3-1 ©2008 prentice hall, inc.. 3-2 ©2008 prentice hall, inc. the corporate income tax (1 of 2) ...

©2008 Prentice Hall, Inc. 3-2

THE CORPORATETHE CORPORATEINCOME TAXINCOME TAX (1 of 2) (1 of 2)

Corporate electionsComputing corporation’s

taxable incomeComputing a corporation’s

income tax liability


THE CORPORATETHE CORPORATEINCOME TAXINCOME TAX (2 of 2) (2 of 2)

Controlled groups of corporations

Tax planning considerationsCompliance and procedural

considerationsFinancial statement implications


Corporate ElectionsCorporate ElectionsTax Year (1 of 2)Tax Year (1 of 2)

New corp elects tax year by filing return

First return may be for short-periodSome corporations restricted

S-corporation uses calendar yearAffiliated group member must be

same as parentPSCs usually calendar year


Corporate ElectionsCorporate ElectionsTax Year (2 of 2)Tax Year (2 of 2)

Changing the tax yearUsually requires IRS approvalAutomatic approval if

Annualizes short-period incomeKeeps books based on new yearShort period does not have a NOLNo change in accounting period for 48 moNo interest in flow-through entitiesNot a specialized corporation


Corporate ElectionsCorporate ElectionsAccounting MethodsAccounting Methods

AccrualGAAP: generally required for C corps

CashQualified PSC, or C corp w/ gross

receipts < $5MInventories 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


Computing a Computing a Corporation’s Taxable Corporation’s Taxable

IncomeIncomeSales and exchanges of propertyBusiness expensesSpecial deductionsExceptions for closely held

corporations


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 lossesCarryback 3 years and forward 5 yearsCarryovers classified as short-termExpired losses are lost forever


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


Business ExpensesGeneral ruleOrganizational expendituresStart-up expendituresLimitations on deductions for

accrued compensationCharitable contributions


General RuleAll ordinary and necessary

expenses reasonable in amountNo deductions for

Interest on loans to buy tax exemptsIllegal bribes or kickbacksFines or penaltiesInsurance premiums if corp is

beneficiary


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 >

$50KAmortize remainder over 180

months


Organizational Costs(2 of 2)

Expenditures must be incurred before end of first year of business

Failure to file electionCapitalize with no amortization


Start-up Expenditures(1 of 3)

Non-organizational Ordinary and necessary

expensesPaid or incurred BEFORE the

actual start of business operations



Examples of include expenses to:Investigate creation or acquisition

of an active trade or businessCreate an active trade or businessConduct an activity engaged in for

profit or production of income before business operations begin



Election to expense first $5K of org costs$5K reduced $ for $ when org costs > $50KRemainder 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 electionCapitalize with no amortization


Limitation on Deductions for Accrued Compensation

Accrued bonuses/compensation must be paid within 2-1/2 months after close of tax yearIf paid after 2-1/2 months,

payment deemed deferred compensation and is deductible in year paid


Charitable Contributions(1 of 4)

Timing of deductionDeducted in the year paid Accrual basis corps may elect to

include payment made w/in 2-1/2 months following the end of tax yearBoard of directors must have authorized

contribution during year it was accruedMust meet substantiation

requirements to deduct contribution



Donated moneyDeduction equals amount donated

Non-cash propertyAmount USUALLY equal to FMV of

property donatedOrdinary income property

Deduction limited to FMV less Ord Inc or STCG that would have been recognized if property were sold (includes recapture)



Non-cash property (continued)Certain inventory related to

exempt functionDeduction = adjusted basis + 1/2

gainSimilar rule for computer technology

donated for educational purposes



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

Excess carried forward for 5 yrsCreates a deferred tax asset


Special DeductionsU.S. Production activities

deductionDividends-received deductionNet operating lossesSequencing of the deduction

calculations


U.S. Production Activities Deduction

(1 of 3)

