Chapter 11 Corporate Income Tax

Transcription

1 Chapter 11 Corporate Income Tax Income Tax Fundamentals 2011 Gerald E. Whittenburg Martha Altus-Buller

2 Learning Objectives As pertains to corporations: Calculate tax liability using tax rates Compute basic capital gains/losses Ascertain how special deduction may affect taxable income Identify components of Schedule M-1 Outline corporate tax return filing and estimated tax payment requirements Understand how S-Corporations operate and are taxed Understand basic tax rules when forming entity Describe accumulated earnings and personal holding company taxes Define elements of alternative minimum tax calculation

3 Corporate Tax Rates Corporate rates are progressive Marginal rates are from 15% to 39%, depending on taxable income There are eight brackets There are a number of tax bubbles these occur when tax rate schedules recaptures savings from prior brackets For corporations with large income (more than $18.33 million) the rate is a flat 35% Qualified personal service corps taxed at flat 35% Architects, CPAs, consultants, etc.

4 Example Corporate Tax Rates Example Johnson & Kelby Inc. (a dental products wholesaler) has taxable income of $300,000 for the current year. What is the corporation s tax liability? How would the answer change if it was an architectural firm, and Johnson & Kelby were principals who provided personal services?

5 Solution Example Johnson & Kelby Inc. (a dental products wholesaler) has taxable income of $300,000 for the current year. What is the corporation s tax liability? How would the answer change if it was an architectural firm, and Johnson & Kelby were principals who provided personal services? Solution Corporate tax = $100,250 $22,250 + (39%)($300, ,000) If Johnson & Kelby is a qualified personal service corporation, corporate tax = $105,000 ($300,000 x 35%)

6 Corporate Capital Gains A corporation can choose from two alternative tax treatments on capital gains Taxed at ordinary rates or Elect to pay an alternative tax (35%) on net longterm capital gain (LTCG) Essentially equivalent to maximum regular corporate tax (no tax benefit to LTCG) Bottom line: there is no difference in tax on ordinary vs. capital income

7 Dividends Received Deduction Corporations are allowed a deduction for a percentage of the dividends received from other corporations Attempt to alleviate triple taxation Dividends received deduction is allowed based upon ownership Percentage Ownership Dividends Received % Deduction < 20% 70% 20% or more, less than 80% 80% > 80% 100% Divends received deduction is limited by % of corporate taxable income shown above (calculated before certain deductions)

8 Amortization of Organizational Expenditures Examples of organizational expenditures Legal/accounting services incidental to organization Incorporation fees Organizational expenditures are capitalized and then amortized over 180 months However, can make election to deduct up to $5,000 of organization costs in the year corporation begins business $5,000 amount is reduced $1 for each $1 that organizational expenses exceed $50,000

9 Charitable Contributions Corporations are allowed a deduction for charitable contributions Cash basis taxpayers can deduct when paid Accrual basis taxpayers have until the 15th day of the third month following year-end to contribute, as long as pledge is made by year-end Charitable contributions limited to 10% of taxable income* Carry forward unused deduction for five years *Calculated before any loss carry backs, net operating losses (NOLs) or the dividend received deduction

10 Example Charitable Contributions Example Ferndale Corp. had net operating income of $400,000 for the current year and made charitable contributions of $60,000. A dividends received deduction of $80,000 is included in the net operating income calculation. What is Ferndale s charitable contribution deduction; what is the charitable contribution carry forward?

11 Solution Example Ferndale Corp. had net operating income of $400,000 for the current year and made charitable contributions of $60,000. A dividends received deduction (DRD) of $80,000 is included in the net operating income calculation. What is Ferndale s charitable contribution deduction; what is the carry forward? Solution The charitable contribution deduction is $48,000 ($400, ,000) x 10% = $48,000 limit* Therefore, carry forward is $32,000 ($80,000 48,000) *Note: had to add back DRD first!!

12 Reconciliation of Income (Loss) per Books with Income Per Return Schedule M-1 of Form 1120 reconciles accounting (book) income to taxable income Amounts added to book income (left column) Federal tax expense Capital losses Income recorded on tax return but not on books Expenses recorded on books but not on tax return Amounts deducted from book income (right column) Income recorded on books but not on tax return Expenses recorded on tax return but not on books See chapter for other items included on Schedule M-1

13 Filing Requirements & Estimated Tax Form 1120 filed for regular corporation Form 1120S filed for S Corporation Returns are due by the 15th day of the third month after year-end Can file Form 7004 and receive automatic 6-month extension Corporations must make estimated tax payments in similar manner as self-employed taxpayers, in four installments

