Corporate Taxation Flashcards
What is the main tax form for corporations’ tax liabilities?
Form 1120
What is the overall calculation for corporate income tax?
Income - deductions = taxable income x tax rate = tax liability - payments - credits = tax due (or overpaid)
This is the outline of Form 1120
When must a corporation file Form 1120?
By the 15th day of the third month after the corporation’s tax year – which is usually March 15
What is the purpose of Form 7004?
It extends the filing deadline for Form 1120 by six months – though it does not extend the deadline for paying taxes
What is peculiar about federal corporate income tax rates?
They do not consistently increase with income, but decrease at various points
What are the 2013 federal income tax rates for corporations?
Under $15k -- 15% $50k - $75k -- 25% $75k - $100k -- 34% $100k - $335k -- 39% $335k - $10mil -- 34% $10mil - $15mil -- 35% $15mil - $18,333,333 -- 38% Over $18,333,333 -- 35%
Why do corporate income tax rates increase and then decrease?
Various brackets have a higher % in order to phase out the benefits from the lower bracket, making it as if the entire income up to that point were at a fixed rate
E.g. for 2013, after a corporation pays 39% tax on up to $335k in income, it will have an effective tax rate through that $335k of 34% – the total taxes divided by the income will be 34%
Do any corporations pay different income tax rates?
Yes, some personal service organizations are required to pay a flat 35% tax rate
Which concepts of individual income taxation do not apply to corporate taxation?
AGI, standard or itemized deductions, and personal exemptions
What is a dilemma provided by organizational and startup costs for a corporation?
Business expenses can normally be deducted, but those only apply to expenses for an already-running business, whereas startup expenses by definition do not apply to that
How can organizational and startup costs be deducted?
As of 2013, the total amount is capitalized and can be deducted as it is amortized over 180 months, but $5,000 can be deducted in the first year
This $5,000 is phased out as the startup costs range from $50,000 to $55,000, however
-see if this is correct for 2013 still
Which costs are included in and excluded from organizational costs?
Costs for (1) organizational meetings, (2) incorporation fees, (3) temporary directors, and (4) accounting or legal expenses related to organization are included
Costs for issuing stock are not
What are startup costs?
Any costs for creating an active trade or business, incurred before the actual business begins
Examples:
(1) market or product analysis costs (though not research or experimental costs)
(2) ads for executives or other positions
(3) pay for employees in training
(4) costs to attain prospective distributors, suppliers, or customers
What is the dividends received deduction (DRD)?
If a corporation is a shareholder in another corporation, the ordinary double taxation of corporate income paid out to shareholders can become triple (or quadruple, etc.) taxation
To reduce this, there is a deduction available for corporations who own stock in another corporation
How much of a deduction does the dividends received deduction (DRD) provide?
Depends on the corporate stockholder’s percentage of ownership
80% ownership: 100% deduction
20-80% ownership: 80% deduction
<20% ownership: 70% deduction
What is the taxable income limitation on the dividends received deduction (DRD)?
If the full DRD does not cause or further a net operating loss, then the DRD cannot be greater than the same % of taxable income
This can occur if the DRD is 70% or 80%, but not if it is 100%
What is an example of a taxable income limitation on the DRD?
A corporation has $100k of dividend income from a 50%-controlled corporation but a final taxable income of only $85k. The full DRD would be 80% of $100k ($80k), but the DRD is in this case restricted to 80% of taxable income = $85k x 80% = $68k
Other than when the DRD is 100%, when does the taxable income limitation not apply?
If the full DRD, when subtracted from taxable income would cause a NOL (or further extend one)
What is an example where the taxable income limitation on the DRD does not apply?
A corporation has $100k of dividend income from a 50%-controlled corporation but a final taxable income of only $70k. If the full DRD ($80k) is deducted from taxable income, the result would be a NOL of -$10k. In this case, the corporation need not limit the deduction to 80% of taxable income, but can deduct the full $80k.
How is a DRD deduction calculated if a corporation has both 70%-deductible dividends and 80%-deductible dividends?
The same general rules apply regarding the taxable income limitation and NOLs, but the relevant numbers are calculated by first deducting the 80% deduction and then the 70% deduction
Under what circumstances does the dividends received deduction not apply?
