1. 3-1 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

2. 3-2 THE CORPORATE INCOME TAX (1 of 2)  Corporate elections  Computing corporation’s taxable income  Computing a corporation’s income tax liability ©2011 Pearson Education, Inc. Publishing as Prentice Hall

3. 3-3 THE CORPORATE INCOME TAX (2 of 2)  Controlled groups of corporations  Tax planning considerations  Compliance and procedural considerations  Financial statement implications ©2011 Pearson Education, Inc. Publishing as Prentice Hall

4. 3-4 Corporate Elections 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

5. 3-5 Corporate Elections Tax Year (2 of 2)  Changing the tax year  Usually requires IRS approval  Automatic approval if  Annualizes short-period income  Keeps books based on new year  Short period does not have a NOL  No change in accounting period for 48 mo  No interest in flow-through entities  Not a specialized corporation ©2011 Pearson Education, Inc. Publishing as Prentice Hall

6. 3-6 Corporate Elections 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

7. 3-7 Computing a Corporation’s Taxable Income  Sales and exchanges of property  Business expenses  Special deductions  Exceptions for closely held corporations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

8. 3-8 Sales and Exchanges of Property Capital Gains and Losses  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  Carryovers classified as short-term  Expired losses are lost forever ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9. 3-9 Sales and Exchanges of Property §291 Tax Benefit Recapture Rule  §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  No §1250 recapture under MACRS ©2011 Pearson Education, Inc. Publishing as Prentice Hall

10. 3-10 Business Expenses  General rule  Organizational expenditures  Start-up expenditures  Limitations on deductions for accrued compensation  Charitable contributions ©2011 Pearson Education, Inc. Publishing as Prentice Hall

11. 3-11 General Rule  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

12. 3-12 Organizational Expenditures (1 of 2)  Expenses incident to creating corp  E.g., legal, accounting, temporary director fees, state incorporation fees  §248 election deemed to be made  No need to filed election w/ 1 st return  May expense first $5K of org costs  $5K reduced $ for $ when org costs > $50K ©2011 Pearson Education, Inc. Publishing as Prentice Hall

13. 3-13 Organizational Expenditures (2 of 2)  Amortize remainder over 180 months  Expenditures must be incurred before end of first year of business  May elect to capitalize and not amortize  Election irrevocable ©2011 Pearson Education, Inc. Publishing as Prentice Hall

14. 3-14 Start-up Expenditures (1 of 3)  Non-organizational  Ordinary and necessary expenses  Paid or incurred BEFORE the actual start of business operations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

15. 3-15 Start-up Expenditures (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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

16. 3-16 Start-up Expenditures (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  Election deemed to be made w/ 1 st return  May elect to capitalize with no amortization ©2011 Pearson Education, Inc. Publishing as Prentice Hall

17. 3-17 Limitation on Deductions for Accrued Compensation  Accrued bonuses/compensation must be paid within 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

18. 3-18 Charitable Contributions (1 of 4)  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  Must meet substantiation requirements to deduct contribution ©2011 Pearson Education, Inc. Publishing as Prentice Hall

19. 3-19 Charitable Contributions (2 of 4)  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) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

20. 3-20 Charitable Contributions (3 of 4)  Non-cash property (continued)  Certain inventory related to exempt function  Deduction = adjusted basis + 1/2 gain  Similar rule for computer technology donated for educational purposes  Special rules pertaining to contributions of computer equipment, book inventory, and wholesale food inventory ©2011 Pearson Education, Inc. Publishing as Prentice Hall

21. 3-21 Charitable Contributions (4 of 4)  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 deduction  Excess carried forward for 5 yrs  Creates a deferred tax asset ©2011 Pearson Education, Inc. Publishing as Prentice Hall

22. 3-22 Special Deductions  U.S. Production activities deduction  Other names for the deduction  Domestic production activities deduction  Manufacturing deduction  Dividends-received deduction  Net operating losses  Sequencing of the deduction calculations ©2011 Pearson Education, Inc. Publishing as Prentice Hall

