1. 1 Chapter 3: The Corporate Income Tax

2. 2 THE CORPORATE INCOME TAX  Tax years  Accounting methods  Taxable income & tax liability  Controlled groups  Compensation planning  Estimated taxes  Filing requirements

3. 3 Selecting a Tax Year (1 of 2)  New corp elects tax year by filing return  First return may be for short-period  Some corporations restricted  S-corporation uses calendar year  Affiliated group member must be same as parent  PSCs usually calendar year

4. 4 Selecting a Tax Year (2 of 2)  Changing the tax year  Usually requires IRS approval  Automatic approval if  No change within last 10 years  Short period does not have a NOL  Annualized short period is at least 80% of last years income  Special status does not change  No S election in the following year

5. 5 Accounting Methods  Accrual  GAAP: generally required for C corps  Cash  Qualified PSC, or C corp w/ gross receipts < $5M  Inventories cannot be significant  If inventories significant, must use accrual method for sales, COGS, inventories, accts. rec., & accts. pay. (the hybrid method)  Family farm w/ gross receipts < $25M

6. 6 Tax Formula: General (1 of 3) Gross Income -Deductions and Losses -Special Deductions =Taxable Income xAppropriate Rate (or rates) =Regular Tax Liability before credits

7. 7 Tax Formula: General (2 of 3) Regular Tax Liability before credits -Foreign tax credit -Other Credits +Credit recapture =Regular tax liability

8. 8 Tax Formula: General (3 of 3) Regular Tax Liability +AMT Liability +Special Taxes (if any) -Estimated Payments =Refund or tax due  See Table C3-1 for regular tax and AMT calculations

9. 9 Tax Formula: AMT (1 of 2) Taxable Income before NOL adj +Tax preference items +/-Adjustments to income +/-ACE adjustment factor -AMT NOL deduction =AMT taxable income -Statutory exemption =AMT Tax Base

10. 10 Tax Formula: AMT (2 of 2) AMT Tax Base xAMT Rate =Tentative Minumum tax before credits -AMT foreign tax credit -AMT investment credit -Regular tax liability =AMT Liability

11. 11 Corporate Taxable Income (1 of 3)  Deductions and losses  Capital gains and losses  Depreciation recapture  Business expenses  Organizational costs  Start-up costs

12. 12 Corporate Taxable Income (2 of 3)  Accrued compensation  Charitable contributions  Dividends received deduction  Net operating losses  Sequencing charitable, DRD, and NOL deductions

13. 13 Corporate Taxable Income (3 of 3)  Shareholder transactions  At-risk rule  Tax computation  PSCs

14. 14 Deductions and Losses (1 of 3)  No §212 deductions  No personal exemptions  No standard deduction  Not subject to hobby loss limitations  Not subject to investment interest limit

15. 15 Deductions and Losses (2 of 3)  Public firms not subject to PAL limitation  Amortization of organization costs  Amortization of start-up costs  Special dividends received deduction

16. 16 Deductions and Losses (3 of 3)  Net capital losses not deductible  Casualty losses fully deductible  Charitable contribution limits

17. 17 Capital and §1231 Gains and Losses (1 of 2)  Net capital gain taxed at ordinary income rates  Net capital losses cannot offset ordinary income  Net capital losses carryback 3 years and forward 5 years  Expired losses are lost forever

18. 18 Capital and §1231 Gains and Losses (2 of 2)  §1231 property  Certain business property subject to depreciation & held long-term  Net gain treated as LTCG  Net loss treated as ordinary

19. 19 Depreciation Recapture (1 of 3)  §1245 Property  Personal property (tangible or intangible)  Other tangible personal property used as integral part of manufacturing, production, extraction or in certain services  Livestock  §1245 Recapture  All gain up to depreciation previously taken classified as ordinary income

20. 20 Depreciation Recapture (2 of 3)  §1250 property  Real property subject to depreciation under §167 but not subject to recapture under §1245  Mainly buildings and structural components placed into service prior to between 1/1/81 and 12/31/86.

21. 21 Depreciation Recapture (3 of 3)  §1250 property sold at a gain  Amount of depreciation in excess of straight line is characterized as ordinary income plus  An additional 20% of all depreciation characterized as ordinary income under §291

22. 22 Business Expenses  All ordinary and necessary expenses reasonable in amount  No deductions for  Interest on loans to buy tax exempts  Illegal bribes or kickbacks  Fines or penalties  Insurance premiums if corp is beneficiary

23. 23 Organizational Costs (1 of 2)  Expenses incident to creating corp  §248 election filed w/ first tax return  May expense first $5K of org costs  $5K reduced $ for $ when org costs > $50K  Amortize remainder over  60 months

24. 24 Organizational Costs (2 of 2)  Expenditures must be incurred before end of first year of business  Failure to file election  Capitalize with no amortization

25. 25 Start-up Costs (1 of 3)  Non-organizational  Ordinary and necessary expenses  Paid or incurred BEFORE the actual start of business operations

26. 26 Start-up Costs (2 of 3)  Examples of include expenses to:  Investigate creation or acquisition of an active trade or business  Create an active trade or business  Conduct an activity engaged in for profit or production of income before business operations begin

27. 27 Start-up Costs (3 of 3)  Election to expense first $5K of org costs  $5K reduced $ for $ when org costs > $50K  Remainder amortized over  180 months Election must be made by due date for filing tax return for first year of operation or ownership  Failure to file election  Capitalize with no amortization

