1. Welcome to Federal Income Tax: Business Entities ACNT 1347 Course # 12690
Atef Abuelaish

2. Instructor Name : Atef Abuelaish
Married with 3 kids, Born in Cairo/Egypt.
Like traveling, Reading, and Sports activities.
Master of Science in Accounting, Kaplan University.
Master Tax Advisor, Enrolled Agent.
Accreditation council for accountancy & Taxation [ATP # ].
Working with HR Block for 10 years.
Atef Abuelaish

3. Instructor Name : Atef Abuelaish
Accountant with long experiences with domestic and international companies.
Master of Science in Accounting, Kaplan University [3.92 GPA; Highest honor].
Bachelor degree in accounting and diploma in accounting applied science [3.85 GPA - highest honor].
Atef Abuelaish

4. Contact Me Email address: atef.abuelaish1@hccs.edu Cell # 832-474-1118
Online
Eagle Online
McGraw – Hill’s Connect
HCC – Learning Web
All Course materials under the course name and number.
Atef Abuelaish

5. Assigning Tax Return - Course Project
Meet
NO.
Dates
Chapter
Topic
Homework Assignment 1
06/10 15
Entities Overview
Using Connect – 6 Questions & Learning Smart for 60 Points. 2
06/17 16
Corporate Operations 17
Accounting for Income Tax
Assigning Tax Return - Course Project 3
06/24 18
Corporate Taxation: Non-Liquidating Distributions
Quiz # 1 – CH 15, 16, and 17, at Home on Connect for 25 Points.
Atef Abuelaish

6. Corporate Formation, Reorganization, and Liquidation
Meet
NO.
Dates
Chapter
Topic
Homework Assignment 3
06/24 19
Corporate Formation, Reorganization, and Liquidation
Using Connect – 6 Questions & Learning Smart for 60 Points 4
07/01 20
Forming and Operating Partnership 21
Dispositions of Partnership Interests and Partnership Distributions
Case Study in Class # 1 5
07/08 22
S Corporations
Using Connect – 4 Questions & Learning Smart for 60 Points
Atef Abuelaish

7. Chapters 15, 16, 17, 18, and 19 for 90 Points
Meet
NO.
Dates
Chapter
Topic
Homework Assignment 5
07/08 MT
MID – TERM EXAM
Chapters 15, 16, 17, 18, and 19 for 90 Points
Using Connect 6
07/15 23
State and Local Taxes
Using Connect – 3 Questions & Learning Smart for 60 Points TR
1065
Case Study in Class # 2
For Form 1065 7
07/22 24
The U. S. Taxation of Multinational Transactions
Quiz # 2 – CH 21, 22, and 23, at Home on Connect for 25 Points
Atef Abuelaish

8. COURSE FINAL EXAM 7 07/22 25 Transfer Taxes and Wealth Planning
Meet
NO.
Dates
Chapter
Topic
Homework Assignment 7
07/22 25
Transfer Taxes and Wealth Planning
Using Connect – 4 Questions & Learning Smart for 60 Points
Turn-in Tax Return (Project) for 100 Points for Grading. 8
07/29 TR
Course Tax Return (Project) Presentation
FINAL
COURSE FINAL EXAM
Chapters 01 – 11 & 13
20, 21, 22, 23, 24, and 25 for 100 Points, Using Connect;
In class room
Atef Abuelaish

9. Evaluation Requirements
Homework – At Home Points
2 Quizzes Points
Mid-Term Exam – In Class Points
Final Exam – In Class Points
Individual T. Return Points
Grand Total points
Atef Abuelaish

10. HCC Grading Scale 90 – 100% = A 901 –1000 points
80 – 89% = B – 900 points
70 – 79% = C – 800 points
60 – 69% = D – 700 points
BELOW 60% = F – 600 points
Atef Abuelaish

11. COURSE PLAN
Syllabus: Service to direct the activities that all of us must undertake to move everyone from where he/she is, to where he/she wants to be.
Atef Abuelaish