Deduction is lesser of a % timesQualified production activities income ORTaxable income before the U.S.

production activities deductionPhased-in percentages

6% for 2007-20099% for 2010 and thereafter



(2 of 3)

Qualified production activities incomeDomestic 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



(3 of 3)

Deduction limited to 50% of W-2 wages

Not an expense for financial accountingCreates a permanent difference


Dividends Received Deduction(1 of 2)

Corps owning < 20% of a domestic corporation deduct lesser of70% of Dividends Received or70% of taxable income before NOL,

capital loss carryback or DRDException to taxable income

limitationIf 70% of dividend received creates an

NOL, then the full DRD is deductible



Corps owning 20% and < 80% of a domestic corp 80% deduction instead of 70%

Corps owning 80% of domestic corpMember of affiliated group 100% deduction



No deduction is allowed if :Paying corp is a foreign corpStock purchased w/borrowed moneyStock of paying corp held for < 46 days

Results in a permanent differenceAffects effective tax rate, but not

deferred taxes


Net Operating Losses(NOL)

Deductions exceed gross income for the year before NOL carrybacks

NOL may be carried back 2 yrs & then forward 20 yrsCorp may elect to forgo carryback &

only carry NOL forward 20 yrsCreates a deferred tax asset


Sequencing of the Deduction Calculations

Charitable contributions, DRD, NOL, and all other deductions must be taken in the following order1. All other deductions2. Charitable contributions3. DRD4. NOL5. U.S. production activities deduction


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



Special rules apply to shareholder who own >50% of corp (continued)Corporation and shareholder using

different accounting methodsDefers deduction for accrued expenses

owed by accrual-method corp to cash-method controlling shareholder until income recognized by cash-method shareholder



Loss limitation rulesIf 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 yearMay also be subject to passive activity

rulesPSCs and closely held corps subject to

passive activity limitation rules


Computing a Computing a Corporation’s Income Tax Corporation’s Income Tax

LiabilityLiabilityGeneral rulesRegular income tax formulaPersonal service companies


General RulesThe tax rates are graduatedRate surcharges eliminate

benefit of lower graduated tax rates from lower income brackets

Corps with income >$18.33M pay a flat 35% on all income


Regular Tax Formula(1 of 3)

Gross Income- Deductions and Losses- Special Deductions=Taxable IncomexAppropriate Rate (or rates)=Regular Tax Liability before

credits



Regular Tax Liability before credits

- Foreign tax credit- Other Credits+ Credit recapture=Regular tax liability



Regular Tax Liability+ AMT Liability+ Special Taxes (if any)- Estimated Payments=Refund or tax due


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


Personal Service Corporations

(2 of 2)

Substantially all stock must be owned by employees, former employees or survivors of employees


Controlled GroupsControlled GroupsWhy special rules are neededWhat is a controlled group?Special rules applying to

controlled groupsConsolidated tax returns


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 ratesLower graduated rates must be

spread among all corporations in a controlled group


What Is a Controlled Group?Two or more corps owned directly

or indirectly by same shareholder or group of shareholders

Types of controlled groupsParent-subsidiaryBrother-sisterCombined


Parent-Subsidiary Controlled Group

One corp directly owns at least:80% of voting power of all classes

of voting stock OR80% of total value of all classes of

stock of subsidiary corporation


Brother-Sister Controlled Group

80%-50% definitionFive 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 2nd test above


Combined Controlled GroupsThree 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


Special Rules Applying to Controlled Groups (1 of 2)

Benefits allocated among members5% and 3% surcharge

50%-only test for brother-sister groups$40,000 AMT exemption amount

50%-only test for brother-sister groupsThe $250,000 minimum accumulated

earnings credit50%-only test for brother-sister groups


Special Rules Applying to Controlled Groups (2 of 2)

