Income Tax Fundamentals 2010 Gerald E. Whittenburg & Martha Altus-Buller Student’s Copy 2010 Cengage Learning

 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’ - occurs when tax rate schedules recaptures 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

 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 2010 Cengage Learning

 Corporations are allowed a deduction for a % of the dividends received from other corporations ◦ Attempt to alleviate triple taxation  Dividends received deduction is allowed based upon ownership 2010 Cengage Learning Percentage Ownership Dividends Received % Deduction < 20% 70% 20% or more, less than 80% 80% > 80% 100% Deductions limited by % and other items

 Examples of organizational expenditures ◦ Legal/accounting services incidental to organization ◦ Incorporation fees  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 organizational expenses exceed $50, Cengage Learning

 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 chapter for other items included on Schedule M Cengage Learning

 Certain 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 2010 Cengage Learning

 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 2010 Cengage Learning

 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 losses on a daily basis 2010 Cengage Learning

 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 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 2010 Cengage Learning Note: generally assumption of shareholder liabilities that are attached to property are not considered boot received.