©The McGraw-Hill Companies, Inc. 2008McGraw-Hill/Irwin Chapter 15 Corporate Taxation...

©The McGraw-Hill Companies, Inc. 2008McGraw-Hill/Irwin

Chapter 15

Corporate Taxation

“Corporations don’t pay taxes, they collect them.”

-- Paul H. O’Neill

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LO #1 Corporate Formation and Filing Requirements


• Corporations are legal entities formed under the laws of a state.

• Corporations can use the cash basis of accounting if sales < $5 million or if inventory is not a material factor.

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• Corporations are not limited to a calendar year fiscal year. They can choose any fiscal year in their first year of operation.

• Corporations file a Form 1120 or 1120A

• Tax returns are due 2.5 months after the fiscal year end– Can obtain an automatic 6-month

extension.

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LO #1 Corporate Formation and Filing Requirements – Concept Check 15-1LO #1 Corporate Formation and Filing Requirements – Concept Check 15-1

1. A corporation can use either the cash or accrual method of accounting. True or False?

False

2. Corporate tax returns are due ________ if no extension is requested.

5 months after the end of the fiscal year

3. The tax year of a corporation must end on December 31. True or False?

False

15-5

LO # 2 - BasisLO # 2 - Basis

• On formation of a corporation, individuals are exchanging cash or property for stock.

• Generally, on corporate formation, no gain is recognized if, immediately after the transfer, the transferors control 80% or more of the corporation.

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• Two cases in which gain may be recognized– 1. If shareholder contributes an asset with

a liability and the relief of liability > basis – 2. Boot received triggers gain equal to the

lesser of the boot received or the gain

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• Basis of the contributed property to the corporation– Equal to the basis in the hands of the

shareholder plus any gain recognized by the shareholder

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• Basis of the stock to the shareholder– Equal to the basis of the property

contributed, plus any gain recognized, minus any boot received (boot includes any relief of liability).

• Unless shareholder increases or decreases his or her proportionate ownership, generally there is no change to basis.

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LO # 2 – BasisConcept Check 15-2

LO # 2 – BasisConcept Check 15-2

1. When forming a corporation, if the transferors control at least 80% of the corporate entity, then the formation will generally be tax free. True or False?

True

2. The basis to the corporation of property received is equal to _______________.

Shareholder basis plus gain recognized by shareholder.

3. Arturo contributed land with a fair value of $100,000 and basis of $40,000 to a newly-formed corporation in exchange for 90% of the stock. Arturo’s basis in the stock is ______________.

$40,000

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LO #3 – Taxable Income & Tax LiabilityLO #3 – Taxable Income & Tax Liability

• Determination of taxable income generally follows the rules associated with a trade or business (Chapter 6).– The notion of AGI does not exist.

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• Net capital losses are not permitted.– If a corporation has a net capital loss, it can

carry it back three years and then forward five.

– Only offsets net capital gains in the carryback or carryforward periods.

• Capital gains are included in income and taxed at ordinary rates.

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• Charitable contributions are limited to 10% of taxable income before charitable contributions.– Excess is carried forward five years.

• Contribution amount for “ordinary income property” such as inventory is limited to basis.

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• Corporations receive a Dividends Received Deduction (DRD) for dividends from other domestic corporations.– DRD is 70% if ownership is < 20%– DRD is 80% if ownership => 20% or < 80%– DRD is 100% ownership => 80%

• DRD may be limited.

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• Organizational expenses and startup expenses can be amortized and deducted over 60 months– Corporation must make election.

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• Taxable income is subject to tax rates of up to 35%.– Tax rate schedule is progressive, but the

benefit of lower rates for lower income is recaptured as taxable income increases.

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• Corporations must make estimated payments– Payment is lesser of 100% of tax due for

the year or 100% of the tax for the prior year.

– Due on 15th day of fourth, sixth, ninth, and twelfth months of fiscal year.

– Underpayment penalty applies if payments not sufficient.

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• If a corporation has a net operating loss, it can be carried back two years and then carried forward 20.– Corporations can make an affirmative

election to carry the NOL only forward.

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LO #3 – Taxable Income & Tax Liability – Concept Check 15-3


1. Corporations follow the same tax rules for capital gains as do individuals. True or False?

False

2. The tax liability of a corporation with taxable income of $520,000 is ___________.

$176,800

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3. A corporation reported taxable income before charitable contribution of $390,000. The corporation made charitable contributions of $50,000. Its permitted deduction for charitable contributions in the current tax year is ________.

$39,000

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4. Organizational expenses are automatically deductible over 60 months. True or False?

False

5. Corporate net operating losses can be carried back ____ years and forward ____ years.

2 years, 20 years

15-21

LO #4 – Transactions with ShareholdersLO #4 – Transactions with Shareholders

• Corporations have earnings and profits (E&P). Similar, but not identical, to retained earnings

• Distributions of cash or property from E&P are dividends– Taxable to shareholders– Not deductible by the corporation

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• Distributions in excess of E&P– Nontaxable to shareholder to the extent of

basis in the stock– A capital gain if in excess of basis.

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• Distribution of property with FMV in excess of basis – Corporation reports gain (write up to FMV)– Amount of distribution to shareholder is

based on FMV.

