Chapter 3 3 The Corporate Income Tax

Filing Requirements and Computing the Tax

Slide C3-3 Filing Requirements C corporations are separate tax-paying and tax- reporting entities from their owners Annual tax returns required Form 1120 or Form 1120-A (corporations with gross receipts, total income and total assets < $500,000) Original due date is the 15 th day of the third month following the fiscal year-end [IRC §6072(b)] Can obtain an automatic 6 month extension of time to file using Form 7004 [IRC §6081] Extension of time to file the tax return does not extend the time for paying the tax

Slide C3-4 The Corporate Tax Formula For C Corporations: Total Income - Allowable Deductions Taxable Income before NOLs and Special Deductions - NOLs and Special Deductions =Taxable Income

Slide C3-5 Corporate Tax Rates [IRC §11(b)(1)] If TI is overBut not overThe tax is:Of TI less: $050,00015%$0 50,00075,000$7, %50,000 75,000100,00013, %75, ,000335,00022, %100, ,00010,000,000113, %335,000 10,000,00015,000,0003,400, %10,000,000 15,000,00018,333,3335,150, %15,000,000 18,333, ,416, %18,333,333

Slide C3-6 Corporate Tax Rates Exception: Personal Service Corporations Taxed at a flat 35% [IRC §11(b)(2)] Definition [IRC §448(d)(2)]

Slide C3-7 Example 1a: Computing the Tax The Purple Corporation has taxable income of $125,000. What is the tax before credits if this corporation is not a personal service corporation? Answer: 22,250 + (125,000 – 100,000) x 39% = $32,000

Slide C3-8 Example 1b: Computing the Tax The Purple Corporation has taxable income of $125,000. What is the tax before credits if this corporation is a personal service corporation? Answer: 125,000 x 35% = $43,750

Slide C3-9 Example 2a: Computing the Tax The Green Corporation has taxable income of $425,000. What is the tax before credits if this corporation is not a personal service corporation? Answer: 113,900 + (425,000 – 335,000) x 34% = $144,500 Alternatively: 425,000 x 34% = $144,500

Slide C3-10 Example 2b: Computing the Tax The Green Corporation has taxable income of $425,000. What is the tax before credits if this corporation is a personal service corporation? Answer: 425,000 x 35% = $148,750

Tax Accounting Periods

Slide C3-12 Accounting Periods Generally, a corporation’s tax period is the same as its fiscal period for financial accounting purposes [IRC §441(b)(1) and (c)] Can be any 12 month period ending on the last day of any month [IRC §441(d) and (e)] Can elect a 52/53 week around the end of any month [IRC §441(f)] Short tax periods (less than 12 months) may occur in a corporation’s first or last years of business, or in the year of a change in accounting period

Slide C3-13 Accounting Periods Exception: Personal Service Corporations Definition [IRC §441(i)(2)] Principal activity is performance of personal services By owner-employees who own more than 10% of stock Must use a calendar year unless can establish, to the satisfaction of the IRS, a business purpose for using a different fiscal year [IRC §441(i)(1)] Can elect a different year-end if deferral period is not longer than 3 months [IRC §444(a) and (b)(1)] If minimum distribution requirements are not met, deductions for payments to owner/employees of PSCs are limited of deferred to future years [IRC §280H]

Slide C3-14 Changing Accounting Periods Corporation can just pick a year-end for its first tax return but after that, IRS approval is generally required to change tax years [IRC §442] Regulations and Rev. Proc allow an automatic approval of a change in accounting period if certain conditions are strictly met [Reg. § (c)]

Slide C3-15 Changing Accounting Periods If a short period return results from a change in accounting period, the tax is calculated using the “annualized” taxable income method [IRC §443]

Slide C3-16 Example 3a: Short Periods The Blue Corporation (not a PSC) files a tax return for the short period September 1st to December 31st. Taxable income reported in the short period return is $82,000. What is the tax for the short-period if this is the corporation’s first year of business? Answer: 13,750 + (82,000 – 75,000) x 34% = $16,130

Slide C3-17 Example 3b: Short Periods The Blue Corporation (not a PSC) files a tax return for the short period September 1st to December 31st. Taxable income reported in the short period return is $82,000. What is the tax for the short-period if the corporation changed its fiscal year from August to December? Answer: Annualized TI = 82,000 x 12/4 = $246,000 Tax on ATI = 22,250 + (246,000 – 100,000) x 39% = $79,190 Tax due for the short period = 79,190 x 4/12 = $26,397

Tax Accounting Methods

Slide C3-19 Accounting Methods Accounting method determines when an item of income or expense is included in taxable income Method is selected in the corporation’s first tax return Must get IRS consent to change accounting methods once established [IRC §446(e) and (f)] Method taxpayer regularly uses to compute income in per books [IRC §446(a)] Method must “clearly reflect income” or IRS can impose a different method [IRC §446(b)]

Slide C3-20 Accounting Methods Overall accounting methods that are generally permissible include [IRC §446]: Cash method Accrual method Hybrid method

Slide C3-21 Accounting Methods Exception: C corporations generally cannot use the cash method [IRC §448(a)(1)] Exception 1: Qualified farming businesses may use cash method [IRC §448(b)(1) and (d)(1)] Exception 2: Qualified personal service corporations may use cash method [IRC §448(b)(2) and (d)(2)] Exception 3: Corporations with gross receipts of not more than $5,000,000 may use cash method [IRC §448(b)(3)]

Slide C3-22 Cash Method Income is generally taxable when it is received or constructively received [Reg. § (c)(1)(i)] Exception: Inventory sales must be accounted for using the accrual method [Reg. § (c)(2)(i)]

Slide C3-23 Cash Method Expenses are generally deductible when they are actually paid [Reg. § (c)(1)(i)] Exception: Inventory purchases and cost of goods sold must be accounted for using the accrual method [Reg. § (c)(2)(i)] Exception: Prepaid interest must be deducted when accrued rather than when paid [IRC §461(g)] Exception: Payments creating assets with useful lives of more than one year must be capitalized [IRC §263] These may then be depreciated or amortized