If the stock is held for a short period of time
For most stock, it must be held for 45 days within a 90-day period that starts 45 days before the dividend date
For preferred stock, it must be held for 90 days within a 180-day period that starts 90 days before the dividend date
Can a corporation deduct life insurance premiums for officers?
No, no such premiums for any important people in the corporation are deductible – and neither are proceeds from such policies taxable as income
Can a corporation deduct charitable contributions?
Yes, but only to 10% of its taxable income
This taxable income is calculated without already incorporating (1) the DRD, (2) any NOL carrryback, (3) any capital loss carryback, or (4) the charitable contribution deduction itself
What happens to charitable contributions in excess of 10% of taxable income?
They can still be deducted, as they can be carried forward for five years
How do individual and corporate taxation differ regarding capital gains and losses?
Individual taxpayers can have a net capital loss, but corporate taxpayers can, at best, apply capital losses against capital gains to reduce such gains to zero
If a corporation has an excess capital loss, how can it still deduct it?
Such net losses can be carried back three years or carried forward five years
However, these carrybacks and carryforwards are always treated as short-term losses, not long-term
How may a corporation apply a net operating loss (NOL)?
Can be carried back 2 years or carried forward 20
How does the Worker, Homeownership, & Business Act of 2009 (WHBA) relate to NOLs?
It extended the carryback period of NOLs from 2 years to 5 years for many taxpayers in 2008 and 2009
This NOL can generally be applied only to one of those extra years, but eligible small businesses can apply it to two
How does the WHBA limit the carryback of a NOL to five years in the past?
If the NOL is applied to the furthest year back (5 years back), then the NOL applied to that year cannot be >50% of that year’s taxable income
What is the alternative minimum tax (AMT) for corporations?
Functions similarly to the AMT for individuals – the alternative minimum taxable income (AMTI) must be calculated and compared to regular taxable income, and the greater of the two is taxed
Both include adjustments, preferences, and exemptions
Which corporations are exempt from paying an AMT?
Only those who qualify as small corporations – must have had a gross income <$7.5 mil for the past three years
Once a status as a small corporation is lost, it cannot be regained
In calculating corporate AMT, what are some examples of adjustments?
Adjustments regarding:
(1) passive activities
(2) excess depreciation
(3) long-term contracts employing the percentage-of-completion method
(4) adjustments to a property’s basis
(5) installment sales
These can be added or subtracted when calculating AMT
In calculating corporate AMT, what are some examples of preferences?
Preferences regarding:
(1) appreciated property donated to a charity
(2) tax-exempt interest on private activity bonds
(3) accelerated depreciation
(4) intangible drilling costs
(5) % depletion over a property’s adjusted basis
These are always added when calculating AMT
What are adjusted current earnings (ACE)?
A further calculation of income taken by making adjustments to AMTI
If ACE > AMTI, then 75% of the difference is a positive adjustment to AMTI
What are some examples of ACE adjustments?
The 70% dividends received deduction and interest income from municipal securities
What kind of exemption can corporations claim when calculating AMT?
As of 2013, all are allowed a $40,000 exemption
This phases out by 25% as the AMTI ranges from $150k to $310k
How do credits affect the calculation of AMT?
Just as with individual taxation, various credits can reduce the AMT after it is calculated
Example: foreign tax credit
What is the AMT credit?
If a corporation’s AMT is higher than its ordinary tax debt, then it receives a credit for the difference
This credit can be carried forward indefinitely to apply to ordinary tax debts (but not future AMTs)
Which part of Form 1120 is for reconciling book income and taxable income?
Schedule M-1 – modifies book income to arrive at taxable income
What does Schedule M-1 not require when reconciling book income to taxable income?
Any distinction between temporary and permanent differences
This has to be recognized when the reconciliation occurs in financial accounting
In Schedule M-1, what is added to book income?
(1) federal income tax expense
(2) net capital loss
(3) income items which are taxable though excluded from book income
(4) expense items which are deductible from book income but not from taxable income
In Schedule M-1, what are some income items that are taxable though excluded from book income?
(a) royalties
(b) prepaid rent
(c) service fees
(d) interest income
In Schedule M-1, what are some expense items that are deductible from book income but not from taxable income?
(a) premiums for key-person life insurance
(b) accrued contingencies
(c) charitable contributions >10% of taxable income
(d) depreciation expense from using a different method
In Schedule M-1, what is subtracted from book income?
