Chapter 11 Corporate Income Tax 2013 Cengage Learning Income Tax Fundamentals 2013 Student Slides Gerald E. Whittenburg Martha Altus-Buller Steven Gill

Corporate Tax Rates  Corporate rates are progressive °Marginal rates are from 15% to 39%, depending on taxable income °There are eight brackets °There are a number of ‘tax bubbles’ – these occur when tax rate schedules recapture savings from prior brackets  For corporations with large income (more than $18.33 million) the rate is a flat 35%  Qualified personal service corps taxed at flat 35% ◦ Architects, CPAs, consultants, etc Cengage Learning

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 tax benefit to LTCG)  Bottom line: there is no difference in tax on ordinary vs. capital income 2013 Cengage Learning

Dividends Received Deduction  Corporations are allowed a deduction for a percentage of the dividends received from other corporations –Attempt to alleviate triple taxation  Dividends received deduction is allowed based upon ownership 2013 Cengage Learning Percentage Ownership Dividends Received % Deduction < 20% 70% 20% or more, less than 80% 80% > 80% 100% Dividends received deduction is limited by % of corporate taxable income shown above (calculated before certain deductions)

Charitable Contributions  Corporations are allowed a deduction for charitable contributions ◦ Cash basis taxpayers can deduct when paid ◦ Accrual basis taxpayers have until the 15th day of the third month following year-end to contribute, as long as pledge is made by year-end  Charitable contributions limited to 10% of taxable income* ◦ Carry forward unused deduction for five years *Calculated before any loss carry backs, net operating losses (NOLs) or the dividend received deduction 2013 Cengage Learning

Reconciliation of Income (Loss) per Books with Income Per Return  Schedule M-1 of Form 1120 reconciles accounting (book) income to taxable income  Amounts added to book income (left column) ◦ 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 (right column) ◦ Income recorded on books but not on tax return ◦ Expenses recorded on tax return but not on books See Schedule M-1 on page Cengage Learning

S Corporations  Certain qualified small business corporations may elect to be taxed in a manner similar to partnerships  Qualified small business corporation may elect S Corporation status if several criteria apply ◦ 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 U.S. citizens or resident aliens 2013 Cengage Learning

S Corporation Pass Through Items  Many items retain tax character when passing through to the S Corporation’s shareholders on individual K-1  Examples of such items include ◦ Capital gains/losses ◦ §1231 gains/losses ◦ Dividend Income ◦ Charitable contributions ◦ Tax-exempt interest ◦ Most credits 2013 Cengage Learning

Shareholder Basis in Stock  A shareholder’s initial basis in his/her stock is calculated as follows Basis of property transferred Less Boot received* Plus Gain recognized Less Liabilities transferred Equals 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 *Boot is any property other than stock 2013 Cengage Learning Note: generally, corporate assumption of shareholder liabilities that are attached to property are not considered boot received

Accumulated Earnings Tax (AET)  Penalty tax designed to prevent a corporation from avoiding tax by retaining earnings  15% AET imposed on “unreasonable” accumulation of earnings; this is in addition to corporate income tax o Corporation may accumulate up to $250,000 a year that is exempt from AET tax or $150,000 for a service corporation o May accumulate more if can prove a valid business purpose 2013 Cengage Learning