23. 3-23 U.S. Production Activities Deduction (1 of 3)  Deduction is lesser of a % times  Qualified production activities income OR  Taxable income before the U.S. production activities deduction  Phased-in percentages  6% for 2007-2009  9% for 2010 and thereafter ©2011 Pearson Education, Inc. Publishing as Prentice Hall

24. 3-24 U.S. Production Activities Deduction (2 of 3)  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

25. 3-25 U.S. Production Activities Deduction (3 of 3)  Deduction limited to 50% of W-2 wages  Not an expense for financial accounting  Creates a permanent difference ©2011 Pearson Education, Inc. Publishing as Prentice Hall

26. 3-26 Dividends Received Deduction (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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

27. 3-27 Dividends Received Deduction (2 of 3)  Corps owning  20% and < 80% of a domestic corp  80% deduction instead of 70%  Corps owning  80% of domestic corp  Member of affiliated group  100% deduction ©2011 Pearson Education, Inc. Publishing as Prentice Hall

28. 3-28 Dividends Received Deduction (3 of 3)  No deduction is allowed if :  Paying corp is a foreign corp  Stock purchased w/borrowed money  Stock of paying corp held for < 46 days  Results in a permanent difference  Affects effective tax rate, but not deferred taxes ©2011 Pearson Education, Inc. Publishing as Prentice Hall

29. 3-29 Net Operating Losses (NOL)  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  Creates a deferred tax asset ©2011 Pearson Education, Inc. Publishing as Prentice Hall

30. 3-30 Sequencing of the Deduction Calculations  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

31. 3-31 Exceptions for Closely-Held Corporations (1 of 3)  Special rules apply to shareholders 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 shareholder  Loss may be recovered by shareholder if later sells prop at a gain ©2011 Pearson Education, Inc. Publishing as Prentice Hall

32. 3-32 Exceptions for Closely-Held Corporations (2 of 3)  Special rules apply to shareholder who own >50% of corp (continued)  Corporation and shareholder using different accounting methods  Defers deduction for accrued expenses owed by accrual-method corp to cash- method controlling shareholder until income recognized by cash-method shareholder ©2011 Pearson Education, Inc. Publishing as Prentice Hall

33. 3-33 Exceptions for Closely-Held Corporations (3 of 3)  Loss limitation rules  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  May also be subject to passive activity rules  PSCs and closely held corps subject to passive activity limitation rules ©2011 Pearson Education, Inc. Publishing as Prentice Hall

34. 3-34 Computing a Corporation’s Income Tax Liability  General rules  Regular income tax formula  Personal service companies ©2011 Pearson Education, Inc. Publishing as Prentice Hall

35. 3-35 General Rules  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

36. 3-36 Regular Tax Formula (1 of 3) Gross Income -Deductions and Losses -Special Deductions =Taxable Income xAppropriate Rate (or rates) =Regular Tax Liability before credits ©2011 Pearson Education, Inc. Publishing as Prentice Hall

37. 3-37 Regular Tax Formula (2 of 3) Regular Tax Liability before credits -Foreign tax credit -Other Credits +Credit recapture =Regular tax liability ©2011 Pearson Education, Inc. Publishing as Prentice Hall

38. 3-38 Regular Tax Formula (3 of 3) Regular Tax Liability +AMT Liability +Special Taxes (if any) -Estimated Payments =Refund or tax due ©2011 Pearson Education, Inc. Publishing as Prentice Hall

39. 3-39 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

40. 3-40 Personal Service Corporations (2 of 2)  Substantially all stock must be owned by employees, former employees or survivors of employees ©2011 Pearson Education, Inc. Publishing as Prentice Hall

41. 3-41 Controlled Groups  Why special rules are needed  What is a controlled group?  Special rules applying to controlled groups  Consolidated tax returns ©2011 Pearson Education, Inc. Publishing as Prentice Hall

