

Equals Taxable Income- Before Div. Rec'd Ded.

Less:

Equals Taxable Income- Before carrybacks

Less: NOL & Cap. Loss carrybacks [172(b), 1212(a)]

Equals Taxable Income

Dividend Received Deduction [243+]

Gross income

Charitable Contributions - 1•Overall limit 10% of taxable income before–Charitable contribution deduction–Dividend received deduction–NOL or capital loss carryback. §170(b)(2), (c)•Excess carried forward up to 5 years. §170(d)(2)

•Accrual basis corporation can deduct contributions in year accrued if

–Payment authorized by board before year end

–Payment made by 15th day of 3rd month following close of tax year in which accrued. §170(a)(2)

Charity Deductions-2 Amount deductible for property contributions depends on type of property contributed §1.170A-1(c)

Long-term capital gain property deduction = fair market value of property–Exception: Corp may only deduct basis if tangible personal property contributed and not used by charity in its exempt function.

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Charity Deductions-3

Long-term capital gain property deduction = fair market value of property (cont’d)

–Exception: Deduction for property contribution to certain private nonoperating foundations is limited to basis in property

Charity Deductions-4

Ordinary income property deduction = basis in property. §170(e)

–Exception: Basis plus 50% of appreciation can be deducted if inventory or scientific property is contributed which is used by charity as required by Code

83

Charity –Code -5

170(b)(2) Corporations. In the case of a corporation, the total deductions under subsection (a) for any taxable year shall not exceed 10 percent of the taxpayer's taxable income computed without regard to

(A) this section,

(B) part VIII (except section 248),

(C) any net operating loss carryback to the taxable year under section 172, and

(D) any capital loss carryback to the taxable year under section 1212(a)(1).

84

Cable-Charity Deductions-6 In 2011, Cable Corp., contributed $80,000 to charities. Cable also had carryover contributions of $10,000 from 2010. Cable's 2011 taxable income (after a $40,000 DRD [(Div. Rec. Deduction)- owned 25% of stock] but before Charity deduction was $820,000. Cable’s 2011 charity deduction is?a. $80,000 b. $82,000 c. $86,000 d. $90,000 CPANov1995

85

Cable-Charity Deductions-7

In 2011, Cable Corp., contributed $80,000 to charities. Cable also had carryover contributions of $10,000 from 2010. Cable's 2009 taxable income (after a $40,000 DRD) before charity deductions was $820,000. Cable’s 2011 charity deduction is?

$86,000 (Charity limit is computed before DRD)

86

1 Operating Income 810,000 2 Dividend Income (40% owned) 50,000

3 Subtotal 860,000 4 Dividends Received Deduction

5 Taxable income after div. received deduct.

but before charitable contribution deduct.

6 Contributions made this year7 Carryover from last year

8 Total contribution including carryover9 Cont. deductible - current yr(10% of line 3) 86,000

10 Taxable Income

Cable - Charitable Contribution Deduction-8

87

1 Operating Income 810,000

2 Dividend Income (40% owned) 50,000

3 Subtotal 860,000

4 Dividends Received Deduction (40,000)

Taxable income after div. received deduct.

5 but before charitable contribution deduct. 820,000

6 Contributions made this year 80,000

7 Carryover from last year 10,000

8 Total contribution including carryover 90,000

9 Cont. deductible - current yr(10% of line 3) 86,000

10 Taxable Income 734,000$

Cable- Charitable Contribution Deduction-9

Big Corp. taxable income 2010

2010 is first year for Big Corp. FactsSales $200,000 Cost of sales (100,000)Gross Margin 100,000 Net capital gains Net cap. losses (over cap. gains) (3,000)Capital loss carryoverSalaries (30,000)Rent paid, payroll taxes, deprec. (31,000)Taxable income before charity 36,000 Charitable contributions paid (6,000)Charitable cont. carryoverTaxable incomeDividends paid $5,000

Big Corp. taxable income 2010 2011

2010 is first year of operations Facts Facts

Sales $200,000 $300,000

Cost of sales (100,000) (150,000)

Gross Margin 100,000 150,000

Net capital gains 5,000

Net cap. losses (over cap. gains) (3,000)

Capital loss carryover

Salaries (30,000) (30,000)

Rent paid, payroll taxes, deprec. (31,000) (31,000)

Taxable income before charity 36,000 94,000

Charitable contributions paid (6,000) (5,000)

Charitable cont. carryover $2,100

Taxable income $35,100

Dividends paid $5,000 $15,000

90

Gross Sales $340,000 Cost of Goods Sold $150,000 Depreciation - Books 60,000 Charitable Contribution 10,000 Salaries 130,000 Meals & entertainment 20,000 Total Expenses 370,000

($30,000)

Maple Corp. had the following for 2010:

a. $(5,000) b. $(35,000) c. $(25,000) d. $(20,000)

Net income (loss) per books

Taxable income for 2010? Maple’s tax deprec. for 2010 will be $75,000.

