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Chapter 16

Chapter 16. Corporations. Learning Objectives. Define a corporation Calculate the corporate income tax liability and explain specific tax rules Apply the non-recognition of gain or loss rules for corporate formations. Learning Objectives. Understand the significance of earnings and profits

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Chapter 16

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  1. Chapter 16 Corporations

  2. Learning Objectives • Define a corporation • Calculate the corporate income tax liability and explain specific tax rules • Apply the non-recognition of gain or loss rules for corporate formations

  3. Learning Objectives • Understand the significance of earnings and profits • Determine the consequences of nonmoney distributions and stock redemptions • Understand the consequences of a corporate liquidation to shareholders and the liquidating corporation

  4. How A Business May Be Organized • Sole Proprietorship • C (regular) Corporation • S Corporation • Partnership • Limited Liability Partnership - LLP • Limited Liability Company - LLC

  5. Major Types • FLOW-THROUGH OR CONDUIT OR PASS-THROUGH ENTITIES • S corporation • Limited Liability Companies • Limited Partnerships • Partnership • TAXABLE ENTITIES • Sole proprietorship • C corporation

  6. Taxation Of Businesses • Income from sole proprietorships and flow-through entities • is taxed once at the individual owner level while corporate income is taxed twice, • once at the corporate level • and again at the shareholder level upon dividend distributions or stock sales

  7. Define A Corporation • A business entity with two or more owners is classified as either a corporation or a partnership • A business entity with one owner is classified as a corporation or a sole proprietorship

  8. Define A Corporation • A business entity is a corporation if it is organized under a federal or state statue that refers to the entity as incorporated or as a corporation • If a business entity incorporates, it is a corporation

  9. Define A Corporation • If a business forms itself as a Partnership, Limited Liability Company(LLC) Or Limited Liability Partnership(LLP), the entity can elect to be taxed as either a partnership or corporation

  10. Similarities Of Individuals And Corporations • Similar computation of taxable income • Allowed to deduct ordinary and necessary business expenses • Can deduct interest and depreciation

  11. Differences Between Corporations And Individuals • Personal, consumption-type expenditures and exemptions apply solely to individuals • Computation of AGI applies only to individuals • Corporation is not permitted to use standard deduction or deduct personal and dependency exemptions • Corporations receive a dividends-received deduction • Corporate charitable deductions limited to 10% taxable income • Compensation deduction limitation for Publicly Held Corporations

  12. Specific Rules Applicable To Corporations • Capital gains & losses • Dividends received deduction • Net operating losses • Charitable contributions • Compensation deduction limitation for publicly held corporations

  13. Computation Of Taxable Income • Reflects a stair-step progression (see table I16-1) • Corporation income tax is essentially a flat tax for large corporations • Special rules for certain Personal Service Corporations

  14. Computation Of Corporate Alternative Minimum Tax • Designed to ensure that no corporation with substantial economic income can use exclusions, deductions, and credits to avoid significant tax liability • 20% of alternative minimum taxable income (AMTI) less than exemption amount

  15. Exception To AMT For Small Corporations • For tax years after 1997 AMT does not apply to small corporations • $5 million gross receipts test in its first tax year after 1996

  16. Penalty Taxes • Two penalty taxes • Accumulated earnings tax • Personal holding company tax

  17. Transfers Of Property To Controlled Corporations • Section 351 non-recognition requirements • Basis considerations • Treatment of liabilities • Character of gain recognized

  18. Capitalization Of The Corporation • Debt has two main tax advantages: • Interest payments are deductible • Principal repayments are a tax-free return of capital • Safe harbor rule

  19. Earnings And Profits • Calculation of earnings and profits • Current versus Accumulated E&P

  20. NonMoney Distributions • Tax consequences to the shareholders • Amount distributed= FMV of property (reduced by liabilities) • Treated as taxable dividend if corporation has sufficient E&P • Basis of distributed property=FMV (without reduction for liabilities)

  21. Nonmoney Distributions • Tax consequences to the distributing corporation • General rule, the corporation recognizes no gain or loss upon a distribution to its shareholders • If corporation distributes appreciated property to its shareholders, the corporation is treated as if it sold the property to the shareholder for its FMV immediately before the distribution, and the corporation recognizes any realized gain

  22. Stock Redemption • Redemption treated as a taxable dividend (E&P) • Redemption treated as an exchange, resulting in capital gain or loss by shareholder

  23. Determining Whether A Redemption Is A Dividend Or Capital Gain • Subject to capital gain or loss if any of following met: Redemption... • Is not essentially equivalent to a dividend • Is substantially disproportionate with respect to shareholders’ interest • Results in a complete termination of shareholders’ interest • Is made in partial liquidation of corporation

  24. Corporate Distributions In Complete Liquidation • Tax consequences to the liquidating corporation • Tax consequences to the shareholders • Section 332: Liquidation of a subsidiary corporation

  25. Typical Misconception • It is sometimes assumed that the liquidation of a corporation always is associated with the discontinuance of business activities. Sometimes the business is operated as a partnership or sole proprietorship after the liquidation

  26. Tax Planning Considerations • Capital structure and Section 1244 • Dividend policy • Use of losses • Charitable contributions • Dividends-received deductions

  27. Compliance & Procedural Considerations • Filing requirements • Corporation must file Form 1120 • Not based on gross income • Due date is one month earlier than individual returns • Due date for estimated tax installment also one month earlier

  28. Compliance & Procedural Considerations • Schedule M-1 and M-2 reconciliation • M-1 used to reconcile financial accounting net income with taxable income (before NOL & dividends-received deductions) • M-2 reconciles the beginning year balance in retained earnings with year-end balance • Maintenance of records/E&P

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