Updates for the American Taxpayer Relief Act of Replacement Pages for Two-Sided (Duplex) Printing

Transcription

1 Quickfinder Small Business Quickfinder Handbook (2012 Tax Year) Updates for the American Taxpayer Relief Act of 2012 Replacement Pages for Two-Sided (Duplex) Printing Instructions: This packet contains marked up changes to the pages in the Small Business Quickfinder Handbook that were affected by the American Taxpayer Relief Act of 2012, which was enacted after the handbook was published. This is a specially designed update packet for owners of the 3-ring binder version of the handbook who have access to a printer that prints two-sided (duplex). Simply print the entire PDF file (make sure to select two-sided or duplex printing), three-hole punch the pages and then replace the pages in your handbook. It s that easy.

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3 TAX PREPARATION Small Business Quickfinder Handbook Forms: 1065, 1120, 1120S, 1041, 706, 709 and Tax Year Replacement Page 01/2013 Filing Information Tax Return Return Due Extensions Form 1065: Partnership/LLC Forms 1120/1120S: Corporation Form 1041: Estates and Trusts Form 706: Estates Form 709: Gift Tax Form 990: Exempt Organizations Form 1120 Corporation Tax Rate Schedule Quick Tax Method For tax years beginning after December 31, 1992 TAXABLE INCOME % MINUS $ = TAX $ 0 $ 50,000 15% minus $ 0 = Tax 50,001 75,000 25% minus 5,000 = Tax 75, ,000 34% minus 11,750 = Tax 100, ,000 39% minus 16,750 = Tax 335,001 10,000,000 34% minus 0 = Tax 10,000,001 15,000,000 35% minus 100,000 = Tax 15,000,001 18,333,333 38% minus 550,000 = Tax 18,333,334 and over 35% minus 0 = Tax Note: See Basics of Corporations on Page C-1 for exceptions to above tax rates and an example of how to use the Quick Tax Method. Form Fiduciary Tax Rate Schedule Quick Tax Method TAXABLE INCOME % MINUS $ = TAX $ 0 $ 2,400 15% minus $ 0.00 = Tax 2,401 5,600 25% minus = Tax 5,601 8,500 28% minus = Tax 8,501 11,650 33% minus = Tax 11,651 and over 35% minus 1, = Tax Note: The 10% tax bracket that applies to individuals does not apply to estates and trusts. Replacement Page 01/ th day of fourth month following close of tax year. 15th day of third month following close of tax year. 15th day of fourth month following close of tax year. Nine months after date of decedent s death. April 15th following close of tax year of gift. 15th day of fifth month following close of tax year. Form 7004 extends deadline five months. Form 7004 extends deadline six months. Form 7004 extends deadline five months. Form 4768 extends deadline six months. Form 4868 or 8892 extends deadline six months. Form 8868 extends deadline three months. A second Form 8868 extends three additional months. Forms 706 and 709 Estate and Gift Tax Rate Schedule Quick Tax Method For gifts made and estates of decedents dying in 2012 TAXABLE AMOUNT % MINUS $ = TAX 1 $ 0 $ 10,000 18% minus $ 0 = Tax 10,001 20,000 20% minus 200 = Tax 20,001 40,000 22% minus 600 = Tax 40,001 60,000 24% minus 1,400 = Tax 60,001 80,000 26% minus 2,600 = Tax 80, ,000 28% minus 4,200 = Tax 100, ,000 30% minus 6,200 = Tax 150, ,000 32% minus 9,200 = Tax 250, ,000 34% minus 14,200 = Tax 500,001 and over 35% minus 19,200 = Tax 1 Less applicable credit amount. See the charts at the beginning of Tab H. Estate Tax Exclusion Exclusion Amounts Gift Tax Exclusion 1 Annual Gift Exclusion $5,120,000 $5,120,000 $13,000 1 Plus the amount, if any, of deceased spousal unused exclusion amount see Tab H Business Quick Facts 500,000 Section 179 Deduction: Maximum deduction... $ 139,000 Qualifying property limit ,000 SUV deduction limit... 2,000,000 25,000 Depreciation Limits (First Year): Luxury autos no bonus... $ 3,160 Luxury autos with bonus... 11,160 Light trucks and vans no bonus... 3,360 Light trucks and vans with bonus... 11,360 Business Standard Mileage Rate January December... $.555 Depreciation component Copyright 2012 Thomson Reuters Tax Year Small All Business Rights Reserved. Quickfinder Handbook COV-1