(1) income items which are not taxable though included in book income
(2) expense items which are deductible from taxable income but not from book income
In Schedule M-1, what are some income items that are not taxable though included in book income?
(a) proceeds from key-person life insurance
(b) interest from tax-exempt bonds
In Schedule M-1, what are some expense items that are deductible from taxable income but not from book income?
(a) depreciation expense from using a different method
(b) charitable contribution carryovers
(c) dividends-received deduction
What is Schedule M-3?
It fulfills the same purpose as Schedule M-1, but for corporations with >$10 million in assets
Done to make the reconciliation more detailed for these businesses
How does Schedule M-3 differ from M-1?
M-3 has temporary and permanent differences distinguished and reported separately
M-3 also reconciles worldwide consolidated income for consolidated tax groups
If a business is not required to file Schedule M-3, when might it still do so?
It may file M-3 instead of following the disclosure requirements for reportable transactions
What are earnings and profits (E&P)?
A corporation’s economic ability to pay dividends (similar to retained earnings)
What are the two types of E&P?
Current and accumulated
Accumulated = sum of previous years’ current E&P on the first day of a given taxable year
What is the importance of distinguishing between current and accumulated E&P?
It determines the extent to which distributions are treated as dividends and thus taxable, rather than being returns of capital and thus nontaxable
What occurs if current E&P is positive but accumulated E&P negative?
All distributions to the extent of current E&P are deemed dividends
What occurs if current E&P is negative but accumulated E&P positive?
Current and accumulated E&P must be added
If the result is positive, distributions are dividends to the extent of the net E&P
-if not, distributions are returns of capital
What occurs if current E&P and accumulated are both positive or both negative?
Positive = distributions are dividends
Negative = distributions are returns of capital
If multiple distributions are made in one year by a corporation, how does it affect current and accumulated E&P?
Distributions reduce current E&P pro rata, but are applied directly to accumulated E&P as they occur
What is an example of distributions being applied against current E&P and accumulated E&P?
A company has $25k in accumulated E&P and $20k in current E&P. It has two distributions during the year of $40k and $10k (and thus a total distribution of $50k).
The first distribution reduces current E&P by $40k/$50k x $20k = $16k. The remaining $24k is applied against accumulated E&P to result in $1k.
The second distribution reduces current E&P by $10k/$50k x $20k = $4k. The remaining $6k is applied against accumulated E&P to result in -$5k. Since $5k of this $10k is negative, 1/2 will be dividend income and the other half will be a return of capital.
When distributions are treated as returns of capital, how does it affect the stockholders’ basis in the stock?
A return of capital reduces the stockholders’ basis in their stocks – and if the basis is reduced to 0, any further distribution is treated as a capital gain
E.g. if someone has a basis of $600 and receives a $1k distribution that is a return of capital, he will have a $600 basis-reduction and recognize a $400 capital gain
What are some items which need to be added to taxable income to calculate E&P?
(a) tax-exempt income
(b) life insurance proceeds for key persons
(c) accelerated depreciation over the SL amount
(d) intangible drilling costs
(e) charitable deduction carryovers
What are some items which need to be subtracted from taxable income to calculate E&P?
(a) federal income taxes
(b) loss on related-party sales
(c) life insurance premiums for key persons
(d) charitable contributions >10% of taxable income
How do corporations treat non-cash distributions to shareholders?
As if they were selling the property to shareholders – if the FMV exceeds the basis, a gain is recognized, but no loss can be recognized
If there is any debt on the property, the FMV cannot be less than the debt when calculating a gain
If non-cash distributions are given to stockholders, how does it affect E&P?
E&P is reduced by the greater of (1) the property’s FMV or (2) its adjusted basis – minus any debt on the property
However, any gain in distributing property increases E&P
How does a corporation treat a repurchase of stock from stockholders (i.e. a stock redemption)?
For tax reasons, just like a sale
How do stockholders treat stock redemption?
The proceeds are taxable as dividends unless one of five conditions obtains – in which case the stockholder would recognize a capital gain or loss
What are the first two of five reasons a stockholder would treat redemption as a capital gain or loss?
(1) redemption isn’t “substantially equivalent” to a dividend – e.g. after the sale, the stockholder loses voting rights, rights to assets on liquidation, rights to earnings, etc.
(2) redemption is “substantially disproportionate” – i.e. the stockholder owns much less in the corporation than before: both under 80% of what he had and under 50% of total voting stock
What are the last three of five reasons a stockholder would treat redemption as a capital gain or loss?
