©2008 Prentice Hall, Inc.

CORPORATIONS (1 of 3) Definition of a corporation Similarities and differences between corporations and individuals Specific rules applicable to corporations Computation of tax ©2008 Prentice Hall, Inc.

CORPORATIONS (2 of 3) Transfers of property to controlled corporations Corporate Capital Structure Earnings and profits Nonmoney distributions Stock redemptions ©2008 Prentice Hall, Inc.

CORPORATIONS (3 of 3) Corporate distributions in complete liquidation Tax planning considerations Compliance and procedural considerations ©2008 Prentice Hall, Inc.

Definition of a Corporation Organization Forms Available Sole proprietorships Partnerships Corporations C Corporations S Corporations Limited liability companies (LLCs) Limited liability partnerships (LLPs) ©2008 Prentice Hall, Inc.

Definition of a Corporation Flow-Through Entities Earnings not taxed at entity level Flow-through directly to owners Sole proprietorships Partnerships S Corporations LLCs LLPs ©2008 Prentice Hall, Inc.

Definition of a Corporation C Corporation (1 of 2) C corps only entity that pays tax at entity level Earnings distributed to owners taxed again at owner level Business entity w/ ≥ 2 owners classified as either a corporation or a partnership Business entity w/ 1 owner classified as a corporation or a sole proprietorship ©2008 Prentice Hall, Inc.

Definition of a Corporation C Corporation (2 of 2) A business entity is a corporation if organized under federal or state statute that refers to the entity as incorporated or as a corporation If a business entity incorporates, it is a corporation LLCs and LLPs can elect to be taxed as a corporation or partnership ©2008 Prentice Hall, Inc.

Similarities and Differences Between Corps & Individuals (1 of 3) Similar computation of taxable income as for sole proprietorship Allowed to deduct ordinary and necessary business expenses Can deduct interest and depreciation ©2008 Prentice Hall, Inc.

Similarities and Differences Between Corps & Individuals (2 of 3) AGI only applies to individuals Corps cannot deduct personal expenses Corps cannot use standard deduction, or personal and dependency exemptions Only corps get dividends received deduction ©2008 Prentice Hall, Inc.

Similarities and Differences Between Corps & Individuals (3 of 3) Differences (continued) Corp charitable contributions 10% of TI Individuals 50% of AGI Compensation deduction limitation for Publicly Held Corporations No preferential tax rate on net LTCG for corps ©2008 Prentice Hall, Inc.

Specific Rules Applicable to Corporations Capital gains and losses Dividends-received deduction Net operating losses Charitable contributions Compensation deduction limitation for publicly held corporations Deduction for U.S. production activities ©2008 Prentice Hall, Inc.

Capital Gains and Losses Computation same as for individuals See Chapter I13 Corporate capital loss limitations Cannot deduct net LTCL or net STCL Carryback net capital loss back 3 years and forward 5 years ©2008 Prentice Hall, Inc.

Dividends-Received Deduction (1 of 2) Corps owning < 20% of a domestic corporation deduct lesser of 70% of Dividends Received or 70% of taxable income before NOL, capital loss carryback or DRD Exception to taxable income limitation If 70% of dividend received creates an NOL, then the full DRD is deductible ©2008 Prentice Hall, Inc.

Dividends-Received Deduction (2 of 2) Corps owning  20% and < 80% of a domestic corp 80% deduction instead of 70% Corps owning  80% of a domestic corp 100% deduction ©2008 Prentice Hall, Inc.

Net Operating Losses Deductions exceed gross income for the year before NOL carrybacks NOL may be carried back 2 yrs & then forward 20 yrs Corp may elect to forgo carryback & only carry NOL forward 20 yrs ©2008 Prentice Hall, Inc.

Charitable Contributions (1 of 2) Some restrictions imposed on individuals apply to corps Timing of deduction Deducted in the year paid Accrual basis corps may elect to include payment made w/in 2-1/2 months following the end of tax year Board of directors must have authorized contribution during year it was accrued ©2008 Prentice Hall, Inc.

Charitable Contributions (2 of 2) Non-cash property Increased contribution for certain property Max deduction is 10% of “adjusted taxable income” (ATI) ATI is taxable income before NOL carryback, capital loss carryback, dividend received deduction or charitable contribution ©2008 Prentice Hall, Inc.

Compensation Deduction Limitation for Publicly Held Corporations Limitation for CEO and its four highest compensated officers Cash and non-cash compensation in excess of $1M for each officer not deductible ©2008 Prentice Hall, Inc.

Deduction for U.S. Production Activities (1 of 2) Deduction is lesser of a % times Qualified production activities income OR Taxable income before the U.S. production activities deduction Phased-in percentages 3% for 2005 & 2006 6% for 2007-2009 9% for 2010 and thereafter ©2008 Prentice Hall, Inc.