12. An Introduction to Tax
Atef Abuelaish

13. Who cares about taxes? 1) Businesses:
What organizational form should a business use?
Where should the business locate?
How should business acquisitions be structured?
How should the business compensate employees?
What is the appropriate mix of debt and equity for the business?
Should the business rent or own its equipment and property?
How should the business distribute profits to its owners?
Atef Abuelaish

14. Who cares about taxes? 2) Politicians:
Politicians often distinguish themselves from their opponents based on their tax rhetoric.
Voters must have basic knowledge of taxes to evaluate the merits of alternative tax proposals.
Atef Abuelaish

15. Who cares about taxes? 3) Individuals: Would you like to own a home?
Tax deductions for home mortgage interest and real estate taxes can reduce the after-tax costs of owning a home.
Would you like to retire?
Understanding the tax-advantaged methods of saving for retirement can increase the after-tax value of your retirement nest egg.
Atef Abuelaish

16. What qualifies as a Tax?
A Tax is a payment required by a government agency that is unrelated to any specific benefit or service received from the government agency.
Key components of a tax:
Payment required
Payment imposed by government agency (federal, state, local)
Payment not tied directly to benefit received by the taxpayer.
Atef Abuelaish

17. Tax Question? Which of the following constitute a tax?
Payment for drivers license?
(Not a tax)
Payment for required (by government) house appraisal?
Payment for hotel use of 1% of bill to pay for city projects.
(A tax)
Payment for rental car use of 3% of bill to pay for the roads.
Atef Abuelaish

18. How to calculate a Tax? To calculate a tax, a taxpayer must know:
Tax Rate: level of taxes imposed on the tax base and is usually expressed as a percentage
Tax Base: defines what is actually taxed and is usually expressed in monetary terms
Tax = Tax Base * Tax Rate
Atef Abuelaish

19. Different ways to measure tax rates
1) Marginal Tax Rate: the tax rate that applies to the next additional increment of a taxpayer’s taxable income.
2) Average Tax Rate: the taxpayer’s average level of taxation on each dollar of taxable income.
3) Effective Tax Rate: the taxpayer’s average rate of taxation on each dollar of total income (both taxable and non-taxable)
Atef Abuelaish

20. Tax Rates Example
Bill and Mercedes have $160,000 of taxable income and additional $10,000 of nontaxable income. Using the 2017 married-joint tax rates, what is their tax due, average tax rate, and effective tax rate? If they receive an additional $80,000 of taxable income, what is their marginal tax rate on this income?
Atef Abuelaish

21. Tax Rates Solution Tax Due = $39,977, computed as:
Average tax rate: 24.99% ($39,977 /160,000)
Effective tax rate: 23.52% ($39,977 /170,000)
Marginal tax rate: 22.77% ($58,193 - $39,977 )/ ($240,000 - $160,000)
Atef Abuelaish

22. Tax Rate Structures
1) Proportional Tax Rate (Flat Tax): imposes a constant tax rate throughout the tax base.
2) Progressive Tax Rate: imposes an increasing marginal tax rate as the tax base increases.
3) Regressive Tax Rate: imposes a decreasing marginal tax rate as the tax base increases.
Atef Abuelaish

23. Tax Rate Structure Question
How would a chart look which is mapping out the three different tax structures?
Atef Abuelaish

24. Tax Rate Structures Example
Atef Abuelaish

25. Break for Minutes
Atef Abuelaish

26. Types of Taxes 1) Federal Taxes: Income taxes
Employment and unemployment taxes
Excise taxes
Transfer taxes
2) State and local taxes:
Sales and use taxes
Property taxes
3) Implicit taxes
Atef Abuelaish

27. 1) Federal Taxes Income taxes
Represents approximately 55.3% of all tax revenues collected in the United States (Individuals 47.4% and Corporations 7.9%)
Levied on individuals, corporations, estates, and trusts
Employment and Unemployment taxes
Second largest group of taxes imposed by the U.S. government
Employment taxes include the OASDI (Social Security tax), and the MHI tax (Medicare tax)
Unemployment taxes fund temporary unemployment benefits for individuals terminated from their jobs without cause
Atef Abuelaish