91

Maple Corp. - 2010 Facts ReturnGross Sales $340,000

Cost of Goods Sold 150,000

Depreciation - Books 60,000 Depreciation - TaxCharitable Contribution 10,000

Salaries 130,000 Meals & entertainment 20,000

Total Expenses 370,000

Net income (loss)-books ($30,000)Taxable income?

92

Maple Corp. - 2010 Facts ReturnGross Sales $340,000 $340,000

Cost of Goods Sold 150,000 150,000

Depreciation - Books 60,000 Depreciation - Tax 75,000 Charitable Contribution 10,000 -

Salaries 130,000 130,000 Meals & entertainment 20,000 10,000

Total Expenses 370,000 365,000

Net income (loss)-books ($30,000)

($25,000)Taxable income?

7. Net operating losses. [Page 17]

Sec. 172

94

Net Operating Losses (NOLs). An NOL is the amount by which a corporation's deductions exceed its gross income. In computing an NOL, no deduction is allowed for a carryover or carryback of an NOL from a preceding or succeeding year. If the corporation has an NOL, it also would not be allowed a U.S. production activities deduction because it has no positive taxable income. For tax years beginning after August 5, 1997, an NOL may be carried back two years and forward 20 years. Alternatively, the corporation may elect to forgo the carryback period. Changes in 2009, 5 years back.

95

Net operating loss of individual and corporation may be:

–Carried back two years

–Unused portion carried forward 20 years

§172

In 2008 and 2009, carryback period is 5 years.

Owner of C Corp. has asked for advice.Corporation was started in 2006.

Actual Actual Actual Plan

Amounts ($000) 2006 2007 2008 2009

Revenue $100 $200 $200 $300

Expenses (98) (173) (225) (225)

Taxable income (loss) $2 $27 ($25) $75

1. Can the corp. benefit from the loss in 2008?

2. Is there a choice regarding the 2008 loss?

3. Compute the savings under two options.

4. How do you apply present value methods here?5. Laws in 2008 and 2009 modify this example.

9. Dividends received deduction. [Page 18]

SPECIAL DEDUCTIONS- CORPS241 Allowance of special deductions

243 Dividends received by corps

244 Dividends received - pref. stock

245 Dividends received - foreign corps

246 Rules -dividends received deduct.

246A DRD - certain debt financed stock

247 Dividends paid – public utilities

248 Organizational expenditures

249 Limit- bond prem. on repurchase

99

Dividend Received DeductionTo relieve burden of multiple taxationDRD based on % ownership in paying corp

100% DRD for 80% or more owned affiliate 80% DRD for ownership of 20% up to 80% 70% DRD for ownership less than 20%

DRD limited to percentage timeslesser of taxable income or dividend income

Unless deducting DRD % x dividendincome creates or increases NOL

100

Grant, Inc. acquired 30% of South Co.’s voting stock for $200,000 on January 1, 2010. Grant’s 30% interest in South gave Grant the ability to exercise significant influence over South’s operating and financial policies. In 2010, South earned $80,000 and paid dividends of $50,000. What amount of income should Grant include in its 2010 Federal income tax return as a result of the investment?a. $15,000 b. $24,000 c. $35,000

d. $50,000 e. $80,000 CPA Nov. 1995.

101

Dividend Received-Green Corp -1Green Corp. owns 25% of Cande Corp. In 2010, Green received $10,000 dividends from the Cande stock. Assuming no other limitations apply, Green’s dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $ - 0 -.

102

Div. Received- Green Corp– 2Green Corp. owns 25% of Cande Corp. In 2010, Green received $10,000 dividends from the Cande stock. Assuming no other limitations apply, Green’s dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $ - 0 -.

