Chapter 2A. Corp.

Tax Law
Howard Godfrey, Ph.D., CPA Professor of Accounting
Copyright 2011 Edited 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 Outline
A 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

FICA Rates for 2010

A 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
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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.

C Corp. - 2010 [Fm 1120]

Revenue $ Cost of Sales Gross Margin Saary-Others Salary -Owner Payroll Taxes Other Expenses Total Expenses Net Income Income Tax After-Tax Income Retained Earnings: Beginning Balance After-Tax Income Subtotal Dividends Paid End. Retained Earn. 800,000 500,000 300,000 100,000 70,000 16,000 54,000 240,000 60,000

Single Person - Form 1040- 2010

Gross Income Salary Dividends Flow through - entity Total Income Deductions for AGI:

-0-

AGI [Adj. Gross Income] Exemptions Itemized Deductions Total deduct. from AGI Taxable Income Income Tax Self-Employment Tax Total tax before credits

3,650 26,350 30,000

None

C Corp. - 2010 [Fm 1120]

Revenue $ Cost of Sales Gross Margin Saary-Others Salary -Owner Payroll Taxes Other Expenses Total Expenses Net Income Income Tax After-Tax Income Retained Earnings: Beginning Balance After-Tax Income Subtotal Dividends Paid End. Retained Earn. 800,000 500,000 300,000 100,000 70,000 16,000 54,000 240,000 60,000 10,000 50,000 -050,000 50,000 50,000

Single Person - Form 1040- 2010

Gross Income Salary Dividends Flow through - entity Total Income Deductions for AGI: $ 70,000

70,000

AGI [Adj. Gross Income] Exemptions Itemized Deductions Total deduct. from AGI Taxable Income Income Tax Self-Employment Tax Total tax before credits

70,000 3,650 26,350 30,000 40,000 None

S Corp. - 2010 [Fm 1120S]

Revenue $ Cost of Sales Gross Margin Pay-Others Pay -Owner Payroll Taxes Other Expenses Total Expenses Net Income Income Tax After-Tax Income Retained Earnings: Begin. Balance After-Tax Income Subtotal Dividends Paid End. Retained Earn. 800,000 500,000 300,000 100,000 70,000 16,000 54,000 240,000 60,000 None 60,000 -0-

Single Person - 1040- 2010

Gross Income Salary Dividends Flow through - entity Total Income Deductions for AGI:

Adjusted Gross Income Exemptions Itemized Deductions Total ded. from AGI Taxable Income Income Tax Self-Employment Tax Total tax before credits

3,650 26,350 30,000

None

S Corp. - 2010 [Fm 1120S]

Revenue $ Cost of Sales Gross Margin Pay-Others Pay -Owner Payroll Taxes Other Expenses Total Expenses Net Income Income Tax After-Tax Income Retained Earnings: Begin. Balance After-Tax Income Subtotal Dividends Paid End. Retained Earn. 800,000 500,000 300,000 100,000 70,000 16,000 54,000 240,000 60,000 None 60,000 -060,000 60,000 60,000

Single Person - 1040- 2010

Gross Income Salary $ 70,000 Dividends Flow through - entity 60,000 Total Income 130,000 Deductions for AGI:

Adjusted Gross Income 130,000 Exemptions 3,650 Itemized Deductions 26,350 Total ded. from AGI 30,000 Taxable Income 100,000 Income Tax Self-Employment Tax None Total tax before credits

Schedule C on 1040 - 2010

Revenue Cost of Sales Gross Margin Salary-Others Salary -Owner Payroll Taxes Other Expenses Total Expenses Net Income Income Tax After-Tax Income Capital Statement: Beginning Balance After-Tax Income Subtotal Drawing End. Capital Balance $ 800,000 500,000 300,000 100,000 Not App. 16,000 54,000 170,000 130,000 Not App. Not App. $ 100,000

Single Person-Form 1040- 2010

Gross Income Salary Not App. Dividends Flow through Income-Schedule C Total Income Deductions for AGI: One-half of SE Tax Adjusted Gross Income Exemptions 3,650 Itemized Deductions 26,350 Total ded. from AGI 30,000 Taxable Income Income Tax Self-Employment Tax Total tax before credits