28. 1) Federal Taxes Excise taxes
Third largest group of taxes imposed by the U.S. government
levied on the quantity of products sold
Estate and Gift taxes
levied on the fair market values of wealth transfers upon death or by gift
Atef Abuelaish

29. 2) State and Local Taxes Sales and Use taxes Property taxes
Tax base for a sales tax is the retail sales of goods and some services
Tax base for the use tax is the retail price of goods owned, possessed or consumed within a state that were not purchased within the state
Property taxes
Property taxes are ad valorem taxes, meaning that the tax base for each is the fair market value of the property
Real property taxes consists of taxes on land and structures permanently attached to land
Personal property taxes includes taxes on all other types of property, both tangible and intangible
Atef Abuelaish

30. 2) State and Local Taxes Income taxes
Most state taxable income calculations largely conform to the federal taxable income calculations, with a limited number of modifications
Excise taxes
States typically impose excise taxes on items subject to federal excise tax
Atef Abuelaish

31. 3) Implicit Taxes
Indirect taxes that result from a tax advantage the government grants to certain transactions.
Defined as the reduced before-tax return that a tax-favored asset produces because of its tax advantaged status
Difficult to quantify but important to understand in evaluating the relative tax burdens of tax-advantaged investments Income taxes
Atef Abuelaish

32. How to evaluate different tax systems?
Sufficiency: involves assessing the aggregate size of the tax revenues that must be generated and making sure that the tax system provides these revenues.
Equity: how the tax burden should be distributed across taxpayers.
Certainty: means that taxpayers should be able to determine when to pay the tax, where to pay the tax, and how to determine the tax.
Convenience: tax system should be designed to be collected without undue hardship to the taxpayer.
Economy: should minimize the compliance and administration costs associated with the tax system.
Atef Abuelaish

33. Sufficiency Types of revenue forecasting:
Static: Forecasting revenue ignores how taxpayers might alter their activities in response to a tax law change and to base projected tax revenues on the existing state of transactions.
Dynamic: Forecasting which tries to predict possible responses by taxpayers to new tax laws.
Income Effect: as tax rates go up, people will work harder to maintain same after-tax income.
Substitution Effect: as tax rates go up, people will substitute non-taxable activities because the marginal value of taxable ones has decreased.
Atef Abuelaish

34. Equity
In general terms, a tax system is considered fair or equitable if the tax is based on the taxpayer’s ability to pay.
Horizontal Equity: two taxpayers in similar situations pay the same tax.
Vertical Equity: taxpayers with greater ability to pay tax, pay more tax relative to taxpayers with a lesser ability to pay tax.
Atef Abuelaish

35. Taxation on the CPA Examination Regulations
Taxation is included in 3hrs Regulation section as follows:
Federal tax procedures and accounting issues %
Federal taxation of property transactions 12-16%.
Federal taxation – individuals 13-19%.
Federal taxation – entities 18-24%.
Multiple choice questions & case study [simulations].
Multiple choice is 3 testlets [Q24-30]
2 testlets for simulations.
Atef Abuelaish

36. Chapter 15
Entities Overview
Atef Abuelaish

37. Learning Objectives
Discuss the legal and nontax characteristics of different types of legal entities.
Describe the different types of entities for tax purposes.
Identify fundamental differences in tax characteristics across entity types.
Atef Abuelaish

38. Entity Legal Classification and Nontax Characteristics
Corporation, limited liability company (LLC), general partnership (GP), limited partnership (LP), sole proprietorship
Business owners legally form
Corporation – file articles of incorporation
LLC – file articles of organization
GP – written agreement called partnership agreement
LP – written agreement and file a certificate of limited partnership
Sole proprietors are not required to formally organize their business with the state
Atef Abuelaish

39. Entity Legal Classification and Nontax Characteristics
Responsibility for Liabilities
Corporations and LLCs are solely responsible
Partnerships – GPs are ultimately responsible and LPs are not responsible
Sole proprietorships – Individual owners are responsible (unless single member LLC)
Rights, Responsibilities, and Legal Arrangement among Owners
Atef Abuelaish