Deduction for U.S. Production Activities (2 of 2) Qualified production activities income Domestic production gross receipts from lease, rental, sale, or exchange, of tangible property manufactured in the U.S. LESS Expenses related to qualified income including CoGS, & indirect allocable expenses ©2008 Prentice Hall, Inc.

Computation of Tax Computation of regular tax Computation of the corporate alternative minimum tax Penalty taxes Computation of tax for controlled groups Consolidated returns ©2008 Prentice Hall, Inc.

Computation of Regular Tax (1 of 3) Gross Income - Deductions and Losses - Special Deductions Taxable Income x Appropriate Rate(s) 15%-39% Regular Tax Liability before credits ©2008 Prentice Hall, Inc.

Computation of Regular Tax (2 of 3) Regular Tax Liability before credits - Foreign tax credit - Other Credits + Credit recapture Regular tax liability ©2008 Prentice Hall, Inc.

Computation of Regular Tax (3 of 3) Regular Tax Liability + AMT Liability + Special Taxes (if any) - Estimated Payments Refund or tax due Large corps (TI>$18.3M) taxed at flat 35% PSCs taxed at flat 35% ©2008 Prentice Hall, Inc.

Computation of Corporate AMT Tax Computation (1 of 3) Taxable income before NOL + Tax preference items +/- Adjustments to taxable income other then ACE adjustment and AMT NOL deduction Pre-adjustment AMTI ©2008 Prentice Hall, Inc.

Computation of Corporate AMT Tax Computation (2 of 3) Pre-adjustment AMTI +/- 75% of difference between pre- adjustment AMTI and ACE - AMT NOL deduction AMTI - Statutory exemption Tax base ©2008 Prentice Hall, Inc.

Computation of Corporate AMT Tax Computation (3 of 3) Tax base x 20% tax rate Tentative min tax before credits - AMT FTC Tentative minimum tax (TMT) - Regular income tax liability AMT due (if any) ©2008 Prentice Hall, Inc.

Computation of Corporate AMT AMT Exemption Statutory exemption amount $40,000 Reduced by 25% x (AMTI - $150,000) Fully phased out when AMTI ≥ $310,000 ©2008 Prentice Hall, Inc.

Computation of Corporate AMT Small Business Exception Initial year: all corps exempt 2nd year: exempt if first year gross receipts  $5M 3rd year: exempt if avg. of yr1 and yr 2 gross receipts  $7.5M Subsequent years: exempt if avg. of prior 3 yrs’ gross receipts  $7.5M ©2008 Prentice Hall, Inc.

Penalty Taxes Accumulated Earnings Tax Penalty tax to compel corps to distribute profits not needed for conduct of its business Tax at highest individual tax rate on dividends (15%) S/h must have tax-avoidance motive to avoid receipt of dividends Usually applies to closely held corps ©2008 Prentice Hall, Inc.

Penalty Taxes Personal Holding Company Tax Prevents closely held C corps from sheltering passive income from higher individual tax rates Applies if ≤ 5shareholders who own 50% of outstanding stock at any time during last 6 months of corp’s tax year ©2008 Prentice Hall, Inc.

Computation of Tax for Controlled Groups (1 of 3) Two or more corps owned directly or indirectly by same shareholder or group of shareholders Must allocate lower corp tax rates among all related corporations Otherwise taxpayers could split one corp into 2 or more corps to achieve tax savings ©2008 Prentice Hall, Inc.

Computation of Tax for Controlled Groups (2 of 3) Types of controlled groups Brother-sister 80%-50% definition Five or fewer individuals, trusts or estates own: At least 80% of voting power or at least 80% of value of stock of two or more corporations AND > 50% of the voting power or value is held by identical owners 50%-only definition is 2nd test above ©2008 Prentice Hall, Inc.

Computation of Tax for Controlled Groups (3 of 3) Types of controlled groups (continued) Parent-subsidiary One corp owns ≥ 80% of stock of subsidiary corp Combined Three or more corps meet following criteria: Each corporation is a member of a parent-subsidiary or brother-sister group, AND At least one is both a parent, and a member of a brother-sister group ©2008 Prentice Hall, Inc.

Consolidated Returns Corps that are members of a parent-subsidiary affiliated group eligible to file a consolidated tax return Capital losses offset capital gains from other group members Operating losses reduce operating income from other group members Transactions between two members treated as taking place w/in same entity ©2008 Prentice Hall, Inc.

Transfers of Property to Controlled Corporations §351 nonrecognition requirements Basis considerations Treatment of liabilities ©2008 Prentice Hall, Inc.

§351 Nonrecognition Requirements No gain or loss recognized if: PROPERTY transferred in exchange for stock and Transferors have control (80%) of corp immediately after the exchange Transfers may be for new or existing corps Gain recognized lesser of gain realized or FMV of boot received ©2008 Prentice Hall, Inc.

