Chapter 11 Corporate Income Tax Income Tax Fundamentals 2008 Gerald E. Whittenburg & Martha Altus-Buller Student’s Copy

Corporate Tax Rates Corporate rates are progressive, from 15% to 39%, depending on taxable income For corporations with large income (more than $18.33 million) The rate is a flat 34% Accomplished by ‘tax bubbles’ Occurs when tax rate schedules recaptures savings from prior brackets Qualified personal service corps taxed at flat 35% Architects, CPAs, consultants, etc.

Corporate Capital Gains A corporation can choose from two alternative tax treatments on capital gains Taxed at ordinary rates, or Elect to pay an alternative tax (35%) on net long-term capital gain [LTCG] Essentially equivalent to maximum regular corporate tax [no benefit to LTCG] No difference in tax on ordinary vs. capital income

Dividends Received Deduction Corporations are allowed a deduction for a % of the dividends received from other corporations Attempt to alleviate triple taxation Dividends received deduction [DRD] is allowed based upon ownership Percentage ownership If ownership is: then DRD is:paying dividends DRD % < 20% 70% 20% or more, less than 80% 80% > 80% 100%

Amortization of Organizational Expenditures Examples of organizational expenditures Legal/accounting services incidental to organization Incorporation fees Note: Expenses involved in transferring assets to the corporation are not considered organizational expenses Organizational expenditures are capitalized and then amortized over 180 months However, can make election to deduct up to $5,000 of organization costs in year corporation begins business $5,000 amount is reduced $1 for each $1 that organization expenses exceed $50,000

Reconciliation of Tax to Book Income: Schedule M-1 Schedule M-1 of Form 1120 reconciles book to tax income Computed before NOLs and special deductions Amounts added to book income Federal tax expense Capital losses Income recorded on tax return but not on books Expenses recorded on books but not on tax return Amounts deducted from book income Income recorded on books but not on tax return Expenses recorded on tax return but not on books See p. 11-6 for other items

S Corporations Certain corporations may elect to be taxed in a manner similar to partnerships Qualified small business corporation may elect S Corporation status if: Operates as a domestic corporation Has 100 or fewer shareholders Shareholders may not be corporations or partnerships Has only one class of stock Has only shareholders that are US citizens or resident aliens

Income Reporting Must report all elements of income and expense separately on Form 1120S Then each shareholder reports his/her share of these items of corporate income/expense on personal return K-1 takes total shareholder income/expenses and allocates each item to each shareholder based upon his/her ownership percentage

Loss Reporting Each shareholder of an S Corp may also report his/her respective share of loss Cannot take a loss in excess of adjusted basis in stock If loss exceeds adjusted basis in stock plus loans, shareholder can carry it forward If shareholder entered/departed S Corp midyear, must allocate items of income/loss on a daily basis

Shareholder Basis in Stock A shareholder’s initial basis in his/her stock is calculated as follows: Basis of property transferred Less Boot received [noncash assets] Plus Gain recognized Less Liabilities transferred Basis in stock The corporation has a carry-over basis in the property contributed equal to the basis in the hands of the shareholder, increased by any gain recognized by shareholder on the transfer