42. 3-42 Why Special Rules are Needed  Prevent shareholders from using multiple corporations to avoid having income taxed at 35%  Each corporation would be able to take advantage of lower graduated rates  Lower graduated rates must be spread among all corporations in a controlled group ©2011 Pearson Education, Inc. Publishing as Prentice Hall

43. 3-43 What Is a Controlled Group?  Two or more corps owned directly or indirectly by same shareholder or group of shareholders  Types of controlled groups  Parent-subsidiary  Brother-sister  Combined ©2011 Pearson Education, Inc. Publishing as Prentice Hall

44. 3-44 Parent-Subsidiary Controlled Group  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

45. 3-45 Brother-Sister Controlled Group  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 (common ownership)  50%-only definition is 2 nd test above ©2011 Pearson Education, Inc. Publishing as Prentice Hall

46. 3-46 Combined Controlled 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

47. 3-47 Special Rules Applying to Controlled Groups (1 of 2)  Benefits allocated among members  5% and 3% surcharge  50%-only test for brother-sister groups  $40,000 AMT exemption amount  50%-only test for brother-sister groups  The $250,000 minimum accumulated earnings credit  50%-only test for brother-sister groups ©2011 Pearson Education, Inc. Publishing as Prentice Hall

48. 3-48 S pecial Rules Applying to Controlled Groups (2 of 2)  Benefits allocated (continued)  §179 expense amount  50%-80% test for brother-sister groups  50% used for parent-sub test instead of 80%  The $25,000 general business credit limit  50%-80% test for brother-sister groups  No loss on sale of assets between members ©2011 Pearson Education, Inc. Publishing as Prentice Hall

49. 3-49 Consolidated Tax Returns  Affiliated groups  Advantages of filing a consolidated return  Disadvantages of filing a consolidated return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

50. 3-50 Affiliated Groups (1 of 2)  One or more chains of includible corps connected through stock ownership to a common parent  Common parent directly owns  80% of voting power AND value of at least one includible corporation ©2011 Pearson Education, Inc. Publishing as Prentice Hall

51. 3-51 Affiliated Groups (2 of 2)  Each corp owned at least 80/80 by another member of the group  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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

52. 3-52 Consolidated Return Advantages  Losses of one member offset gains of another member  Capital losses of one member offset capital gains of another member  Profits and gains from intercompany transactions deferred until sale outside the group ©2011 Pearson Education, Inc. Publishing as Prentice Hall

53. 3-53 Consolidated Return Disadvantages  Election binding on all subsequent tax years  Unless IRS grants permission otherwise  Losses from intercompany transactions deferred until sale outside the group  Additional administrative costs ©2011 Pearson Education, Inc. Publishing as Prentice Hall

54. 3-54 Tax Planning Considerations  Compensation planning for shareholder-employees  Special election to allocate reduced tax rate benefits  Using NOL carryovers and carrybacks ©2011 Pearson Education, Inc. Publishing as Prentice Hall

55. 3-55 Compensation Planning  Salary payments  Reduce double taxation if paid to shareholder-employees  Fringe benefits  Deducted by corporation and certain benefits are not be taxable to shareholder-employee ©2011 Pearson Education, Inc. Publishing as Prentice Hall

56. 3-56 Allocating Reduced Tax Rate Benefits  A controlled group may apportion lower tax rates in any manner to member corporations  Reduce benefits to members with little or no income  Increase benefits to members with the highest income ©2011 Pearson Education, Inc. Publishing as Prentice Hall

57. 3-57 Using NOL Carryovers and Carrybacks  Two options  Carryback to 2 nd previous year, then 1 st previous year, then forward  Forgo the carrybacks and carry forward  Examine marginal tax rates in prior years and expected marginal tax rates in future years to maximize tax benefit ©2011 Pearson Education, Inc. Publishing as Prentice Hall

58. 3-58 Compliance and Procedural Considerations Estimated Taxes  Estimated taxes required if corp owes >$500 for current year.  Pay in four installments  Each installment 25% of annual liability  Underpayment of estimated tax penalty  Small corps exempt from penalty if  Pay in lesser of 100% of prior or current year’s tax liability ©2011 Pearson Education, Inc. Publishing as Prentice Hall