40. Entity Legal Classification and Nontax Characteristics
Atef Abuelaish

41. Entity Tax Classification
Business entities classification for tax purposes
Check the box regulations
Taxpaying entities
Flow-through entities
Corporations are C corporations unless shareholders make a valid S election
Unincorporated entities
taxed as partnerships if they have more than one owner
taxed as sole proprietorships if owned by an individual or as disregarded entities if held by some other entity
may elect to be taxed as C corporations
Atef Abuelaish

42. Entity Tax Classification
Check the box regulations summary
Atef Abuelaish

43. Entity Tax Characteristics
Double Taxation
Income generated by flow-through entities is taxed only once while income of C corporations is taxed twice
Flow-through entity owners pay tax on their share of income as if they had earned it themselves
Corporations pay first level of tax on their taxable income at the corporate marginal tax rate
Current marginal tax rate
Lowest – 15 percent and highest – 39 % - Individual.
Most profitable corporations – 35 %
Shareholders are subject to double taxation when second level of tax is paid
Atef Abuelaish

44. Entity Tax Characteristics
After-Tax Earnings Distributed
1) Individual Shareholders
Pay second tax at 0, 15, or 20 percent depending on taxpayers income level
May also pay 3.8 net investment income tax, depending on income level
Individual shareholders’ overall tax rates will be higher with a corporation when the corporation’s marginal tax rate is expected to be greater than or equal to the shareholders’ marginal tax rates
Atef Abuelaish

45. Lounch Break for 30 Minutes
Atef Abuelaish

46. Double Tax Example
Assume that Nicole did some income projections to help her determine the taxable form of her business. She makes the following assumptions:
CCS earns taxable income of $350,000.
CCS will pay out all of its after-tax earnings annually as a dividend.
Her ordinary marginal tax rate is 33 % and her dividend tax rate is 18.8 % (including 3.8% net investment income tax).
Given these assumptions, if Nicole organizes CCS as a corporation, what would be the overall tax rate on CCS’s income (corporate-level tax + shareholder-level tax)/taxable income)?
Atef Abuelaish

47. Double Tax Example Solution
Atef Abuelaish

48. Entity Tax Characteristics
After-Tax Earnings Distributed
2) Corporate Shareholders
Dividends are subject to corporate ordinary rates
Corporations receiving dividends are potentially subject to third level of tax
Dividend received deduction (DRD) can be claimed for dividends
DRD percentage is 70, 80, or 100% depending on the extent of recipient corporation’s ownership in the dividend-paying corporation
Atef Abuelaish

49. Entity Tax Characteristics
After-Tax Earnings Distributed
3) Institutional Shareholders
Do not pay shareholder-level tax on dividends
4) Tax- Exempt and Foreign Shareholders
Organizations like churches and universities are exempt from tax on investment income including dividend income
Atef Abuelaish 49

50. Entity Tax Characteristics
Some or all After-Tax Earnings Retained
Individual shareholders
Share value (capital gains) increases when after-tax earnings are retained
Capital gains are taxed at 0, 15, or 20 percent rate depending on taxpayer’s income level
May also pay 3.8 percent on net investment income, depending on income level
Taxes on capital gains must be discounted to reflect their present value
Personal Holding Company tax and accumulated earnings taxes prevent corporations from unnecessarily retaining earnings
Atef Abuelaish

51. Entity Tax Characteristics
Mitigating the Double Tax
Strategies for reducing the corporate-level tax
Paying salaries to shareholders
Paying fringe benefits to shareholders
Leasing property to shareholders
Pay interest on loans to shareholders
Strategies for reducing the shareholder-level tax
Retain earnings
Hold stock before selling
Atef Abuelaish

52. Entity Tax Characteristics
Deductibility of Entity Losses
C corporations with NOL for the year can carry back the loss to offset taxable income reported in the two preceding years and carry it forward for up to 20 years
Losses from C corporations are not available to offset their shareholders’ personal income
Atef Abuelaish

