Business Organizations and the Tax Environment

1. Business Organizations and the Tax Environment Chapter 6

2. Alternative Forms of Business Organization • Sole Proprietorship - unincorporated business owned by one individual

3. Alternative Forms of Business Organization • Sole Proprietorship • Partnership - unincorporated business owned by two or more persons

4. Alternative Forms of Business Organization • Sole Proprietorship • Partnership • Corporation - legal entity created by a state, separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability

5. Alternative Forms of Business Organization • Sole Proprietorship • Partnership • Corporation • corporate charter is filed with the state providing information about the company and directors

6. Alternative Forms of Business Organization • Sole Proprietorship • Partnership • Corporation • corporate charter is filed with the state providing information about the company and directors • bylaws are for internal management and procedures

7. Board of Directors President VP Finance(CFO) VP Marketing VP Manufacturing Treasurer Controller Director ofCapitalBudgeting FinancialAccounting Credit Manager InventoryManager Cost Accounting TaxDepartment Finance in the Organizational Structure of the Firm

8. The Goals of the Corporation • Stockholder wealth maximization • considers the risk and timing associated with expected earnings per share in order to maximize the price of the firm’s common stock

9. The Goals of the Corporation • Stockholder wealth maximization • Managerial incentives to maximize shareholder wealth

10. The Goals of the Corporation • Stockholder wealth maximization • Managerial incentives to maximize shareholder wealth • Social responsibility

11. The Goals of the Corporation • Stockholder wealth maximization • Managerial incentives to maximize shareholder wealth • Social responsibility • Stock price maximization and social welfare

12. Managerial Actions to Maximize Shareholder Wealth • Profit Maximization • Will profit maximization also result in stock price maximization?

13. Managerial Actions to Maximize Shareholder Wealth • Profit Maximization • Consider: • total corporate profit versus earnings per share (EPS) • timing of earnings • risk of project • risk of financing • dividend payout versus reinvestment

14. Agency Relationships • Owner/principal hires an agent and delegates decision-making authority to that agent to act on behalf of the principal • Agency problem exists when conflict of interest between principal and agent • between stockholders and managers • between stockholders and creditors

15. Stockholders versus Managers • The threat of firing • The threat of hostile takeover • due to underpriced stock • may be warded off with poison pill or greenmail • Structuring management incentives • executive stock options • performance shares

16. Stockholders versus Creditors • Creditors lend based on expectations • riskiness of the firms existing assets • expectations concerning the riskiness of future asset additions • the firm’s existing capital structure • expectations concerning future capital structure changes (amount of debt) • Stakeholders must be treated fairly

17. Factors Affecting Stock PricesThe External Environment • Legal constraints • General level of economic activity • Tax laws • Conditions in the stock market

18. Factors Affecting Stock PricesExternal Constraints • Antitrust laws • Environmental regulations • Product and workplace safety regulations • Employment practice rules • Federal reserve policy • International developments

19. Factors Affecting Stock PricesStrategic Policy Decisions Controlled by Management • Types of product or services produced • Production methods used • Relative use of debt financing • Dividend policy

20. Factors Affecting Stock Prices Level of Economic Activity and Corporate Taxes • Expected profitability • Timing of cash flows • Degree of risk

21. Factors Affecting Stock Prices Stock Market Conditions • Stock price

22. Business Ethics • Company’s attitude and conduct toward its stakeholders (employees, customers, stockholders…) • Ethical behavior requires fair and honest treatment toward all parties

23. Business Ethics • Avoids fines and legal expenses • Builds public trust • Attracts business from customers who appreciate and support the firm’s policies • Attracts and keeps employees of the highest caliber • Supports the economic viability of the communities in which it operates

24. Forms of Businesses in Other Countries • Public limited company (PLC) • Aktiengesellshaft (AG) • Sociedad Anónima (SA) • Industrial groups • keiretsu • chaebol

25. Multinational Corporations • Operate in more than one country • To seek new markets • To seek raw materials • To seek new technology • To seek production efficiency • To avoid political and regulatory hurdles

26. Multinational versus Domestic Managerial Finance • Different currency denominations

27. Multinational versus Domestic Managerial Finance • Different currency denominations • Economic and legal ramifications • Language differences • Cultural differences

28. Multinational versus Domestic Managerial Finance • Different currency denominations • Economic and legal ramifications • Language differences • Cultural differences • Role of governments

29. Multinational versus Domestic Managerial Finance • Different currency denominations • Economic and legal ramifications • Language differences • Cultural differences • Role of governments • Political risk

30. The Federal Income Tax System • Count on changes • indexed items • new tax laws

31. Individual Income Taxes • Progressive tax: higher tax on higher incomes • Taxable income is gross income minus exemptions and allowable deductions • Marginal tax rate is the tax on the last unit of income • Average tax rate is taxes paid divided by taxable income

32. Taxes On Dividend and Interest Income • Dividends are paid out of earnings that have already been taxed • Interest on most state and local government bonds (municipals) is not subject to federal income taxes

33. Yield on tax-free investment 1 - Marginal tax rate Comparing Yields Tax-free and Taxable Equivalent pre-tax yield on a taxable investment = A taxpayer in the 30% marginal tax bracket who could buy a municipal bond that yields 10 % would have to receive a before-tax yield of 14.3% on a corporate or US Treasury bond to have the same after-tax yield.

34. Individual Income Taxes • Interest paid by individuals is generally not deductible, with the exception of mortgage interest • Capital gains versus ordinary income • profit from sale of capital asset • benefits of long-term capital gains • Business versus personal expenses

35. Corporate Income Taxes • Interest and dividend income received by a corporation • 70% of dividends received by another corporation is excluded from taxable income • Interest and dividends paid by a corporation • interest is deducted from income

36. Corporate Income Taxes • Corporate capital gains • currently taxed at same rate • Corporate loss carryback and carryover • losses can be carried back 2 years and carried over to the next 20 years • Accumulated earnings tax

37. Corporate Income Taxes • Consolidated corporate tax returns • if own 80% or more • S Corporations • small corporation that elects to be taxed as a proprietorship or partnership yet retains limited liability and other benefits of incorporating

38. Corporate Tax Rates in Other Countries

39. Corporate Tax Rates in Other Countries

40. Depreciation • Expensing the price of a long-term asset over time

41. End of Chapter 6 Business Organizations and the Tax Environment