Benefits allocated (continued)$112,000 §179 expense amount

80%-50% test for brother-sister groupsThe $25,000 general business credit

limitation 80%-50% test for brother-sister groups

No loss on sale of assets between members


Consolidated Tax ReturnsAffiliated groupsAdvantages of filing a

consolidated returnDisadvantages of filing a

consolidated return


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 & value of at least one includible corporation


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 returnCapital losses offset capital gains from

other group membersOperating losses reduce operating

income from other group members


Consolidated Return Advantages

Losses of one member offset gains of another member

Capital losses of one member offset capital gains of another member

Gains from intercompany transactions deferred until sale outside the group


Consolidated Return Disadvantages

Election binding on all subsequent tax yearsUnless IRS grants permission otherwise

Losses from intercompany transactions deferred until sale outside the group

Additional administrative costs


Tax Planning Tax Planning ConsiderationsConsiderations

Compensation planning for shareholder-employees

Special election to allocate reduced tax rate benefits

Using NOL carryovers and carrybacks


Compensation PlanningSalary payments

Reduce double taxation if paid to shareholder-employees

Fringe benefitsDeducted by corporation and

certain benefits are not be taxable to shareholder-employee


Allocating Reduced Tax Rate Benefits

A controlled group may apportion lower tax rates in any manner to member corporationsReduce benefits to members with

little or no incomeIncrease benefits to members

with the highest income


Using NOL Carryovers and Carrybacks

Two optionsCarryback to 2nd previous year, then

1st previous year, then forwardForgo the carrybacks and carry

forwardExamine marginal tax rates in prior

years and expected marginal tax rates in future years to maximize tax benefit


Compliance Procedure Compliance Procedure Estimated TaxesEstimated Taxes

Estimated taxes required if corp owes >$500 for current year.

Pay in four installmentsEach installment 25% of annual liability

Underpayment of estimated tax penaltySmall corps exempt from penalty if

Pay in lesser of 100% of prior or current year’s tax liability


Compliance Procedure Compliance Procedure Filing RequirementsFiling 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


Financial Statement Financial Statement ImplicationsImplications

Scope, objectives, & principles of SFAS No. 109

Temporary differencesDeferred tax assets and the

valuation allowanceBalance sheet classificationTax provision process


Scope, Objectives, & Principles

of SFAS No. 109 (Scope)

Establishes principles of accounting for current and deferred taxesArising from temporary and

permanent differences



of SFAS No. 109 (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



of SFAS No. 109 (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


Temporary Differences(1 of 2)

Deferred tax liabilities occur whenRev/gains recognized earlier for

book than taxExp/losses deducted earlier for tax

than bookTax basis of asset < book basisTax basis of liability > book basis


Temporary Differences(2 of 2)

Deferred tax assets occur whenRev/gains recognized earlier for tax than

bookExp/losses deducted earlier for book than

taxTax basis of asset > book basisTax basis of liability < book basisLoss/credit carryforwards exist


Deferred Tax Assets and the Valuation Allowance

Deferred tax assetFirm will realize tax benefit of

event in the futureValuation allowance used for

portion of benefit not likely to be realizedUse “more likely than not” standard


Balance Sheet ClassificationClassify as current or noncurrentIf related to another asset or

liability use classification of related asset/liab

Net current assets and liabilitiesNet noncurrent assets and

liabilities


Tax Provision Process(1 of 2)

1. Determine pretax book income (PBI)

2. Identify perm diff, temp diff, & CF3. Adjust PBI for perm differences4. Step 3 amount x current tax rate5. Adjust step 3 for temp diff to get

tax income or NOL


Tax Provision Process(2 of 2)

6. Step 5 x current rate to get tax liability or NOL benefit

7. Calculate def tax liab/asset by using current rate

8. Adjust def tax assets by valuation allowance if necessary

Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorado’s

Kenneth W. Monfort College of [email protected]

3-70©2008 Prentice Hall, Inc.

3-1 ©2008 prentice hall, inc.. 3-2 ©2008 prentice hall, inc. the corporate income tax (1 of 2) ...

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