Corporate Taxation Chapter One: Overview

Transcription

1 Presentation: Corporate Taxation Chapter One: Overview Professors Wells January 21, 2015

2 Relevance of this Corporate Taxation Course Federal income tax planning concerns: 1. Choice of business enterprise form 2. Capital structure, e.g., debt or equity (or both) 3. Dividend/profits distribution policy 4. Compensation policy 5. Disposition of corporate interests 6. Estate planning/wealth transfers 2

3 Business Entity Choices Corporation C or S status Partnership general or limited Limited Liability Company (LLC) Trust or Estate Sole Proprietorship Disregarded Entity (DRE) RICs & REITS and other flow-throughs 3

4 Fundamental Corporate Tax Technical Issues 1. Contributions to the corporation gain recognition to either party? 2. Arrangements between owners & the entity e.g., assignment of income permitted? 3. Distributions of appreciated property. 4. Corporate liquidations, including sales in conjunction with a corporate liquidation. 5. Corporate reorganizations possible postponement of gain recognition. 4

5 Cradle to Grave Approach In This Course 1. Formation of Corporations: Capital Structure Debt vs. Equity. Is an interest expense deduction available? Tax-free repatriation of debt available? 3. Liquidating and Nonliquidating distributions -Redemptions & partial liquidations -Stock dividends & 306 stock 4. Taxable complete or partial liquidation 5. Corporate tax-free reorganizations & divisions 6. Carryover of Corporate Tax Attributes 7. Corporate Affiliated Groups 8. S Corporations 5

6 Corporation/Shareholder Tax Policy Issues Slaying Dragons or Tilting At Windmills? p.4 1) Double taxation 2) Tax rates on ordinary income Shareholder Tax Shareholder 3) Preferential capital gains rates. 4) Non-recognition for owner-shifts Corporate Tax Corporation Double Tax 6

7 Incidence of Corporate Tax p.5 Who bears the burden of the corporate tax? 1) The corporation? 2) Shareholders/owners? 3) Employees? 4) Corporate managers? 5) Consumers of the corporation s output? 6) Other investors? 7

8 Concepts of Tax Common Law p.10 Non-codified federal income tax rules (particularly relevant in the corporate income tax context): 1) The sham transaction rule. 2) Substance over form analysis. 3) The business purpose doctrine. 4) The step transaction doctrine. 5) Codified 7701(o) re: economic substance 8

9 Income Taxation of the Corporation p.14 1) Code 11 graduated tax rate structure. -Code 11(b)(1) no lower initial brackets for personal service companies. 2) Determination of the corporation s taxable income no above the line vs. below the line ; why? - capital gains & losses (no rate benefit but limits) 1211 & dividends received deduction is available. 243 p.16 - deduction for domestic production p.17 3) Accounting period is the calendar year required? 441(b) & (i) 4) Accrual method of accounting? 448(a). p.19 9

10 Income Taxation of the Corporation, Cont. p ) Code 267 limitations on loss transactions and timing mismatches between corporation and its owners, i.e., potential gaps. p. 18 6) Corporate Alternative Minimum (ALTMIN) Tax p. 19 repealed for small corporations. 7) Multiple corporations p.22 Consolidated tax returns for an affiliated group of corporations ) The S corporation alternative p

11 Problem (a) C Corporation Scenario p.26 (a) Determining corporate level gross income: Inventory Sales 2,600,000 Capital Gains 200,000 2,800,000 Exclusion under 103 for $10,000 muni-bond interest continued 11

12 Problem (a) Deductions Against Gross Income p.26 Operating Expenses 800,000 Depreciation 800,000 Capital Loss (limit $220,000 to gain) 200,000 Total Deductions 1,800,000 continued 12

13 Problem (a) Determining Tax Liability p.26 11(b)(1) tax calculation on $1 million taxable income (2.8 less 1.8): 15% of 50,000 7,500 25% of 25,000 6,250 34% of 925, ,500 Plus: Lesser of $45,000 (5% of 900,000) or 11,750 11,750 Total Tax Liability 340,000 13

14 Problem (b) Dividend Distribution p.27 Distribution of $660,000 after-tax profit 61(a)(7) dividend income 20% percent of $660,000 = $132,000 Total taxes: ( ) $472,000 Amount for shareholders: $528,000 Effective tax rate: 47.2 percent (Is a 47.2% effective tax rate too much?) 14

15 Problem (c) Deductible (?) Payments p.27 1) $500,000 salaries each paid to eliminate all corporate level income. Reasonable compensation amount? Consequences are zero corporate tax but $400,000 individual taxes leaving $600,000 after-tax (compare this to $528,000) in Problem (b)) 2) Other corporate level deductions available for this purpose? 79 - group term insurance 105 & 106 health benefits 15

16 Definition of Corporation Code 7701(a)(3) p (a)(3) defines a corporation to include associations, joint stock companies, and insurance companies. Choices of business entities: 1. Regular corporation 2. S corporation 3. Foreign corporation 4. Limited liability company LLC 5. Limited partnership, including MLP 6. General partnership 7. Sole proprietorship (& the tax nothing ) 16

