REG 3 Flashcards
Formation of a Corporation: Corporation tax consequences
Corporation tax consequences:
1) General rule-no gain or loss recognized in the following transactions: formation, reacquisition, and resale (sale of treasury stock)
2) General rule: The basis of property received from the transferor/shareholder is the GREATER of:
(i) Adjusted basis (net book value) of the transferor/shareholder (plus any gain recognized by the shareholder, if any) OR
(ii) Debt assumed by corporation
Formation of a Corporation: Shareholder tax consequences
1) No gain or loss recognized (contributing property i.e. cash, fixed assets) IF the following conditions are met:
(i) Immediately after transaction those shareholders contributing property own at least 80% of the voting stock and nonvoting stock.
(ii) Boot is not involved (boot is not received by shareholder) such as cash, receipt of debt securities (boot received may generate gain to transferor)
***Regarding cancellation of debt (“COD”): The amount of liabilities assumed that exceeds the adjusted basis of the total assets transferred to the corporation is not boot (per se) but does generate gain.
NBV Assets
(Liabilities)
=Excess Liab=Boot, gain is recognized by shareholder
Basis of Common stock (to shareholder)
a. Cash - amount contributed
b. Property-adjusted basis-NBV
(i) the adjusted basis of property is reduced by any debt on the property (e.g. COD) assumed by the corp.
(ii) Gain recognized by shareholder (when debt exceeds the asset’s adjusted basis)
c. Services-Fair market value is taxable as ordinary income
Tax-free reorganizations
Parent/Sub liquidation: no gain or loss is recognized by either the parent corporation or the subsidiary corporation when the parent, who owns at least 80%, liquidates its subsidiary.
Organizational costs and amortization
Organizational costs are amortizable over a minimum period of 15 years (180 months) and subject to a $50K total expenditure limitation. A $5K deduction is allowed in Yr 1.
Allowable costs consist of 1) legal fees to obtain the corporate charter, necessary accounting services, 2) expenses of temporary directors, and 3) incorporation fees paid to the state.
***Org costs exclude stock issue costs and commissions paid to underwriters to help sell the shares.
Definition of a Personal holding company (PHC) if:
1) Corporations more than 50% owned by 5 or fewer individuals (at any time during the last half of the year), and having
2) at least 60% of its adjusted ordinary gross income for the year is investment-type income, consisting of: NIRD
N-Net rent (if less than 50% of ordinary gross income);
I-Interest that is taxable (nontaxable is excluded);
R-Royalties (but not mineral, oil, gas, or copyright royalties);
D-Dividends from an unrelated domestic corporation
*PHC are taxed an additional 20% on the net income not distributed.
Accrual basis method of accounting for tax purposes is required for the following:
1) The accounting for purchases and sales of inventory (inventories must be maintained)
2) Tax shelters
3) Certain farming corporations (other than farming or tree-raising businesses)
4) C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million average annual gross receipts for the 3 yr period ending with the tax year.
*C corporations has considerable flexibility in choosing an accounting period
Corporate liquidation
Distributions are subject to two levels of taxation
1) The *corporation must recognize gain or loss as if it sold the assets for the fair market value.
2) The *shareholders would report gain or loss determined by the difference between the fair market value of the assets received and the shareholders’ adjusted basis of the stock
Capital loss in corporations
Capital losses can only be used to offset capital gains, and any amount not utilized in the year of generation can be either be carried back 3 years or carried forward for 5 years. (considered short-term capital loss)
Capital gains are taxed at the same rate as ordinary income for a corporation.
Dividends received deduction (“DRD”)
Purpose to prevent triple taxation of earnings.
% of ownership:
0 to less than 20% = 70% DRD
20% to less than 80% = 80% DRD
80% to 100% = 100% DRD
Income \+Dividend income =Gross income (Charity deduction) =Taxable income before DRD (DRD) =Taxable income
Taxable income limitation
The dividends received deduction (DRD) equals the LESSER of:
i) 70% (or 80%) dividends received; OR
ii) 70% (or 80%) of taxable income before DRD, any NOL deduction, capital loss carryback, or domestic production activities deduction
Exceptions to Taxable Income Limitation
The above rule does not apply if after taking into account the full dividends received deduction, the result is a net operating loss (NOL).
Then you take the most because you are already a “loser”
Charitable contributions for corporations
Corporations are allowed a maximum deduction of 10% of their taxable income for charitable contributions.