Schedule C on 1040 - 2010

Revenue Cost of Sales Gross Margin Salary-Others Salary -Owner Payroll Taxes Other Expenses Total Expenses Net Income Income Tax After-Tax Income Capital Statement: Beginning Balance After-Tax Income Subtotal Drawing End. Capital Balance $ 800,000 500,000 300,000 100,000 Not App. 16,000 54,000 170,000 130,000 Not App. Not App. $ 100,000 100,000 100,000

Single Person-Form 1040- 2010

Gross Income Salary Not App. Dividends Flow through Income-Schedule C 130,000 Total Income 130,000 Deductions for AGI: 8,363 One-half of SE Tax Adjusted Gross Income 138,363 Exemptions 3,650 Itemized Deductions 26,350 Total ded. from AGI 30,000 Taxable Income 108,363 Income Tax 16,725 Self-Employment Tax Total tax before credits

Tax Year - 2010

Sch. C Net Income Net. SE Income $130,000 92.35% $120,055 2.90% 15.30% Self-Employment Tax (1040-Line 57) Income Tax Deduction (1040-Line 30) $16,725 50% $8,362 $3,482 $106,800 12.40% $13,243

Tax Year - 2010 - Alternate Approach

Sch. C Net 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) $16,725 50% Income Tax Deduction (1040-Line 30) $8,362

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

Corporate Tax Rates 15% on first $50,000 25% on $50,001 - $75,000 34% on $75,001 - $100,000 39% (34% + 5% surtax) on $100,001 - $335,000 34% on $335,001 - $10,000,000 35% on $10,000,001 - $15,000,000 38% (35% + 3%) on $15,000,001 - $18,333,333 35% on over $18,333,333

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.
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Corporation Distributes All After-tax Income Shareholders are individuals What is combined effective tax rate? Corp. taxable income Tax rate Corp. after-tax income Shareholder tax rate Total income tax Total Tax as % of T.I. above $1,500,000

0.00%

Corporation Distributes All After-tax Income Shareholders are individuals What is combined effective tax rate? Corp. taxable income Tax rate Corp. after-tax income Shareholder tax rate $1,500,000 34% $510,000 $990,000 15% 148,500 658,500 43.90%

Total income tax Total Tax as % of T.I. above

Corporation Distributes All After-tax Income Assume 15% dividend rate expires. Shareholders are individuals What is combined effective tax rate? Corp. taxable income Tax rate Corp. after-tax income Shareholder tax rate $1,500,000 34% $510,000 $990,000 35% 346,500 856,500 57.10%
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Total income tax Total Tax as % of T.I. above

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.
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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. Toms 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.

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. $45,000 Sec. 451, 1.451-1
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Nare, Contd 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.

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 Sharons 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.
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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 : $ 40,000 Cash from Tenants 10,000 Expenses Paid $ 30,000 Net Income $ 6,000 Rental Receivable 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 this is not the first year of operations?

Accounting Methods Hall Co., -Continued The rent receivable of $6,000 must be included in revenue using the accrual method. Corrected computations: Revenue $46,000 Expenses $10,000 Taxable 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.
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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.

Accrual Accounting-2
Manufacturer provides a 3-year warranty. Financial statement for its first year: Sales $1,000,000 Cost of sales 600,000 Expenses 300,000 Net 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
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Accrual Accounting-3
Manufacturer provides a 3-year warranty. Financial statement for its first year: Sales $1,000,000 Cost of sales 600,000 Expenses 300,000 Net income before taxes $100,000 Accrued warranty liability Taxable Income $20,000 $120,000

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

Accrual Accounting-4
Manufacturer provides a 3-year warranty. Financial statement for its first year: Sales $1,000,000 Cost of sales 600,000 Expenses 300,000 Net income before taxes $100,000 Expenses include a reserve of $20,000 [Reserve for future repair costs on units sold in the current year.] Tax Rate 40% . What is the balance in the deferred tax asset or liability account at end of Year 1?