59. 3-59 Compliance and Procedural Considerations 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

60. 3-60 Financial Statement Implications  ASC 740 - Income Taxes (SFAS 109)  Temporary differences  Deferred tax assets and the valuation allowance  ASC 740 - Uncertain Tax Positions (FIN 48)  Balance sheet classification  Tax provision process ©2011 Pearson Education, Inc. Publishing as Prentice Hall

61. 3-61 ASC 740 - Income Taxes Scope  Establishes principles of accounting for current and deferred taxes  Arising from temporary differences ©2011 Pearson Education, Inc. Publishing as Prentice Hall

62. 3-62 ASC 740 - Income Taxes Principles  Addresses financial statement consequences of  Rev, exp, gains/losses recognized in different years for tax and financial statement purposes  Events affecting book/tax differences in bases of assets and liabilities  Loss & credit carrybacks or carryforwards ©2011 Pearson Education, Inc. Publishing as Prentice Hall

63. 3-63 ASC 740 - Income Taxes Objectives  Recognize current yr taxes payable or refundable  Recognize deferred tax liabilities and assets for future tax consequences of events on fin stmts or tax return ©2011 Pearson Education, Inc. Publishing as Prentice Hall

64. 3-64 Temporary Differences (1 of 2)  Deferred tax liabilities occur when  Rev/gains recognized earlier for book than tax  Exp/losses deducted earlier for tax than book  Tax basis of asset < book basis  Tax basis of liability > book basis ©2011 Pearson Education, Inc. Publishing as Prentice Hall

65. 3-65 Temporary Differences (2 of 2)  Deferred tax assets occur when  Rev/gains recognized earlier for tax than book  Exp/losses deducted earlier for book than tax  Tax basis of asset > book basis  Tax basis of liability < book basis  Loss/credit carryforwards exist ©2011 Pearson Education, Inc. Publishing as Prentice Hall

66. 3-66 Deferred Tax Assets and the Valuation Allowance  Deferred tax asset  Firm will realize tax benefit of event in the future  Valuation allowance used for portion of benefit not likely to be realized  Use “more likely than not” standard ©2011 Pearson Education, Inc. Publishing as Prentice Hall

67. 3-67 ASC 740 - Uncertain Tax Positions Formerly FIN 48  Two-step to account for uncertain tax positions  Determine if position exceeds “more likely than not” (>50%) probability of being sustained on its merits by IRS  If not, corp cannot recognize tax benefit  Records liability for unrecognized tax benefits  If yes, measure amount of benefit ©2011 Pearson Education, Inc. Publishing as Prentice Hall

68. 3-68 Balance Sheet Classification  Classify as current or noncurrent  If related to another asset or liability use classification of related asset/liab  Net current assets and liabilities  Net noncurrent assets and liabilities ©2011 Pearson Education, Inc. Publishing as Prentice Hall

69. 3-69 Tax Provision Process (1 of 3) 1. Identify temporary differences and tax carryforwards 2. Prepare “roll forward” schedules 3. Apply appropriate tax rates in roll forward schedules to determine deferred tax asset/liability balances 4. Adjust deferred tax assets by valuation allowance if necessary ©2011 Pearson Education, Inc. Publishing as Prentice Hall

70. 3-70 Tax Provision Process (2 of 3) 5. Adjust income tax expense for uncertain tax positions under FIN 48 6. Determine current federal income taxes payable (current tax expense) 7. Determine total federal income tax expense (benefit) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

71. 3-71 Tax Provision Process (3 of 3) 8. Prepare and record tax journal entries 9. Prepare tax provision reconciliation 10. Prepare tax rate reconciliation 11. Prepare financial statements ©2011 Pearson Education, Inc. Publishing as Prentice Hall

72. 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 3-72 ©2011 Pearson Education, Inc. Publishing as Prentice Hall