Basis Considerations Basis of Stock Received by Transferors Substituted basis in stock received Basis formula Basis of property transferred to corp + Gain recognized by transferor - Money & FMV of property received - Liabilities transferred to corp Basis of stock received ©2008 Prentice Hall, Inc.

Basis Considerations Basis of Property Received by Corporation Carryover basis in property received Basis formula Basis of property in hands of transferors + Gain recognized by transferor Basis of property received by corp ©2008 Prentice Hall, Inc.

Treatment of Liabilities Assumption of liabilities by transferee corporation does not trigger gain recognition to transferors Shareholders must reduce basis by amount of liabilities transferred ©2008 Prentice Hall, Inc.

Corporate Capital Structure Debt has two main tax advantages: Interest payments deductible Principal repayments tax-free return of capital If corp too thinly capitalized IRS may classify part or all of debt as equity Deductible interest payments become non-deductible dividends ©2008 Prentice Hall, Inc.

Earnings and Profits (E&P) Calculation of E&P (1 of 2) Generally E&P based on corp’s economic ability to pay dividends income instead of taxable income Adjustments to taxable income for permanent & timing differences including use of different depreciation methods Distribution a dividend to extent of E&P Excess distribution a return of capital ©2008 Prentice Hall, Inc.

Earnings and Profits (E&P) Calculation of E&P (2 of 2) Taxable income + Excluded taxable income + Taxable inc deferred to another year +/- Inc & deduct recomp under E&P rules + Deductions disallowed for E&P - Nondeductible items that reduce E&P = Current E&P (or current E&P deficit) ©2008 Prentice Hall, Inc.

Earnings and Profits (E&P) Current vs. accumulated E&P Current E&P (CE&P) computed on last day of the corp’s tax year Distributions first from CE&P Distributions greater than CE&P CE&P allocated to distributions pro rata regardless of payment date Then AE&P (only if positive) allocated to distributions in chronological order ©2008 Prentice Hall, Inc.

Nonmoney Distributions Tax Consequences to the Shareholders Amount distributed = FMV of property Reduced by liabilities Treated as taxable dividend if corp has sufficient E&P Basis of distributed property = FMV W/o reduction for liabilities ©2008 Prentice Hall, Inc.

Nonmoney Distributions Tax Consequences to the Distributing Corporation Generally corps recognize no gain or loss upon distribution to shareholders Appreciated property distributed to shareholders treated as if property sold for FMV immediately before distribution Corporation recognizes realized gain, but not realized loss ©2008 Prentice Hall, Inc.

Stock Redemptions (1 of 2) Redemption treated as a taxable dividend (E&P) unless distribution meets one of the following criteria Substantially disproportionate rule Not essentially equivalent to a dividend Results in a complete termination of shareholders’ interest Is made in partial liquidation of corp ©2008 Prentice Hall, Inc.

Stock Redemptions (2 of 2) If not a dividend, redemption treated as an exchange Resulting in capital gain or loss by shareholder ©2008 Prentice Hall, Inc.

Corporate Distributions in Complete Liquidation Tax consequences to the liquidating corporation Tax consequences to the shareholders Section 332: Liquidation of a subsidiary corporation ©2008 Prentice Hall, Inc.

Tax Consequences to the Liquidating Corporation (1 of 2) Gains & losses recognized on asset dispositions Exception for certain losses No loss recognition on liquidation of subsidiary to minority shareholders No loss when property distributed to a related party §351 contributions of loss property for tax avoidance ©2008 Prentice Hall, Inc.

Tax Consequences to the Liquidating Corporation (2 of 2) Tax attributes of distributed property disappear ©2008 Prentice Hall, Inc.

Tax Consequences to the Shareholders Shareholder assumed to have sold stock for FMV of net assets received Basis of assets received is FMV FMV of assets - liabilities received - Basis of stock surrendered = Amount of gain (loss) recognized ©2008 Prentice Hall, Inc.

Section 332: Liquidation of a Subsidiary Corporation Neither parent nor subsidiary recognizes gain or loss of an 80%-owned corporation Property must be distributed to parent in one or a series of distributions in complete liquidation Basis carries over to parent ©2008 Prentice Hall, Inc.

Tax Planning Considerations Capital structure and Section 1244 Dividend policy Use of losses Charitable contributions Dividends-received deductions Reduced taxes on taxpayer stock sales ©2008 Prentice Hall, Inc.

Compliance and Procedural Considerations Filing requirements Corporation must file Form 1120 Not based on gross income Due date is one month earlier than individual returns Due date for estimated tax installment also one month earlier ©2008 Prentice Hall, Inc.

©2008 Prentice Hall, Inc.