Accrual Accounting-5
Manufacturer provides a 3-year warranty. Financial statement for its first year: Sales $1,000,000 Cost of sales 600,000 Expenses 300,000 Net income before taxes $100,000 Accrued warranty liability Taxable Income Timing difference Tax rate Deferred tax asset $20,000 $120,000 $20,000 40% $8,000

Compute taxable income for Hurd, Inc.

Hurd, Inc. reported for year: Info. Book income before taxes $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 60,000 Taxable income Tax Rate 40% Tax liability Return $900,000

40%

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Compute taxable income for Hurd, Inc.

Hurd, Inc. reported for year: Book income before taxes Records show: Interest on municipal bonds Depreciation on tax return in excess of deprec. per books Warranty exp.- accrual basis Actual warranty expenditures Taxable income Tax Rate Tax liability Info. $900,000 70,000 Return $900,000 ($70,000)

130,000 ($130,000) 40,000 40,000 60,000 ($60,000) 680,000 40% 40% $272,000

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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 Individuals

Gross 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 similar Depreciation recapture applies to both but corp may have added recapture under 291.
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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 & Losses Net 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.

Corp. Capital Gains & Losses

Capital gains taxed as ordinary income. Capital losses can only offset capital gains. Net loss carried back 3 years as short-term capital loss and forward up to 5 years. Losses not used in carryover periods are lost.
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Corporation had taxable income from business operations: $36,000 Corporation 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. $36,000 d. $35,500 CPA - Nov. 1995
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Corporation had taxable income from business operations: $36,000 Corporation 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. $36,000 d. $35,500 CPA - Nov. 1995
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Big Corp's taxable income before capital gains & losses Big had the following: Long-term capital gain Short-term capital loss Taxable income? $3,000 ($9,000) $100,000 $100,000

Carryover of Corp. Capital Losses

Corp. 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 $290,000 Cost 300,000 Accum. Deprec. (S/L) (60,000) Additional Dep. DDB Adjusted Basis Gain Section 1245 Gain Section 1231 gain (CG?)

Asset - Section 1245

Machine

Owner Individual Selling Price $290,000 Cost 300,000 Accum. 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 $320,000 Cost 300,000 Accum. Deprec. (S/L) (60,000) Additional Dep. DDB Adjusted Basis Gain Section 1245 Gain Section 1231 gain (CG?)

Asset - Sec. 1245

Machine

Owner Individual Selling Price $320,000 Cost 300,000 Accum. 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 300,000 Accum. Deprec. (S/L) (80,000) Additional Dep. DDB 0 Adjusted Basis 220,000 Gain 30,000 Section 1245 Gain Section 1250 gain Section 1231 gain (CG?) 30,000 Unrecaptured 1250 gain How is answer different for a corporation?

Asset - Section 1250

Apartment

Owner Individual Selling Price $ 250,000 Cost 300,000 Accum. Deprec. (S/L) (80,000) Additional Dep. DDB (40,000) Adjusted Basis 180,000 Gain 70,000 Section 1245 Gain Section 1250 gain 40,000 Section 1231 gain (CG?) 30,000

Corp. Income Tax

Gross receipts of $450,000 Cost 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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Corporate Income Tax - Problem

A corporation has Gross receipts Cost of goods sold

Facts $450,000 $145,000

Return $450,000 $145,000

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

A corporation has Gross receipts Cost of goods sold

Facts $450,000 $145,000

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

Return $450,000 $145,000 $305,000 ($276,000) $20,000 $49,000 $7,350

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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. 170

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Gross income
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: Dividend Received Deduction [243+] Equals Taxable Income- Before carrybacks Less: NOL & Cap. Loss carrybacks [172(b), 1212(a)] Equals Taxable

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.

Charity Deductions-3 Long-term capital gain property deduction = fair market value of property (contd) Exception: Deduction for property contribution to certain private nonoperating foundations is limited to basis in property
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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

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).