4 Copyright 2012 Thomson Reuters. All Rights Reserved. ISSN ISBN PO Box 966, Fort Worth TX Phone Fax Quickfinder.thomson.com The Small Business Quickfinder Handbook is published by Thomson Reuters. Reproduction is prohibited without written permission of the publisher. Not assignable without consent. The Small Business Quickfinder Handbook is to be used as a first-source, quick reference to basic tax principles used in preparing business tax returns. This handbook s focus is to present often-needed reference information in a concise, easy-to-use format. The summaries, highlights, examples, tax tips and other information included herein are intended to apply to the average small business taxpayer only. Information included is general in nature and we acknowledge the existence of many exceptions in the area of business taxes. The information this handbook contains has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed. The author/publisher is not engaged in rendering legal, accounting or other advice and will not be held liable for any actions or suit based on this handbook. For further information regarding a specific situation, see applicable IRS publications, rulings, regulations, court cases and Code sections applicable to that situation. This handbook is not intended to be used as your only reference source Employer Retirement Plan Contribution Limits Profit Sharing 401(k) SIMPLE IRA SEP Employee Elective Deferral: < Age 50 Age 50 N/A N/A $17,000 $22,500 $11,500 $14,000 N/A N/A Employer Contribution: Per Participant Total Deductible Contribution Lesser of: 100% of comp or $50,000 25% of total comp 2 paid to all participants Lesser of: 100% of comp or $50,000 25% of total comp 2 paid to all participants (excluding employee deferrals) 1 20% of net SE income for self-employed. 2 Limited to $250,000 per participant. Type of Depositor Deposit Due Dates Reason Classified N/A Lesser of: 25% 1 of comp or $50,000 Either: 1) 100% match up to 3% of comp or 2) 2% of comp 2 Payroll Deposit Deadlines (Form 941) Monthly 15th day of following month 1) Total federal payroll taxes were $50,000 or less in the lookback period or 2) New employer. Semiweekly Payday on: Wednesday, Thursday, Friday Payday on: Saturday, Sunday, 25% of total comp 2 paid to all participants Due on: Following Wednesday Due on: Following Friday Monday, Tuesday Total federal payroll taxes were more than $50,000 in the lookback period. Exceptions: Employer accumulates less than $2,500 in taxes during the current or preceding quarter: Deposit as above or send payment with quarterly tax return. Employer accumulates $100,000 or more in taxes during deposit period: Deposit due on next day (that is not a Saturday, Sunday or legal holiday) after the day on which the $100,000 threshold is reached. Employers notified by the IRS to file Form 944 that accumulate less than $2,500 in taxes during the fourth quarter: Pay fourth quarter tax liability with Form 944. See IRS Pub. 15 for exceptions to the deposit penalties under Depositing Taxes. Employer Identification Numbers (EINs) Responsible Parties All EIN applications (online, telephone, fax or mail) must disclose the name and taxpayer identification number (TIN) (that is, an SSN, EIN or ITIN) of the true principal officer, general partner, grantor, owner or trustor (responsible party). This is the individual or entity that controls, manages or directs the applicant entity and the disposition of its funds and assets. A nominee (someone given limited authority to act on behalf of an entity, usually for a limited period of time such as during formation) is not a responsible party, is not authorized by the IRS to obtain EINs and should not be listed on the Form SS-4. Online To receive an EIN for immediate use, go to the IRS website at and click on Apply for an EIN Online under Tools in the center of the screen. The online application process is available for all entities whose principal business, office or agency, or legal residence in the case of an individual, is located in the U.S. or its territories. Third party designees filing online applications must retain a complete signed copy of the paper Form SS-4 and signed authorization statement for each application filed. Telephone Call the IRS at (International applicants must call ) The hours of operation are 7:00 a.m. to 7:00 p.m. M-F for the 800 number. Complete Form SS-4 before contacting the IRS. An IRS representative will use the information from