McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Principles of Taxation Chapter 10 The Corporate Taxpayer

Slide 10-2 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 The Corporate Taxpayer  Schedule M-1 reconciliation  Regular tax, credits, AMT  Payment and filing requirements  Double taxation  Tax incidence  Legal characteristics  Dividends-received deduction

Slide 10-3 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Corporation Legal Characteristics Limited liability of shareholders –How do owners of small business often become liable? Unlimited life (compare to partnerships?) Free transferability –How is this limited for closely held businesses? Centralized management

Slide 10-4 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Affiliated Groups and Consolidations.  Parent + all >= _____% subsidiaries. Do foreign subs qualify?  Is a consolidated return required?  What is the tax advantage to consolidated filing?  Like financial accounting, intercompany transactions are eliminated.

Slide 10-5 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Nonprofit Corporations  Section 501(c)(3) organizations require IRS recognition of tax-exempt status.  Nevertheless, tax-exempt organizations may pay tax on what activity?  Thinking question: What types of business activities do tax-exempt organizations do that put them in competition with for-profit taxpayers?

Slide 10-6 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Computing Corporate Taxable Income  Page 1 of the Form 1120 resembles a financial income statement or a Schedule C in a personal tax return (Ch 9).  Use chapters 5, 6, 7 and 8 for general rules on business income.  Other rules:  Deduct only ____% of meals and entertainment expenses.  Deduct charitable contributions up to ___% of taxable income BEFORE what deductions?

Slide 10-7 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Dividends-Received Deduction  Ownership Deduction  < 20% of stock _____% DRD  20%<= own < 80% _____% DRD  80%<= own _____% DRD  Reason for DRD?  Additional details: DRD can’t create loss - tricky computations not in this text.

Slide 10-8 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Book versus Taxable Income - Schedule M-1  This schedule reconciles book income to taxable income.  Net book income - line ___.  Federal tax expense for books - line ____.  Lines ______ explain increases in taxable income relative to books.  Lines ______ explain decreases in taxable income relative to books.  Line 10 = taxable income before NOLD and DRD = line ____ of form  Try problem AP7.

Slide 10-9 McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Book versus Taxable Income - Schedule M-1  Book-tax differences are scrutinized by IRS. Mills (1998 Journal of Accounting Research) shows that IRS audit adjustments are related to M-1 difference).  The Schedule M-1 contains permanent and temporary items.  The tax footnote in the financial statement contains numerous estimates of amounts that are finalized by the time the return is filed. Thus, Schedule M-1 will not exactly = amounts in F/S footnotes.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Computing Regular Tax  What do the surtax rates of 39% and 38% do?  Corporations with taxable income > $_______ million just pay a flat rate of 35% on all income.  Personal service corporations are taxed at a flat ____% rate.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Tax Credits  Why are credits better than deductions?  Tax credits are generally limited to some % of tax before credits. Often a provision permits carry back or carry forward of excess credits.  Biggest credits: R&D credit, foreign tax credit (see Chapter 12).

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Alternative Minimum Tax - Who is Subject?  New corporation exempt in year 1.  Exempt in year 2 if year 1 sales <=$___ million.  Exempt in year 3 if average (sales1+sales2) <= $___ million.  Exempt in subsequent years if average gross receipts for _____ prior years <= $7 million.  Once corporation fails to be exempt, it is ineligible for AMT exemption for all subsequent tax years.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 AMT Exemption Example  In which of the following years is the corporation exempt from AMT?  Year 1 sales = $4 million  Year 2 sales = $8 million  Year 3 sales = $10 million  Year 4 sales = $2 million  Subject to AMT all subsequent years.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Alternative Minimum Tax - Overview  20% of income under an alternative definition of taxable income that has fewer loopholes.  Alternative minimum taxable income (See next slide.)  less (exemption)  = AMTI in excess of exemption  x 20%  Tentative minimum tax (TMT)  less (regular tax)  Alternative minimum tax (AMT)

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Computing AMTI  Start with regular taxable income  Adjustments and preferences include:  Other differences between book and taxable income may create adjustments.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 AMT - More Details  Exemption = $________ - 25% (AMTI - $__________).  Minimum tax credit  In future year(s), when regular tax exceeds TMT, corporation may subtract a credit equal to prior year(s) AMT. Can’t reduce regular tax below what?  See AP16 for a nice example.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Payment and Filing Requirements  Tax return due 15th day of ___ month, may extend to 15th day of ____th month.  Estimated payments are due on the 15th day of __th, __th, __th, and __th months.  Must pay 100% of tax due. (What is the safe harbor rule for small corporations?)  Underpayment penalty is computed like interest expense but is nondeductible.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Distributions to Investors  Consider interest, dividends and wages:  Which payments are deductible to the corporation?  When are payments on stock treated as taxable dividends?  Payments in excess of earnings and profits are first a return of capital and then a gain to the shareholder.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Distributions to Investors  Why do corporations pay dividends? (This is still a puzzle.)  Investors may prefer that the corporation keep the funds and reinvest them; sell stock for a capital gain in future.  Double taxation unlikely to change in near future.  Many corporations borrow money because interest expense is deductible.

Slide McGraw-Hill/Irwin ©The McGraw-Hill Companies, Inc., 2002 Incidence of the Corporate Tax  Corporations do not pay taxes - people do.  What are examples of ways that the incidence of the corporate tax could be born by individual taxpayers in the U.S.?