(3) all one’s stock is redeemed
(4) the redemption is a partial liquidation, if the stockholder is not a corporation
(5) the redemption’s purpose is to pay death taxes
Which corporations are exempt from the accumulated earnings tax?
(1) S corporations
(2) personal holding companies (including foreign ones)
(3) passive foreign investment companies
How does a corporation treat its distributions in the event of a full liquidation?
It recognizes gain or loss as if the liquidated property were being sold to stockholders at FMV
However, this does not occur if the shareholder is a corporation taking the property at a carryover basis, e.g. if a parent subsumes a subsidiary
What is the amount of the credit for the accumulated earnings tax?
$250k (or $150k for personal service corporations)
+ dividends paid in first 2 1/2 months of subsequent tax year
- accumulated E&P at end of previous tax year
What is the purpose of the accumulated earnings tax?
To tax corporations that retain earnings more than needed in order to avoid shareholder taxation
What is the role of the credit for the accumulated earnings tax?
A corporation can accumulate up to the amount of the credit without needing to explain why the accumulated capital is needed
What is the tax rate for the accumulated earnings tax?
20% for 2013
What is the purpose of the personal holding company (PHC) tax?
To discourage such corporations from hoarding various types of passive income
What is the PHC tax rate, and when is it imposed?
Any corporation classified as a PHC must pay, in 2013, a 20% tax
How do PHCs pay the PHC tax?
By filing Form PH with Form 1120
What two tests determine whether a corporation qualifies as a PHC?
(1) gross income test: at least 60% of adjusted ordinary gross income (AOGI) is passive income
(2) stock ownership test: >50% of stock owned by the company is held by five or fewer persons at any given time in the year
What kinds of passive income are relevant to the PHC tax?
- dividends
- interest income
- rent
- royalties
- personal service contracts
Under what circumstances can a PHC avoid paying the penalty tax?
If the shareholders receive “consent dividends,” i.e. dividends where no money is actually distributed but shareholders nonetheless pay tax on a certain amount
What are the different kinds of corporate reorganizations?
Types A, B, C, D, E, F, and G
What is a Type B reorganization?
Acquiring at least 80% of another corporation’s voting power for all stocks and at least 80% of its total nonvoting shares by giving up voting stock (but no boot)
What is a Type A reorganization?
A merger or consolidation
The consideration of the acquiring corporation must be at least 50% stock (i.e. less than 50% cash or property)
What is a Type D reorganization?
One corporation transfers assets to another corporation and receives (or one of its stockholders receives) >=80% of the other corporation’s voting power and >=80% of its nonvoting stock
What is a Type E reorganization?
Major change in capital structure
What is a Type F reorganization?
Change only in identity, form, or location
What is a Type G reorganization?
Reorganization due to bankruptcy
How does a reorganization affect a corporation’s taxes?
Unless the corporation received boot in the reorganization, it is tax-free
However, there can still be capital gains when transferring appreciated property
Under what circumstances does a parent-subsidiary relationship exist?
In an affiliated group, the parent must own (1) 80% of the sub’s total voting power and (2) 80% of its nonvoting stock
In a controlled group, the parent must own either (1) OR 80% of the TOTAL stock
What are the tax implications for an affiliated group?
It can file a consolidated tax return, so that (a) one firm’s losses offset another’s income, (b) intra-group dividends aren’t taxed, (c) intra-group income isn’t taxed, and (d) gains on intra-group sales are deferred until a third party becomes a purchaser
What are the two different ways corporations can be grouped?
Controlled (can be either parent-sub or brother-sister) and affiliated (can only be parent-sub)
How can a corporation elect to become an S corporation?
If it meets all the requirements, it elects such a status via Form 2553
Must be filed by March 15 (or the equivalent day in a non-calendar tax year) at the latest – or else it only kicks in for the next year
Under what circumstances does a brother-sister relationship exist?
Whenever there are commonly controlled corporations in a controlled group
A controlled group must have five or fewer stockholders that, cumulatively, own either >50% of all voting power or >50% of total stock
Is an S corporation required to adopt any particular kind of taxable year?
Yes, either the calendar year or a fiscal year which aligns with stockholders owning >50% of the stock
However, an S corporation can request of the IRS to have a different year
What are the tax implications for a controlled group?