the Form SS-4 to establish the account and assign an EIN. Fax An EIN can be received by fax within four business days. Complete and fax Form SS-4 to the IRS using the Fax-TIN number listed in the Where to File Tax Returns Addresses Listed by Return Type section of the IRS website. Mail Complete Form SS-4 and mail to the IRS using the addresses listed in the Where to File Tax Returns Addresses Listed by Return Type section of the IRS website. Allow four weeks to receive the EIN from the IRS by mail. Form Fiduciary Tax Rate Schedule Quick Tax Method TAXABLE INCOME % MINUS $ = TAX For tax years beginning in 2011 $ 0 $ 2,300 15% minus $ 0.00 = Tax 2,301 5,450 25% minus = Tax 5,451 8,300 28% minus = Tax 8,301 11,350 33% minus = Tax 11,351 and over 35% minus 1, = Tax IRS Frequently Used Phone Numbers Business and Specialty Tax Line E-Help Desk EFTPS Hotline Electronic Funds Withdrawal (Direct Debit) Payments Forms and Publications Practitioner Priority Service Refund Hotline Report Tax Schemes Tax-Exempt Organizations Taxpayer Advocate TeleTax Topic If you have any questions We welcome comments and questions from readers. However, our response is limited to verification of specific information presented in the Quickfinder Handbooks. We cannot give advice on a client s tax situation or provide information beyond the contents of this publication. Questions must be submitted in writing by mail, fax or online at Quickfinder.thomson.com (Content Questions on the Contact Us page). Research editors are not available to answer questions over the phone. Copyright 2012 Thomson Reuters. All Rights Reserved. The Quickfinder logo and Quickfinder Handbooks are trademarks of Thomson Reuters. COV Tax Year Small Business Quickfinder Handbook

5 Reference Materials and Worksheets Where to File: Business Returns Filing Addresses 2012 Returns...Page A-1 Principal Business Activity Codes Forms 1065, 1120 and 1120S...Page A-1 Business Quick Facts Data Sheet...Page A-1 Guide to Information Returns...Page A-2 Types of Payments Where to Report...Page A-4 S Corporation Shareholder s Adjusted Basis Worksheet...Page A-5 Partner s Adjusted Basis Worksheet...Page A-6 Tax Info for Partnership, Corporation, LLC and LLP Returns...Page A-7 Transferor s Section 351 Statement...Page A-9 Tab A Topics Tax Info Sheet for Gift Tax Returns...Page A-10 Estate Inventory Worksheet... Page A-11 Reconciliation of Income Reported on Final Form 1040 and Estate s Fiduciary Return (or Beneficiary s Return)...Page A-12 Depreciation Schedule...Page A-13 Allocation of Indirect Costs to Ending Inventory Under Section 263A...Page A-14 Business Valuation Worksheet...Page A-15 Foreign Asset Reporting Forms 8938 and TD F Page A-16 Types of Foreign Assets and Whether They are Reportable...Page A-16 Where to File: Business Returns Filing Addresses 2012 Returns Note: At the time of publication, the IRS had not released the 2012 filing addresses for business returns. This information will be posted to the Updates section of Quickfinder. com when available. See Where to File 2012 Form 1040 in Tab 3 of the 1040 Quickfinder Handbook for filing addresses for individuals. Principal Business Activity Codes Forms 1065, 1120 and 1120S Note: At the time of publication, the IRS had not released the 2012 principal business activity codes for business returns. This information will be posted to the Updates section of Quickfinder.com when available. Business Quick Facts Data Sheet FICA/SE Taxes Maximum earnings subject to tax: Social Security tax $ 113,700 $ 110,100 $ 106,800 $ 106,800 $ 106,800 Medicare tax No Limit No Limit No Limit No Limit No Limit Maximum tax paid by: Employee Social Security $ 7, $ 4, $ 4, $ 6, $ 6, SE Social Security 14, , , , , Employee or SE Medicare No Limit No Limit No Limit No Limit No Limit Business Deductions Section 179 deduction limit $ 500,000 $ 500,000 $ 500,000 $ 500,000 $ 250,000 Section 179 deduction SUV limit (per vehicle) 25,000 25,000 25,000 25,000 25,000 Section 179 deduction qualifying property phase-out threshold 2,000,000 2,000,000 2,000,000 2,000, ,000 Depreciation limit autos (1 st year with special depreciation) 2 11,160 11,060 11,060 10,960 Depreciation limit autos (1 st year with no special depreciation) 2 3,160 