14 S Corporations Certain qualified small business corporations may elect to be taxed in a manner similar to partnerships Qualified small business corporation may elect S Corporation status if several criteria apply Operates as a domestic corporation Has 100 or fewer shareholders Shareholders may not be corporations or partnerships Has only one class of stock Has only shareholders that are U.S. citizens or resident aliens

15 S Corporations Corporation must make election of S status in a prior year Or within 2-1/2 months of the current tax year S Corp status stays in effect until revocation* Status can be voluntarily revoked by consent of shareholders or Involuntarily revoked If corporation ceases to be a small business corporation or If corporate passive income is 25% or more for three consecutive years and corporation has accumulated earnings and profits at the end of each of those years Election is terminated on the date status is revoked

16 Example S Corporation Election Example Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, In which year may the corporation first be treated as an S Corporation?

17 Solution Example Swannak Electronics Corporation is a calendar year corporation that makes an S Corporation election on May 25, In which year may the corporation first be treated as an S Corporation? Solution Since Swannak did not make the S Corporation election within the first 2-1/2 months of the tax year, it will be treated as a regular corporation for It will become an S Corporation for tax year 2011.

18 Income Reporting Must report all elements of income and expense separately on Form 1120S Then each shareholder reports his/her share of these items of corporate income/expense on personal return K-1 takes total shareholder income/expenses and allocates each item to each shareholder based upon his/her ownership percentage If shareholder dies, his/her portion of S Corp items will be included in shareholder s final return

19 Loss Reporting Each shareholder of an S Corp may also report his/her respective share of loss Cannot take a loss in excess of adjusted basis in stock If loss exceeds adjusted basis in stock plus loans, shareholder can carry it forward If shareholder entered/departed S Corp mid-year, must allocate losses on a daily basis

20 S Corporation Pass Through Items Many items retain tax character when passing through to the S Corporation s shareholders on individual K-1 Examples of such items include Capital gains/losses 1231 gains/losses Dividend Income Charitable contributions Tax-exempt interest Most credits

21 Special Taxes S Corporations, in general, do not pay corporate taxes on their taxable income Certain exceptions exist such as: Built-in gains tax (paid on appreciated assets that were held by corporation prior to S Corp election) Certain tax imposed if corporation has large amount of passive income, such as dividends and income These rules are complex and will not be covered in this text

22 Corporate Formation Shareholders often transfer high-value low-basis assets to a corporation in exchange for stock in company No tax is due on gain from transfer of appreciated assets if following conditions met Shareholder transferred cash or property and Shareholder made transfer solely in exchange for stock* Shareholder is not providing a service and all taxpayers together own at least 80% of stock after transaction *If shareholder receives boot in addition to stock, transaction may qualify for partial nonrecognition of gain

23 Shareholder Basis in Stock A shareholder s initial basis in his/her stock is calculated as follows Basis of property transferred Less Boot received* Plus Gain recognized Less Liabilities transferred Basis in stock Note: generally, corporate assumption of shareholder liabilities that are attached to property are not considered boot received The corporation has a carry-over basis in the property contributed equal to the basis in the hands of the shareholder, increased by any gain recognized by shareholder on the transfer *Boot is any property other than stock

24 Accumulated Earnings Tax (AET) Penalty tax designed to prevent a corporation from avoiding tax by retaining earnings 15% AET imposed on unreasonable accumulation of earnings; this is in addition to corporate income tax Corporation may accumulate up to $250,000 a year that is exempt from AET tax or $150,000 for a service corporation May accumulate more if can prove a valid business purpose

25 Example Accumulated Earnings Tax Example Xinix Corporation (a medical device manufacturing firm) has accumulated earnings of $800,000. The corporation can establish reasonable needs for $500,000 of the accumulation. What would Xinix accumulated earnings tax be?

26 Solution Example Xinix Corporation (a medical device manufacturing firm) has accumulated earnings of $800,000. The corporation can establish reasonable needs for $500,000 of the accumulation. What would Xinix accumulated earnings tax be? Solution Xinix AET = $45,000 ($800, ,000) x 15% Note: this is paid in addition to regular tax

27 Personal Holding Company Tax Penalty tax designed to encourage Personal Holding Companies to distribute earnings to shareholders Tax is 15% on undistributed earnings Corporation is not liable for both the personal holding company tax and the AET in the same year

28 Corporate AMT Corporate AMT - calculated similar to the individual AMT AMT is 20% of Alternative Minimum Taxable Income (defined below) Taxable Income +/- Adjustments + Preferences - Exemption* Alternative Minimum Taxable Income (AMTI) Small corporations are not subject to the AMT Defined as having average annual gross receipts < $7.5 million over a three-year period *Exemption is $40,000, but is phased out when AMTI > $150,000

29 You re Done with Chapter 11