(a) treated as one entity for several taxable things: (i) the first $75k which is taxed at less than 34%, (ii) Section 179 deduction, (iii) accumulated earnings credit, and so on
(b) gains and losses from intra-group sales are not recognized until a third party becomes involved
What is an S corporation required to do if it elects another fiscal year via Section 444?
Since electing another year can result in a deferral of tax revenue for the gov’t, the S corporation must make annual payments each year, due by May 15
If the required payment is <=$500, then it is not required for that year
If a corporation files for S corporation status before the election date but lacks one of the prerequisites for the status, what occurs?
It can attain S corporation status only if it meets all the prerequisites before the election date
What is included in Form 1120S?
The total income for the corporation and also each shareholder’s pro rata share of income
Shareholders must pay tax on their share whether or not it was actually distributed to them as such
When may an S corporation request of the IRS to have a different tax year?
If a “valid business purpose” exists for the different year – which means that, for three straight years, >=25% of the corporation’s gross income was in the last two months of this requested year
Done through Section 444
Where on Form 1120S are nonseparately stated and separately stated income supposed to be?
Nonseparately stated = page 1
Separately stated = Schedule K
How is taxable income calculated for S corporations?
S corporations pass on taxable income to stockholders, but still file an informational return with Form 1120S, due by March 15 (or the equivalent date in another fiscal year)
What are the three different limits on how S corporation stockholders can deduct their share of corporate losses?
(1) the stockholder’s basis
(2) at-risk rules
(3) passive loss rules
These limitations are applied in this order
What are the two different kinds of income passed on to S corporation stockholders?
(1) nonseparately stated = ordinary business income netted with expenses
(2) separately stated = less ordinary income, not netted – e.g., capital gains/losses, Section 1231 gains/losses, dividend or interest income, charitable contributions, income from passive activities, etc.
How do at-risk rules limit an S corporation stockholder’s loss deductions?
If a stockholder has put forth his money or property (including if it’s borrowed) to some activity, then he is “at risk” for that activity – in which case he can deduct losses to that extent
How is an S corporation stockholder’s pro rata share of income calculated?
Simply by the avg. % of stock owned through the year
(a) if someone buys or sells stock, then the buyer is considered to own the stock on that particular day
(b) if a stockholder sells all his stock, the corporation can elect to end the taxable year on that date
What is an accumulated adjustments account (AAA)?
Contains all undistributed net income items – computed at tax year-end
How does an S corporation stockholder’s basis limit his loss deductions?
Losses reduce his basis in stock and then reduce his basis in debt, but cannot be deducted further – though they can be carried forward indefinitely to deduct any future basis
How are S corporation distributions taxed if the corporation has accumulated E&P?
(1) distributions are first from an AAA, which is tax-free
(2) then they are tax-free to the extent of previously taxed income (PTI)
(3) then they are taxed as dividends to the extent of accumulated E&P
(4) then they are tax-free returns of capital, to the extent of stockholders’ basis
(5) then they are taxed as gains on selling the stock
How do passive loss rules limit an S corporation stockholder’s loss deductions?
Passive losses can only offset passive income
How might a business’s S corporation status be revoked?
By not fulfilling the requirements, by receiving inordinate passive income, or by doing so voluntarily
What are the tax implications of distributions upon S corporations?
Depends on whether the corporation has accumulated E&P or not
If not, distributions are tax-free to the extent of stockholders’ basis; otherwise they are taxed as gains on selling stock
If so, it gets more complicated
Can S corporation status be re-elected after being revoked?
Not for five years, unless the IRS permits an earlier re-election
How do fringe benefits for an S corporation relate to stockholders’ income?
If an employee-stockholder has more than 2% of the stock, his fringe benefits must be included in his gross income and can be deducted from the S corporation
What counts as inordinate passive income?
If (a) passive income is >25% of gross income for three straight years and (b) the corporation has accumulated E&P from a previous C corporation status
What is a Type C reorganization?
Acquiring substantially all of another corporation’s assets in exchange for voting stock – though the acquired corporation must then distribute whatever it has
“Substantially all”: >=90% of net assets’ FMV and >=70% of gross assets’ FMV
How can an S corporation status be voluntarily revoked?
If an absolute majority of stockholders consent to do so
If they do not specify a date, the automatic revocation date is the first day of the taxable year in which consent was made (up to the day the taxes are due, March 15)