3,060 3,060 2,960 Depreciation limit trucks and vans (1 st year with special depreciation) 2 11,360 11,260 11,160 11,060 Depreciation limit trucks and vans (1 st year with no special depreciation) 2 3,360 3,260 3,160 3,060 Retirement Plans SIMPLE IRA plan elective deferral limits: Under age 50 at year end $ 12,000 $ 11,500 $ 11,500 $ 11,500 $ 11,500 Age 50 or older at year end 14,500 14,000 14,000 14,000 14, (k), 403(b), 457 and SARSEP elective deferral limits: Under age 50 at year end 17,500 17,000 16,500 16,500 16,500 Age 50 or older at year end 23,000 22,500 22,000 22,000 22,000 Profit-sharing plan/sep contribution limits 51,000 50,000 49,000 49,000 49,000 Compensation limit (for employer contributions to profit-sharing plans) 255, , , , ,000 Defined benefit plans annual benefit limit 205, , , , ,000 Key employee compensation threshold 165, , , , ,000 Highly compensated threshold 115, , , , ,000 Estate and Gift Taxes Estate tax exclusion $ 5,250,000 3 $ 5,120,000 3 $ 5,000,000 3 $ 5,000,000 4 $ 3,500,000 Gift tax exclusion 5,250, ,120, ,000, ,000,000 1,000,000 GST tax exemption 5,250,000 5,120,000 5,000,000 5,000,000 3,500,000 Gift tax annual exclusion 14,000 13,000 13,000 13,000 13,000 1 See Tab 3 in the 1040 Quickfinder Handbook for an expanded Quick Facts Data Sheet amount not yet released by IRS. These have been left blank and can be filled in later. 3 Plus the amount, if any, of deceased spousal unused exclusion amount see Tab H. 4 For decedents who died in 2010, executors could elect for the estate not to be subject to estate tax and have the modified carryover basis rules apply to estate assets. Replacement Page 01/ Tax Year Small Business Quickfinder Handbook A-1

6 Guide to Information Returns If any date shown falls on a Saturday, Sunday or legal holiday, the due date is the next business day. Source: 2012 General Instructions for Forms 1097, 1098, 1099, 3921, 3922, 5498, and W-2G. (Page 1 of 2) Due Date To Recipient Form Title What To Report Amounts To Report To IRS (unless indicated otherwise) 1042-S Foreign Person s U.S. Income such as interest, dividends, royalties, pensions and annuities, etc., Source Income and amounts withheld under Chapter 3. Also, distributions of effectively See form instructions March 15 March 15 Subject to Withholding connected income by publicly traded partnerships or nominees. On or before the 15th day of the 2nd calendar month after 1097-BTC Bond Tax Credit Tax credit bond credits to shareholders. All amounts February 28* the close of the calendar month in which the credit is allowed 1098 Mortgage Interest Mortgage interest (including points) and certain mortgage insurance Statement premiums you received in the course of your trade or business from $600 or more February 28* individuals and reimbursements of overpaid interest. (To Payer/Borrower) January C Contributions of Motor Information regarding a donated motor vehicle, boat, or airplane. (To Donor) Gross proceeds of more Vehicles, Boats, and February 28* 30 days from date of than $500 Airplanes sale or contribution 1098-E Student Loan Interest Student loan interest received in the course of your trade or business. Statement 1098-T Tuition Statement Qualified tuition and related expenses, reimbursements or refunds, and scholarships or grants (optional). $600 or more February 28* January 31 See instructions February 28* January A Acquisition or Information about the acquisition or abandonment of property that is security Abandonment of for a debt for which you are the lender. All amounts February 28* Secured Property 1099-B Proceeds From Sales or redemptions of securities, futures transactions, commodities, and Broker and Barter barter exchange transactions. Exchange Transactions 1099-C Cancellation of Debt Cancellation of a debt owed to a financial institution, the Federal Government, a credit union, RTC, FDIC, NCUA, a military department, the U.S. Postal Service, the Postal Rate Commission, or any organization having a significant trade or business of lending money CAP (To Borrower) January 31 All amounts February 28* February 15** $600 or more February 28* January 31 Changes in Corporate Information about cash, stock, or other property from an acquisition of control Control and Capital