1.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-1 McGraw-Hill/Irwin © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. The Corporate Taxpayer Chapter 10

2.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-2 The Corporate Taxpayer Legal characteristics Dividends-received deduction Schedule M-1 reconciliation Regular tax, credits, AMT Payment and filing requirements Double taxation Tax incidence

3.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-3 Corporation Legal CharacteristicsCorporation Legal Characteristics Limited liability of shareholders –Owners of closely-held corporations often are required to sign personal liability on bank debt. Unlimited life Free transferability –Closely-held corporations:buy-sell agreement may prevent transferability. Centralized management

4.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-4 Affiliated Groups and Consolidations  Parent + all >= 80% domestic subsidiaries.  Affiliated groups may elect to file a consolidated tax return - applies to all members of affiliated group.  Advantage: losses and profits of affiliated members offset. Like financial accounting, intercompany transactions are eliminated.  If the same individual(s) own 80% or more of more than one corporation, these corporations are a ‘controlled group’ (see Ch 11 end). They may not file a consolidated return, but the tax bracket benefits are limited.

5.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-5 Nonprofit Corporations  Section 501(c)(3) organizations require IRS recognition of tax-exempt status.  Nevertheless, tax-exempt organizations may pay tax on “unrelated business taxable income.”  Thinking question: what types of business activities do tax-exempt organizations do that put them in competition with for-profit taxpayers?

6.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-6 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.  Deduct only 50% of meals and entertainment expenses.  Deduct charitable contributions up to 10% of taxable income BEFORE charity and before dividends-received deduction.

7.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-7 Dividends-received Deduction  Ownership Deduction  < 20% of stock 70% DRD  20%<= own < 80% 80% DRD  80%<= own 100% DRD  Reason for DRD? Mitigate “triple” taxation.  Additional details: DRD can’t create loss - tricky computations not in this text.

8.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-8 Book Versus Taxable Income - Schedule M-1  This schedule reconciles book income to taxable income.  net book income - line 1  federal tax expense for books - line 2  lines 3 - 6 explain increases in taxable income relative to books.  lines 7 - 9 explain decreases in taxable income relative to books.  line 10 = taxable income before NOLD and DRD = line 28 form 1120  Try problem AP7.

9.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-9 Book Versus Taxable Income  Book-tax differences are scrutinized by IRS.  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 items will not exactly = amounts in F/S footnotes.

10.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-10 Computing Regular Tax  The surtax rates of 39% and 38% eliminate bracket benefits for ‘rich’ corporations.  Corporations with taxable income > $18.33 million just pay a flat rate of 35% on all income.  Personal service corporations are taxed at a flat 35% rate.

11.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-11 Tax Credits  Credits directly reduce computed tax. Deductions only reduce the income subject to tax. Thus, $1 of credit provides $1 of benefit. $1 of deduction only provides $1 x the tax rate.  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).

12.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-12 Alternative Minimum Tax - Who is Subject?  New corporation exempt in year 1.  Exempt in year 2 if year 1 sales <=$5 million  Exempt in year 3 if average (sales1+sales2) <= $7.5 million  Exempt in subsequent years if average gross receipts for three prior years <= $7.5 million.  Once corporation fails to be exempt, it is ineligible for AMT exemption for all subsequent tax years.

13.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-13 AMT Exemption Example  Year 1 sales = $4 million (exempt because it’s year 1)  Year 2 sales = $8 million (exempt because year 1 sales <=$5 million)  Year 3 sales = $12 million (exempt because average years 1 and 2 = $6 million, <= $7.5 million)  Year 4 sales = $2 million (subject to AMT because average 1, 2, 3 = $8 million, > $7.5 million)  Subject to AMT all subsequent years.

14.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-14 Alternative Minimum Tax - Overview  20% of income under an alternative definition of taxable income that has fewer loopholes.  Alternative minimum taxable income  less (exemption)  = AMTI in excess of exemption  x 20%  Tentative minimum tax (TMT)  less (regular tax)  Alternative minimum tax (AMT)

15.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-15 Alternative Minimum Tax - AMTI  Start with regular taxable income  Adjustments and preferences include:  Accelerated depreciation - AMT depreciation using slower methods.  Exception for post9/11 prop.  Excess of % depletion > cost depletion.  Deduction for NOL carryforward is limited to 90% of AMTI.  Other differences between book and taxable income may create adjustments.

16.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-16 AMT - More Details  Exemption = $40,000 - 25% (AMTI - $150,000).  Minimum tax credit.  In future year(s), when regular tax exceeds TMT, corporation may subtract a credit equal to prior year(s) AMT. See AP16.  Eliminating the AMT is a frequent tax debate in the news.

17.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-17 Payment and Filing Requirements  Tax return due 15th day of 3rd month, may extend to 15th day of 9th month.  Estimated payments are due on the 15th day of 4th, 6th, 9th, and 12th months.  Must pay 100% of tax due (small corporations (TI < $1 mill) may use safe- harbor rule of paying 100% of prior year tax).  Underpayment penalty is computed like interest expense but is nondeductible.

18.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-18 Distributions to Investors  Interest payments are deductible.  Payments on stock are non-deductible.  Payments on stock are taxable dividends to the shareholder if the corporation has either current or cumulative earnings and profits.  E&P similar to tax basis retained earnings  Payments in excess of earnings and profits are first a return of capital and then a gain to the shareholder.

19.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-19 Distributions to Investors  Nondeductibility of dividends makes paying dividends hard to explain.  One result is the high leverage of many corporations, because interest expense is deductible.  Investors may prefer that the corporation keep the funds and reinvest them; sell stock for a capital gain in future.  Will administration eliminate double taxation?

20.  Click to edit Master text styles  Second level  Third level  Fourth level  Fifth level #10-20 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.?  higher consumer prices  lower employee wages  lower dividends