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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. Cables 2011 charity deduction is? a. $80,000 b. $82,000 c. $86,000 d. $90,000 CPANov1995
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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. Cables 2011 charity deduction is? $86,000 (Charity limit is computed before DRD)
85

Cable - Charitable Contribution Deduction-8

1 2 3 4 5 6 7 Operating Income Dividend Income (40% owned) Subtotal Dividends Received Deduction Taxable income after div. received deduct. but before charitable contribution deduct. Contributions made this year Carryover from last year 86,000 810,000 50,000 860,000

8 Total contribution including carryover 9 Cont. deductible - current yr(10% of line 3) 10 Taxable Income

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Cable- Charitable Contribution Deduction-9

1 2 3 4 Operating Income Dividend Income (40% owned) Subtotal Dividends Received Deduction Taxable income after div. received deduct. 5 6 7 8 9 but before charitable contribution deduct. Contributions made this year Carryover from last year Total contribution including carryover Cont. deductible - current yr(10% of line 3) 820,000 80,000 10,000 90,000 86,000 $ 734,000 810,000 50,000 860,000 (40,000)

10 Taxable Income

87

Big Corp. taxable income 2010 is first year for Big Corp. Sales Cost of sales Gross Margin Net capital gains Net cap. losses (over cap. gains) Capital loss carryover Salaries Rent paid, payroll taxes, deprec. Taxable income before charity Charitable contributions paid Charitable cont. carryover Taxable income Dividends paid

2010 Facts $200,000 (100,000) 100,000 (3,000) (30,000) (31,000) 36,000 (6,000)

$5,000

Big Corp. taxable income 2010 is first year of operations Sales Cost of sales Gross Margin Net capital gains Net cap. losses (over cap. gains) Capital loss carryover Salaries Rent paid, payroll taxes, deprec. Taxable income before charity Charitable contributions paid Charitable cont. carryover Taxable income Dividends paid

2010 Facts $200,000 (100,000) 100,000 (3,000) (30,000) (31,000) 36,000 (6,000) $2,100 $35,100 $5,000

2011 Facts $300,000 (150,000) 150,000 5,000

(30,000) (31,000) 94,000 (5,000)

$15,000

Maple Corp. had the following for 2010:

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 Net income (loss) per books ($30,000) Maples tax deprec. for 2010 will be $75,000. Taxable income for 2010?
a. $(5,000) b. $(35,000) c. $(25,000) d. $(20,000)
90

Maple Corp. - 2010

Gross Sales Cost of Goods Sold Depreciation - Books Depreciation - Tax Charitable Contribution Salaries Meals & entertainment Total Expenses Net income (loss)-books Taxable income?

Facts
$340,000 150,000 60,000 10,000 130,000 20,000 370,000 ($30,000)

Return

91

Maple Corp. - 2010

Facts

Return

Gross 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) Taxable income? ($25,000)
92

7. Net operating losses. [Page 17] Sec. 172

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.

94

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.
95

Owner of C Corp. has asked for advice. Corporation was started in 2006.
Actual Actual Actual Plan Amounts ($000) Revenue Expenses Taxable income (loss) 1. 2. 3. 4. 2006 $100 (98) $2 2007 $200 (173) $27 2008 $200 (225) ($25) 2009 $300 (225) $75

Can the corp. benefit from the loss in 2008? Is there a choice regarding the 2008 loss? Compute the savings under two options. 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- CORPS 241 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

Dividend Received Deduction

To relieve burden of multiple taxation DRD 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 times lesser of taxable income or dividend income Unless deducting DRD % x dividend income creates or increases NOL
99

Grant, Inc. acquired 30% of South Co.s voting stock for $200,000 on January 1, 2010. Grants 30% interest in South gave Grant the ability to exercise significant influence over Souths 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.
100

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

101

Div. Received- Green Corp 2

Green Corp. owns 25% of Cande Corp. In 2010, Green received $10,000 dividends from the Cande stock. Assuming no other limitations apply, Greens dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $ - 0 -.
102

Local Corp - 1. had the following: Revenue - operations Operating expenses Operating income (loss) Dividends from IBM Net income before DRD Dividend rec. deduction $500,000 (490,000) 10,000 50,000 60,000

Dividends Received Deduction 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