Revenue - operations $500,000

Operating expenses (490,000)

Operating income (loss) 10,000

Dividends from IBM 50,000

Net income before DRD 60,000

Dividend rec. deduction

Local Corp - 1. had the following:

Limit 1:Dividends Received 50,000$ DRD Percentage 70%Deduction limit - 1 35,000 Limit 2:Taxable income (Adj) 60,000$ DRD Percentage 70%Deduction limit - 2 42,000 Div. Rec. Deduction 35,000

Dividends Received Deduction

Revenue - operations 500,000$

Operating expenses (510,000)

Operating income (loss) (10,000)

Dividends from IBM 50,000

Net income before DRD 40,000

Dividend rec. deduction

Local Corp - 2. had the following:

Limit 1:Dividends Received 50,000$ DRD PercentageDeduction limit - 1Limit 2:Taxable income (Adj) 40,000$ DRD PercentageDeduction limit - 2Div. Rec. Deduction

Dividends Received Deduction

Limit 1:Dividends Received 50,000$ DRD Percentage 70%Deduction limit - 1 35,000 Limit 2:Taxable income (Adj) 40,000$ DRD Percentage 70%Deduction limit - 2 28,000 Div. Rec. Deduction 28,000

Dividends Received Deduction

Revenue - operations 500,000$

Operating expenses (520,000)

Operating income (loss) (20,000)

Dividends from IBM 50,000

Net income before DRD 30,000

Dividend rec. deduction

Local Corp - 3. had the following:

Limit 1:Dividends Received 50,000$ DRD Percentage 70%Deduction limit - 1 35,000 Limit 2:Taxable income (Adj) 30,000$ DRD Percentage 70%Deduction limit - 2 21,000 Div. Rec. Deduction 35,000

Dividends Received Deduction

110

Dividends Received Ded-Code 246(b)(1) General Rule. --… deductions allowed by sec. 243(a)(1), 244(a), and subsection (a) or (b) of sec. 245 shall not exceed the percentage determined under paragraph (3) of the taxable income computed without regard to the deductions allowed by sec. 172, 243(a)(1), 244(a), subsection (a) or (b) of sec. 245, and 247, without regard to any adjustment under sec, 1059, and without regard to any capital loss carryback to the taxable year under section 1212(a)(1).

111

Div. Received Ded-Code

246(b)(1) General Rule. …

(2) Effect of Net Operating Loss. --Paragraph (1) shall not apply for any taxable year for which there is a net operating loss (as determined under §172).

Gross Profit $200,000Expenses ($300,000)Operating loss ($100,000)Dividends Received $180,000Tax. Inc. before DRDDRDNet operating loss

Page Corp. Div. Received Ded.Page owns 15% of company

Gross Profit $200,000Expenses ($300,000)Operating loss ($100,000)Dividends Received $180,000Tax. Inc. before DRD $80,000DRD ($126,000)Net operating loss ($46,000)

Page Corp. Div. Received Ded.Page owns 15% of company

114

Spring CorporationSpring Corp. has income from business of $500,000 & expenses of $750,000. Spring also received dividends from the Acme Corp. of $100,000. Spring owns 25% Acme.

What is Spring’s NOL for the year?

a. ($150,000) b. ($0).

c. ($220,000) d. ($230,000).

Gross Profit $500,000Expenses (750,000)Operating loss (250,000)Dividends Received 100,000Tax. Inc. before DRDDRDNet operating loss

Spring Corp. Div. Received Ded.Spring owns 25% of company

Gross Profit $500,000Expenses (750,000)Operating loss (250,000)Dividends Received 100,000Tax. Inc. before DRD (150,000)DRD (80,000)Net operating loss (230,000)

Spring Corp. Div. Received Ded.Spring owns 25% of company

117

Spring Corporation

Spring Corp. has income from business of $500,000 & expenses of $750,000 for the year.

Spring also received dividends from the Acme Corp. of $100,000.

Spring owns 25% Acme.

What is Spring’s NOL for the year?

($230,000)

118

Pack CorporationThis year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for this year?a. $50,000 b. $30,000 c. $20,000 d. $10,000

119

Pack CorporationThis year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for current year?$30,000

120

Gross Profit $350,000Expenses (400,000)Operating loss (50,000)Dividends Received 100,000Tax. Inc. before DRD 50,000DRD (80%) (80,000)Net operating loss ($30,000)

Pack Corp. Net Operating Loss

10. Organization & start-up expenses.

[Page 19]

Sec. 248, 195.

Organizational Expenditures. Organizational expenditures must be capitalized unless an election is made under Sec. 248 to amortize them. If the election is made a corporation can deduct the first $5,000 of organizational expense. A corporation must reduce the $5,000 by the amount by which cumulative organizational expenditures exceed $50,000, although the $5,000 cannot be reduced below zero.