53. Entity Tax Characteristics
Deductibility of Entity Losses
Losses generated by flow-through entities are generally available to offset the owners’ personal income, subject to certain restrictions
Ability to deduct flow-through losses against other sources of income can be a significant issue for owners of new businesses as they tend to report losses early on as they get established
Atef Abuelaish

54. Entity Loss Example 1
Assume that Nicole will organize CCS as a C corporation and that in spite of her best efforts as CEO of the company, CCS reports a tax loss of $50,000 in its first year of operation (year 1). Also, recall Nicole’s marginal tax rate is 33 % and assume she will have ordinary taxable income of $200,000 from her husband’s salary in year 1. How much tax will CCS pay in year 1 and how much tax will Nicole (and her husband) pay on the $200,000 of other taxable income if CCS is organized as a C corporation?
Atef Abuelaish

55. Entity Loss Example 1 Solution
Answer: CCS will pay $0 in taxes because it reports a loss for tax purposes. Because Nicole may not use the CCS loss to offset her other income, she must pay $66,000 in taxes ($200,000 × 33%).
Atef Abuelaish 55

56. Entity Loss Example 2
Suppose CCS is organized as an S corporation and Nicole’s basis in CCS before the year 1 loss is $50,000. How much tax will CCS pay in year 1, and how much tax will Nicole (and her husband) pay on the $200,000 of other income?
Atef Abuelaish

57. Entity Loss Example 2 Solution
Answer: CCS pays $0 taxes (S corporations are not taxpaying entities) and Nicole pays $49,500 in taxes.
Atef Abuelaish 57

58. Entity Loss Examples 1 and 2 Summary
Atef Abuelaish

59. Entity Loss Example 3
Suppose CCS is organized as an S corporation and Nicole’s basis before the $50,000 year 1 loss is $100,000. Further, assume that Nicole does not participate in CCS’s business activities; that is, assume she is a passive investor in the business entity. How much tax will Nicole (and her husband) pay on the $200,000 of other income?
Atef Abuelaish 59

60. Entity Loss Example 3 Solution
Answer: CCS pays $0 taxes (S corporations are not taxpaying entities) and Nicole pays $66,000. Because Nicole is a passive investor, she is not allowed to deduct the loss allocated to her this year. She must carry it over and use it in future years (this assumes neither Nicole nor her husband have income from other investments in which they are passive investors).
Atef Abuelaish 60

61. Entity Tax Characteristics
Other differences between entities (See Exhibit 15-3)
Owner limitations (see Ch. 22)
Owner contributions of appreciated property to entity (see Chs. 19, 20, and 22)
Accounting periods (see Chs. 8, 20, and 22)
Overall accounting method (see Chs. 8, 16, 20, and 22)
Allocation of income or loss items to owners (see Chs. 20 and 22)
Atef Abuelaish 61

62. Entity Tax Characteristics
Other differences between entities (See Exhibit 15-3)
FICA and self-employment tax (see Chs. 20 and 22)
.9% additional Medicare tax
Share of flow-through entity debt included in basis of owner’s equity interest (see Chs. 20 and 22)
Nonliquidating distributions of noncash property (see Chs. 18, 21, and 22)
Liquidating entity (see Chs. 19, 21, and 22)
Atef Abuelaish 62

63. Entity Tax Characteristics
Converting to Other Entity Types
C corporations
Make election to S corporation
May not qualify to make S election
May liquidate and form as entity taxed as a partnership but tax cost of liquidation prohibitive
Entities taxed as partnerships or sole proprietorships
Generally tax free to form as a corporation
Very common in advance of IPO
Atef Abuelaish 63

64. Happiness is having all homework up to date
Homework assignment
Using Connect – 7 Questions for 60 Points; Chapter 15.
Prepare:
Chapter 16 “Corporate Operations.”
Chapter 17 “Accounting for Income Taxes.”
Happiness is having all homework up to date
Atef Abuelaish

65. Thank you and See You Next Week at the Same Time, Take Care
Atef Abuelaish