Chapter 1

Question 1

How do you compute taxable income from book income?

Answer 1

1. You start with ‘net income’ on the financial statements
2. The corp’s book income is then adjusted to arrive at taxable income:
   
   1. Permanent differences
   2. Temporary or ‘timing’ differences
   3. Capital losses only offset capital gains
   4. Charitable contributions limited to 10% of modified corporate taxable income
   5. Executive compensation limited to $1 million for CEO and its other four highest compensated executives(for public corps)
   6. Usually required to use accrual method
   7. Dividend received deduction
3. Progressive tax rates- current maximum is 35%
4. Long-term capital gains taxed at the same rate as ordinary income

Question 2

The 4 Elements of Consolidated Returns

Answer 2

1. For non-tax reasons, management will frequently desire to hold various corporate businesses in multiple corporations rather than just one – principally to shelter liability
2. Such multiple corporations may file a consolidated return as though the affiliated group of corporations were one corporation
3. Certain ownership and consent rules must be met in order to file a consolidated return
4. If multiple corporations qualify, they almost always will elect to file consolidated:
   
   1. Allowing ordinary business losses from one corporate subsidiary to offset income from another corporate subsidiary
   2. Allowing capital losses from one corporate subsidiary to offset capital gains from another corporate subsidiary
   3. Allowing deferral of intercompany sales and gains
   4. Allowing % limitations (limiting certain deductions and credits) to be calculated using “consolidated” taxable income rather than separate corporation taxable income
   5. Allowing tax-free treatment for dividends paid from one member to another member of the consolidated group

Question 3

What are the nontax factors of entity considerations?

Answer 3

1. Raising capital from outside investors
2. Certainty of governance: C corp provides the highest degree of certainty
3. Limited liability for the entity owners
4. Transferability of interests: a share of stock is very easy to sell
5. Cost of forming the entity

Question 4

What are the tax factors of entity consideration?

Answer 4

1. Double vs single layer of tax: Flow through vs nonflow-through entities
2. Relative tax rates: Individual vs corporate rates
3. Flexibility: allocating income or deductions to certain owners to the exclusion of other owners
4. Ease of complying with tax restrictions
5. Will losses be generated in the early years of the business?

Question 5

Five elements of a Sole Proprietorship

Answer 5

1. One owner
2. No limited liability
3. Very simple
4. No seperate tax return
5. All income subject to regular and self-employment tax

Question 6

6 Elements of C-Corporations

Answer 6

1. Double layer of tax
2. Progressive tax rates are much more gradual
3. All non tax factors listed on prior slide favor a C corp
4. Corporate business operations have little or no impact on shareholders
5. Earnings are generally not taxable to shareholders until distributed
6. If business entity will be publicly traded, C corp is the only option (only exception is a publicly traded partnership)

Question 7

6 Elements of an S Corp

Answer 7

1. In general, there’s a single layer of tax
2. Restrictions on the number of owners, type of owners, types of permissable businesses
3. Earnings are not subject to self-employment tax at the shareholder level
4. Owners are required to take a salary commensurate with services rendered
5. Difficult to liquidate or take appreciated assets out of the coproate solution
6. Losses may flow through to shareholders(watch out for losses financed with corporate debt other than debt from shareholder)

Question 8

6 Elements of Partnerships and LLCs

Answer 8

1. Single layer of tax
2. Greater flexibility than S corps
   
   1. Allocation of income and losses
   2. No restrictions on number of owners, type of owners
3. Potential self-employment tax issues
4. Ease in liquidation or in distributing appreciated assets
5. Partnership does not pay tax
6. Losses flow through to owners- basis is not as big an issue as with S corps since partners may increase their basis with partnership debt regardless of who the creditor is

Question 9

What was the issue and holding of the UPS case?

Answer 9

The Issue: UPS is making a ton of revenue from insuring packages. They setup OBL, a Bermuda corp to filter the rev by paying it to National insurance and then National pays it to OBL and then OBL distributes it back to UPS shareholders.

The Tax Court’s Rationale:

1. The transactions between UPS and National and OBL don’t have economic substance when considering that the main purpose is tax avoidance.
2. There was no defensible business purpose
3. The premiums paid to national were above the market value
4. Memos and other written evidence showed that UPS’s sole motive was tax avoidance

Issue facing the appellate court:

Whether the excess value plan had the kind of economic substance that removes it from ‘shamhood’ even if the business continued as it had before

Appellate Court’s Holding:

UPS prevailed. Transactions had economic substance