123

Organizational Expenditures. Remaining organizational expenditures can be amortized over a 180-month period beginning in the month it begins business. The election must be made in a statement attached to the tax return for the year in which the corporation began to conduct business. If the election is not made, the organizational expenses cannot be deducted until the corporation is liquidated.

124

Organ. Expenses-1

Costs of issuing or selling stock and transferring assets to the corporation reduce the amount of capital raised and are not deductible

125

Organ. Expenses-2Which of the following costs are amortizable organizational expenditures?a. Professional fees to issue the corporate

stock.b. Printing costs to issue the corporate

stock.c. Legal fees for drafting the corporate

charter.d. Commissions paid by the corporation to

an underwriter. CPA Nov. 1994

126

On 1-1-09, ABC Corp.was organized. On thatdate, Bell paid $23,000 toits attorney for organizingthe corporation. Whatis deducted for 2009?a. $6,000 b. $5,120c. $6,200 d. $23,000

Organization costs $23,000Threshold 50,000Excess 0First-Year write-off Amt $5,000Less: excess aboveWrite-offAmount to be amortizedAmort. period- MonthsAmortization per monthNumber of monthsAmortization for yearDeduction & amort.

ABC Corporation - Continued

Organization costs $23,000Threshold 50,000Excess 0First-Year write-off Amt $5,000Less: excess above 0Write-off ($5,000 or less) 5,000 5,000Remainder to be amortized 18,000Amort. period- Months 180Amortization per month 100Number of months 12Amortization for year $1,200 $1,200Deduction & amort. $6,200

ABC Corporation - Continued

129

On Jan. 1, 2009, Bell Corp.was organized. On thatdate, Bell paid $90,000 toits attorney for organizingthe corporation. Whatis deducted for 2009?a. $6,000 b. $5,120c. $5,000 d. $6,800

130

Start-up expenditures are ordinary and necessary business expenses that are paid or incurred to investigate the creation or acquisition of an active trade or business, to create an active trade or business, or to conduct an activity engaged in for profit or the production of income before the time the activity becomes an active trade or business. The expenditures must be such that they would be deductible if they were incurred in the conduct of a trade or business.

Start-Up Expenditures. Under Sec. 195, a corporation may elect to deduct the first $5,000 of start-up expenditures. However, this amount is reduced (but not below zero) by the amount by which the cumulative start-up costs exceed $50,000. The remainder of the start-up costs can be amortized over a 180-month period beginning in the month it begins business. [Starting in 2010, $5,000 is changed to $10,000 and $50,000 to $60,000.]What is the difference between an organization expenditure and a start-up expenditure?

Organization and Startup-New rulesExample: New business incurs $53,000 of startup costs and $40,000 of organization costs in 2009,Two immediate deductions -$2,000 for startup costs and -$5,000 for organization costsStartup costs of $51,000 amortized over 15 yearsOrganization costs of $35,000 amortized over 15 yearsSee new law passed in 2010. Prior slide

133

Already in New Business New Businessthat type of is started or is NOTstartedBusiness acquired or acquired

Deduct Deduct

this year

Rev. Rul. 99-23 this year

Amortize over Never

180 Months

Sec. 195 Deductible

Costs of Investigating Potential Business

Yes

No

134

Pine Corporation

Pine Corp. has opened for business in 2009 and has elected to amortize its startup expenses.

What is the minimum number of months over which the start up costs can be amortized?

a. 60 Months. b. 180 Months.

c. 6 Months. d. 36 Months.

12+. Tax liability Computations. 2-22Reconcile Book to tax. [Page 25]

Tax Planning.

Owner transactions. [Pg.37]

135

Joe owns 100% of the stock of two corporations: § 1561(a)(1) The Furniture Place in Gastonia.(2) The Appliance Place in Monroe. Each corporation has taxable income of $100,000 (total of $200,000). How much total federal income tax is paid by these two corporations for the year?

a.$30,000 b. $35,000 c. $61,250 

 

Furniture $100,000

Appliance 100,000

$200,000

50,000$ 15% $7,500

25,000 25% 6,250

25,000 34% 8,500

100,000 39% 39,000

$200,000 $61,250

Transactions with related parties.

Sec. 267

138

X, a calendar year accrual basiscorp., accrued in 2009 (but did notpay) a year-end bonus of $10,000 toPresident & 100% owner, & $20,000to the Treasurer who owns no stock. Both were paid in February, 2010. How are these bonuses deducted?

2009 2010 2009 2010a. $30,000 $0 b. $20,000 $10,000

c. $10,000 $20,000 d. $0 $20,000

See Sec. 267.

The

End