Taxable income is calculated before the deduction of
1) any charitable contribution;
2) dividends received deduction;
3) any net operating loss carryback;
4) any capital loss carry back; or
5) US production activities deduction
*Excess charitable contributions may be carried forward up to 5 years
Tax deduction on Intangibles
Intangibles, such as goodwill, covenants not to compete, franchises, trademarks, and trade names must be amortized straight-line over a 15-yr period (180 months) beginning with the month of acquisition.
Capital asset gains and losses
The stock is each corporation is a capital asset.
General rule: A loss on the sale or exchange of a capital asset will be a capital loss (either a short-term or long-term capital loss, depending upon the holding period).
However, a special rule applies to “Section 1244 Small business stock”. When a corporation’s stock is sold or becomes worthless, then the original stockholder can be treated as having an ordinary loss (fully deductible), instead of a capital loss, up to $50,000 ($100,000 if married filing jointly) for the year. Any loss in excess is a capital loss.
Book Income vs Taxable Income (Permanent and temporary differences)
1) Temporary differences:
- interest income received in advance
- rental income received in advance
- royalty income received in advance
2) Permanent differences
- Interest income from municipal or state obligations/bonds
- Certain proceeds from life insurance on the life of an officer, where the corporation is the beneficiary
- Federal income taxes are not deductible on the tax return
Trade or Business deductions
1) Domestic production deduction (incentive to keep jobs in America)
- deduction may not exceed 50% of total W-2 wages paid by the corp for the year
- 9% deduction of the lesser of (a) Qualified production activities income “QPAI” which is [Domestic production gross receipts less COGS less Other directly allocable expenses or losses less proper share of other deductions= QPAI or (b) Taxable income
2) Executive compensation: Public company MAY NOT deduct compensation expense in excess of $1M paid to CEO or the other 4 most highly compensated officers
3) Bonus accrual paid only to employees (non-shareholders): Must be paid by March 15th
4) Bad debt-specific charge-off method: under accrual basis=tax deduction when specific AR is written off;
under cash basis=was never income so no tax deduction
5) Business interest expense:
(i) interest expense on business, incurred and paid=deductible
(ii) interest expense on investments=up to investment income
(iii) prepaid interest expense, later when incurred.
6) Charitable contributions (10% of Adjusted taxable income limitation). Accrual must be paid by 2 1/2 months after year-end to be deductible (see other flashcard for detail)
7) Business losses and casualty losses related to business =100% deductible
8) Organizational expenditures and start-up costs: Deduct up to $5,000 of org expenditures and $5,000 start-up costs. Any excess is amortized over 15 years (180 months). Included costs: fees paid for legal services in drafting the corporate charter, bylaws, minutes of org meetings, fees paid for accounting services, and fees paid to state of incorporation. (does not include stock issue costs)
9) Amortization, depreciation, and depletion: Goodwill, covenants not-to-compete, franchises, trademarks, and trade names must be amortized on a straight line basis over 15 year period. For depreciation and depletion use the same rules covered in a later chapter.
10) Life insurance premiums:
(i) corp named as beneficiary=not tax deductible
(ii) insured employee named as beneficiary-employee owns the policy (fringe benefit)=Tax deductible
11) Business gifts=$25 per recipient per year
12) Business meals and entertainment =50% tax deductible
13) Penalties and illegal activities=Not deductible
14) Taxes:
(i) State and local taxes, city income, and federal payroll taxes = tax deductible
(ii) Federal income taxes=not deductible
15) Lobbyist and political expenditures=not tax deductible
16) Capital gains and losses
(i) Capital losses deductions not allowed; ONLY to offset capital gains
(ii) Capital loss carryover=3 back/5 forward
(iii) Capital gains tax calculation based on ordinary tax rates
17) Net operating losses= carryback period 2 back/20 forward
18) Inventory valuation methods: taxpayers who have inventory must use the accrual method of accounting for tax purposes. Inventory method used per the books must the same as used for tax purposes.
19) General business credits: Credit may not exceed “net income tax” (which is regular tax plus alternative minimum tax less nonrefundable tax credits, other than the alternative minimum tax credit) less the greater of:
(i) 25% of regular tax liability above $25K, OR
(ii) “Tentative minimum tax” for the year
Consolidate tax return
An affiliated group means that a common parent directly owns:
80% or more of the voting power of all outstanding stock; and
80% or more of the value of all outstanding stock of each corporation.
*Difference
For tax consolidate if greater than 80%
For books consolidate if greater than 50%