17 Prior Entity Classification Criteria Tax Regs. p.27 1) Associates 2) Business objective 3) Continuity of life 4) Centralization of management 5) Limited liability for debts of entity 6) Free transferability of interests but buy-sell agreement not limiting transferability. Regs. had bias towards partnership status. 17

18 Check The Box Regulations p.29 Premise: Regulations make the choice of entity optional to the taxpayer. 1) But, automatic classification of certain entities as corporations per se treatment; including enumerated foreign corporations. 2) Default partnership status an eligible entity may elect to the contrary (not in foreign context, where one party much have unlimited liability; or both must consent). 18

19 Additional Entity Classification Issues p.30 1) The tax nothing or disregarded entity 2) What tax effect of a change in the number of members of an entity? p.31 3) What income tax effect of elective changes in tax classification of the entity? p.31 a) Partnership (or DE) to corporation? b) Corporation to partnership? 19

20 The Publicly Traded Partnership p.32 Corporate treatment of a publicly traded partnership? IRC What is publicly traded? Purpose of the exception from corporate status where 90% or more of entity s income is passive, including income from natural resource activities? See 7704(d)(1)(E). 20

21 Corporations vs. Partnerships vs. Trusts p.33 Reg Purpose of a trust is to protect or conserve property, but not to conduct business. If so, partnership or corporate status. Types of trusts: - Personal wealth management - Oil royalty trusts - Equipment leasing/airplane trusts 21

22 Trust Income Taxation Subchapter J p.33 1) Grantor trusts: Subchapter J, Subpart E, 671 et. Seq, treated as owner - income taxation to the grantor 2) Nongrantor trusts: Subparts A-D taxation of (a) trust (if no distribution) or (b) beneficiaries to the extent of actual distributions (or required distributions), applying the DNI concept. 22

23 Commissioner v. Bollinger p.34 FACTS: Corporation holding title to real property. Issue: Is the corporation the earner of the income or is it merely the shareholder s agent? Holding: Agency status permitted &, therefore, losses were directly allowable to the individual investors as individuals (also being shareholders of the corporate agency). Bollinger National Carbide Factors 1) Corporation operates in the name and for the account of the principal; 2) Corporation binds the principal; Citizen s Fidelity / Loan (as agent for B) Mass. Mutual Life Creekside Apts Creekside 3) Transmits money to the principal; 4) Income attributable to services of the employees of the principal: 5) Relations with the principal must not be dependent upon the fact that it is owned by the principal; (See Bollinger case discussion) and, 6) Business purpose must be the carrying on of the normal duties of an agent. 23

24 Corporation/Shareholder Tax System Integration p.39 U.S. has a classical tax system, i.e., taxation both on (1) corporation and (2) shareholder. Who pays the corporate tax: The corporation or shareholders? The full integration option: complete flow-through, e.g., the ALI proposal of: (1) Imputation and (2) withholding (for U.S. Treasury cash flow acceleration). In December 2014, the staff of Senator Hatch released Comprehensive Tax Reform for 2015 that sets forth an extended discussion and endorsement of corporate integration efforts. 24

25 Partial Corporate Shareholder Integration 1. Shareholder credit for tax previously paid on the dividend amount-subject to an income gross-up requirement. 2. Deduction available to the distributing corporation for the dividend paid. 3. Shareholder gross income exclusion for all or part of corporate dividend Act reduce individual dividend tax to 20% Dividends from certain foreign corporations located in treaty jurisdiction are eligible for reduce dividend rate. See 1(h)(11) (C)(i)(II) 25

26 Special Concerns About Integration Proposal p Extension of corporate tax preferences to shareholders. 2. Treatment of tax-exempt shareholders (e.g., 401 deferred compensation plans). 3. Treatment of foreign shareholders (only through tax treaty?) under 2003 Act. 4. Treatment of foreign taxes paid by the U.S. corporation. Not creditable? 26

27 Distortions Tilting Towards Non-Corporate Status 1) Higher effective income tax rate on corporate taxable income motivates pass-through entities 8,000,000 7,000,000 6,000,000 5,000,000 Figure 2. Number of C Corporation Returns Compared to the Sum of S Corporation and Partnership Returns, TRA 1986 Passthrough Entities Number of Returns 4,000,000 2) Higher corporate tax 3,000,000 rate motivates 2,000,000 finance with debt C Corporations 1,000,000 (since deductible 0 interest reduces net Year Source: Internal Revenue Service, Statistics of Income, published and unpublished data. tax amount). 3) Higher corporate tax rate motivates not paying dividends but distribute earnings as salary or some other form of deductible payment. Taxing qualified dividends at same rate as capital gains takes away advantage of using excess cash for stock buy-backs. 27

28 Framework for Business Tax Reform 1. Obama Administration s Framework for Business Tax Reform: reduce corporate tax rate to 28% 2. Simpson/Bowles National Commission on Fiscal Responsibility: reduce corporate tax rate to 23%-29% 3. Chairman Ryan s Tax Reform Act of 2014: reduce corporate tax rate to 25% 4. Staff of Senator Hatch s Comprehensive Tax Reform for 2015:? (29%?) Implication: If corporate tax rates are below 30% whereas the top individual rate stays at 39.6%, there will be a strong incentive for individuals to conduct ongoing business activity within C and attempt to bail-out earnings at capital gains rates. As you will soon learn, we are going back to the future!!! 28