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• Distributions in full liquidation– Corporation records all assets and liabilities

at FMV and records gain or loss– Shareholder reports gain or loss equal to

the FMV of the distribution compared to stock basis.

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LO #4 – Transactions with Shareholders – Concept Check 15-4

LO #4 – Transactions with Shareholders – Concept Check 15-41. Dividends are always taxable to a shareholder. True

or False?True

2. If a corporation pays a dividend in property, the stockholder will have a dividend equal to the corporate basis in the property. True or False?

False

3. A corporation has earnings and profits of $10,000 and makes a cash distribution to its sole shareholder in the amount of $11,000. The amount of taxable dividend to the shareholder is ______________.

$10,000

15-26

LO #5 – Schedules L, M-1 and M-3LO #5 – Schedules L, M-1 and M-3

• Schedules L, M-1, and M-3 are all on page 4 of the Form 1120.– Small corporations are not required to

complete

• Schedule L is a beginning and ending balance sheet reported in accordance with the financial accounting method of the corporation.

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• Schedule M-1 is a reconciliation from book income to taxable income (not the other way around).

• Schedule M-1 sets forth all book/tax differences for the year, whether permanent or temporary.

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• Some items that are a positive adjustment from book income to taxable income:– Income tax expense for books– Excess capital losses– Disallowed current year charitable

contribution– Book depreciation in excess of tax

depreciation– 50% of travel and entertainment expense

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• Some items that are a negative adjustment from book income to taxable income:– Life insurance proceeds– Tax exempt interest– Tax depreciation in excess of book

depreciation– Charitable contributions in excess of 10%

limit in prior year

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• Schedule M-3 is a comprehensive book/tax reconciliation for large corporations.– Total assets in excess of $10 million

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LO #5 – Schedules L, M-1 and M-3 – Concept Check 15-5

LO #5 – Schedules L, M-1 and M-3 – Concept Check 15-5

1. Completion of Schedule L is required of all corporations. True or False?

False

2. Schedule M-1 reconciles book income to taxable income. True or False?

True

3. A corporation’s depreciation expense is smaller on the financial statements than it is on the tax return. Would this difference be a negative or positive item on Schedule M-1?

Negative

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LO #6 – Other Corporate IssuesLO #6 – Other Corporate Issues

• Parent-subsidiary group– A common parent owns, directly or

indirectly, at least 80% of one or more other corporations.

– Can elect to file a consolidated return.– Election is irrevocable.

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• Brother-sister group– Five or fewer persons own two or more

corps• Total ownership test – group owns at least 80%

of the voting shares• Common ownership test – group has common,

identical, ownership of at least 50%

– Must disclose to IRS.

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• Larger corporations are subject to AMT– Start with taxable income, add or subtract tax

preference items, subtract exemption amount.– Preferences similar to individuals

• Additional corporate item is the adjusted current earnings (ACE) adjustment

– Exemption amount is $40K• Phased out 25 cents on the dollar for AMT income over

$150K

– Tax rate is 20%

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LO #6 – Other Corporate IssuesConcept Check 15-6

LO #6 – Other Corporate IssuesConcept Check 15-6

1. In order to be considered a parent/subsidiary group, the parent corporation must own, directly or indirectly, at least ____ percent of the subsidiary corporation.

80%

2. A brother-sister group may exist if ______ or fewer persons own two or more corporations.

Five

3. For AMT purposes, the corporate exemption amount is $________.

$40,000

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LO #7 – Subchapter S CorporationsLO #7 – Subchapter S Corporations

• Subchapter S corporations are “regular” corporations that elect to be taxed in a manner similar to a partnership

• File a Form 1120-S

• Filing deadlines and extension rules are the same as Subchapter C corporations

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• Must meet four tests to elect Sub S status– Be a domestic corporation– Have 100 or fewer shareholders– Have one class of stock– Have shareholders who are U.S. citizens or

resident aliens.

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• Sub S corporations report taxable income and separately stated items– Separately stated items are very similar to

those reported by a partnership

• Sub S corporation does not pay tax. The shareholders do.

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• Shareholder basis is determined similar to a partnership except corporate debt does not affect basis.

• Basis increased by:– Net income– Separately stated positive items– Capital contributions– Loans from the shareholder to the

corporation

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• Basis is decrease by:– Net losses– Separately stated negative items– Distributions from the corporation at FMV

• Basis cannot go below zero.

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• Distributions are not taxable to shareholders – They have already been taxed on the

income

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LO #7 – Subchapter S Corporations Concept Check 15-7


1. Corporations with fewer than 100 shareholders are automatically considered Subchapter S corporations. True or False?

False

2. A Subchapter S corporation is taxed in a manner similar to a partnership. True or False?

True

3. Subchapter S corporations file a Form ______.1120-S

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4. Alyssa is a shareholder in a Subchapter S corporation and has a basis of $1,000 in her stock. The corporation gives her a $200 cash dividend. Is this dividend taxable or not taxable to Alyssa?

Not taxable

5. Similar to a partnership, shareholders of a Subchapter S corporation increase the basis of their stock by their share of corporate debts. True or False?

False

©The McGraw-Hill Companies, Inc. 2008McGraw-Hill/Irwin Chapter 15 Corporate Taxation...

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