28. 28 Accrued Compensation  Accrued bonuses/compensation must be paid w/in 2-1/2 months after close of tax year  If paid after 2-1/2 months, payment deemed deferred compensation and is deductible in year paid

29. 29 Charitable Contributions (1 of 3)  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

30. 30 Charitable Contributions (2 of 3)  Donated money  Deduction equals amount donated  Non-cash property  Amount USUALLY equal to FMV of property donated  Ordinary income property  Deduction limited to FMV less Ord Inc or STCG that would have been recognized if property were sold (includes recapture)

31. 31 Charitable Contributions (3 of 3)  Non-cash property  Certain inventory related to exempt fn.  Deduction = adjusted basis + 1/2 gain  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

32. 32 U.S. Production Activities Deduction (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

33. 33 U.S. Production Activities Deduction (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

34. 34 Dividends Received (1 of 3)  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

35. 35 Dividends Received (2 of 3)  Corps owning  20% of a domestic corp deduct lesser of:  80% of dividends received or  80% 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

36. 36 Dividends Received (3 of 3)  Members of an affiliated group  100% deduction for dividends received from members of group  No deduction is allowed if :  Paying corp is a foreign corp  Stock purchased w/borrowed money  Stock of paying corp held for < 46 days

37. 37 Net Operating Loss  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

38. 38 Sequencing Charitable, DRD, & NOL deductions  Charitable contributions, DRD, NOL, and all other deductions must be taken in the following order  1. All other deductions  2. Charitable contributions  3. DRD  4. NOL  5. U.S. production activities deduction

39. 39 Shareholder Transactions (1 of 2)  Special rules apply to s/h who own >50% of corp  §1239 sale of depreciable property to corp causes gain to be ordinary income to the controlling shareholder  §267 disallows loss on sale of property by corp to controlling s/h  Loss may be recovered by s/h if later sells prop at a gain

40. 40 Shareholder Transactions (2 of 2)  Special rules apply to s/h who own >50% of corp (continued)  Corporation and s/h using different accounting methods  Defers deduction for accrued expenses owed by accrual-method corp to cash- method controlling s/h until income recognized by cash-method s/h

41. 41 At-Risk Rule and Passive Activity Limitations  If 5 or fewer s/hs own > 50% of the stock, the corp’s losses are limited to amount corp has “at risk”  Losses not currently deductible are carried over to be used in a later year  PSCs and closely held corps subject to passive activity limitation rules

42. 42 Tax Computation  The tax rates are graduated  Rate surcharges eliminate benefit of lower graduated tax rates from lower income brackets  Corps with income >$18.33M pay a flat 35% on all income

43. 43 Personal Service Corporations (1 of 2)  PSCs taxed at a flat 35%  PSC is defined as a corp that:  Substantially all of the activities involve services in the following fields:  Health, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting

44. 44 Personal Service Corporations (2 of 2)  Substantially all stock must be owned by employees, former employees or survivors of employees

45. 45 Controlled Groups (1 of 8)  Two or more corps owned directly or indirectly by same shareholder or group of shareholders  Types of controlled groups  Parent-subsidiary  Brother-sister  Combined

46. 46 Controlled Groups (2 of 8)  Parent-subsidiary  One corp directly owns at least:  80% of voting power of all classes of voting stock OR  80% of total value of all classes of stock of subsidiary corporation

47. 47 Controlled Groups (3 of 8)  Brother-sister  50%-80% 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 the 2 nd test above

48. 48 Controlled Groups (4 of 8)  Combined groups  Three or more corps which meet the following criteria:  Each corporation is a member of a parent- subsidiary or brother-sister group  At least one is both a parent and a member of a brother-sister group

49. 49 Controlled Groups (5 of 8)  Combined groups (continued)  Following allocated among members based on 50% only test:  $100,000 exemption for the 5% surcharge on TI & the $15M exemption for the 3% surcharge on TI  $40,000 AMT exemption amount  The $250,000 minimum accumulated earnings credit

50. 50 Controlled Groups (6 of 8)  Combined groups (continued)  Following allocated among members based on 50%-80% test  $105,000 (in 2005)§179 expense amount  The $25,000 general business credit limitation  No loss on sale of assets between members

51. 51 Controlled Groups (7 of 8)  Affiliated groups  One or more chains of includible corps connected through stock ownership to a common parent  Common parent directly owns  80% of voting power & value of at least one includible corporation  Each corp owned at least 80/80 by another member of the group

52. 52 Controlled Groups (8 of 8)  Affiliated groups (continued)  An affiliated group MAY file a consolidated return  Capital losses offset capital gains from other group members  Operating losses reduce operating income from other group members

53. 53 Compensation Planning (1 of 2)  Salary payments  Reduce double taxation if paid to s/h- employees  Fringe benefits  Deducted by corporation and certain benefits are not be taxable to s/h- employee

54. 54 Compensation Planning (2 of 2)  Limitation of deductible compensation payments for s/h- employees  Compensation must be reasonable  Unreasonable portion reclassified as a dividend

55. 55 Estimated Taxes  Estimated taxes required if corp owes >$500 for current year.  Pay in four installments  Each installment 25% of annual liability  Underpmt of estimated tax penalty  Small corps exempt from penalty if  Pay in lesser of 100% of prior or current year’s tax liability

56. 56 Filing Requirements  Return is required each year regardless of income  Use form 1120  Use form 1120A if gross receipts, total income & total assets each < $500K  Large corps (assets>$10M) must fill out more detailed schedule M-3

57. 57 Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com