Local Corp - 2. had the following: Revenue - operations Operating expenses Operating income (loss) Dividends from IBM Net income before DRD Dividend rec. deduction $ 500,000 (510,000) (10,000) 50,000 40,000

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

Local Corp - 3. had the following: Revenue - operations Operating expenses Operating income (loss) Dividends from IBM Net income before DRD Dividend rec. deduction $ 500,000 (520,000) (20,000) 50,000 30,000

Dividends Received Deduction 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 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).
110

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).
111

Page Corp. Div. Received Ded. Page owns 15% of company Gross Profit $200,000 Expenses ($300,000) Operating loss ($100,000) Dividends Received $180,000 Tax. Inc. before DRD DRD Net operating loss

Page Corp. Div. Received Ded. Page owns 15% of company Gross Profit $200,000 Expenses ($300,000) Operating loss ($100,000) Dividends Received $180,000 Tax. Inc. before DRD $80,000 DRD ($126,000) Net operating loss ($46,000)

Spring Corporation
Spring 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 Springs NOL for the year? a. ($150,000) b. ($0). c. ($220,000) d. ($230,000).
114

Spring Corp. Div. Received Ded. Spring owns 25% of company Gross Profit $500,000 Expenses (750,000) Operating loss (250,000) Dividends Received 100,000 Tax. Inc. before DRD DRD Net operating loss

Spring Corp. Div. Received Ded. Spring owns 25% of company Gross Profit $500,000 Expenses (750,000) Operating loss (250,000) Dividends Received 100,000 Tax. Inc. before DRD (150,000) DRD (80,000) Net operating loss (230,000)

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 Springs NOL for the year?

($230,000)
117

Pack Corporation
This 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
118

Pack Corporation This 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
119

Pack Corp. Net Operating Loss Gross Profit $350,000 Expenses (400,000) Operating loss (50,000) Dividends Received 100,000 Tax. Inc. before DRD 50,000 DRD (80% ) (80,000) Net operating loss ($30,000)
120

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.

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.
123

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
124

Organ. Expenses-2
Which 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
125

On 1-1-09, ABC Corp. was organized. On that date, Bell paid $23,000 to its attorney for organizing the corporation. What is deducted for 2009? a. $6,000 b. $5,120 c. $6,200 d. $23,000

126

ABC Corporation - Continued

Organization costs Threshold Excess First-Year write-off Amt $5,000 Less: excess above Write-off Amount to be amortized Amort. period- Months Amortization per month Number of months Amortization for year Deduction & amort. $23,000 50,000 0

ABC Corporation - Continued

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

5,000 18,000 180 100 12 $1,200

5,000

$1,200 $6,200

On Jan. 1, 2009, Bell Corp. was organized. On that date, Bell paid $90,000 to its attorney for organizing the corporation. What is deducted for 2009? a. $6,000 b. $5,120 c. $5,000 d. $6,800

129

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.
130

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 startup 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 rules

Example: 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 costs Startup costs of $51,000 amortized over 15 years Organization costs of $35,000 amortized over 15 years See new law passed in 2010. Prior slide

Costs of Investigating Potential Business Already in New Business New Business that type of is started or is NOTstarted Business acquired or acquired

Yes

Deduct this year Rev. Rul. 99-23 Amortize over

Deduct this year Never Deductible

133

No

180 Months Sec. 195

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.
134

12+. Tax liability Computations. 2-22 Reconcile 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 Appliance

$100,000 100,000 $200,000 $ 50,000 25,000 25,000 100,000 $200,000 15% 25% 34% 39% $7,500 6,250 8,500 39,000 $61,250

Transactions with related parties. Sec. 267

138

X, a calendar year accrual basis corp., accrued in 2009 (but did not pay) a year-end bonus of $10,000 to President & 100% owner, & $20,000 to the Treasurer who owns no stock. Both were paid in February, 2010. How are these bonuses deducted? 2009 2010 2009 2010 $0 a. $30,000 b. $20,000 $10,000 $0 $20,000 c. $10,000 $20,000 d.
See Sec. 267.

The End