or the substantial change in capital structure of a corporation. Over $1000 February 28* Structure 1099-DIV Dividends and Distributions, such as dividends, capital gain distributions, or nontaxable Distributions distributions, that were paid on stock and liquidation distributions G Certain Government Unemployment compensation, state and local income tax refunds, $10 or more for refunds Payments agricultural payments, and taxable grants. and unemployment (To Shareholders) January 31 $10 or more, except $600 or more for February 28* January 31** liquidations February 28* January H Health Coverage Tax Health insurance premiums paid on behalf of certain individuals. Credit (HCTC) All amounts February 28* January 31 Advance Payments $10 or more ($600 or 1099-INT Interest Income Interest income. February 28* January 31** more in some cases) 1099-K Merchant Card and Third-Party Network Payments Merchant card Third-party network payments. All amounts $20,000 or more and 200 or more transactions February 28* January LTC Long-Term Care and Payments under a long-term care insurance contract and accelerated death Accelerated Death benefits paid under a life insurance contract or by a viatical settlement All amounts February 28* January 31 Benefits provider. *The due date is March 31 if filed electronically. **The due date is March 15 for reporting by trustees and middlemen of WHFITs. A Tax Year Small Business Quickfinder Handbook

7 Court Case #1: Two individuals agreed to pay business expenses out of their personal funds in exchange for stock in a corporation. Even though the resulting capital contributions were made over a period of time, the court ruled that the amounts were a direct purchase of the stock, relying in large part on the original intent of the shareholders. The Tax Court overruled a previous IRS determination and allowed the taxpayers to treat the entire amount paid as basis under Section (Miller, TC Memo ) Court Case #2: In another case, the court determined that the amount originally paid for stock ($7,500) was the only amount allowable under Section Subsequent contribution of capital of $189,000 was considered allocable to stock which is not Section 1244 stock. (Bledsoe, TC Memo ) Strategy: Careful planning of stock purchases can preserve the benefits of Section 1244 for shareholders. Especially if there is a significant risk of loss on investment in Section 1244 stock, the purchaser should make sure additional shares are issued for each contribution made to capital. If shares are purchased over time, as in the case of agreement to pay corporate expenses in exchange for stock, a written plan should be drafted and carefully followed. Partners and S corporation shareholders. If a partnership acquires Section 1244 stock and later sells at a loss, an ordinary loss deduction may be claimed only by individuals who were partners when the stock was issued. However, loss incurred by an S corporation on the sale of Section 1244 stock cannot be passed on to the shareholders as an ordinary loss [Reg (a)-1(b)]. They must treat the loss as a capital loss. Small Business Stock IRC 1202 and 1045 Options by Holding Period for Small Business Stock 1 Yr or less Over 6 Months Over 1 Yr Over 5 Yrs Short-term capital gain Section 1045 rollover gain Long-term capital gain Section 1202 gain exclusion Individuals may be able to (1) exclude up to 50% (75% for stock acquired 2/18/09 9/27/10; 100% for stock acquired 9/28/10 12/31/11) of gain or (2) defer gain from the sale of qualified small business stock (QSBS). 12/31/13 Exclusion of gain from the sale of small business stock (IRC 1202). An individual may exclude 50% (75% for stock acquired 2/18/09 9/27/10; 100% for stock acquired 9/28/10 12/31/11) of the gain from sale of qualified small business stock (QSBS). The stock must have been issued by a C corporation after August 10, 1993, and held more than five years. The exclusion may not exceed 10 times the taxpayer s basis or $10 million, whichever is greater. Gain remaining after the exclusion is taxed at a maximum rate of 28%, resulting in an effective tax rate of 14%, for example, for 50% exclusion gain. with N Observation: Because of the five-year holding period requirement, 2014 will be the earliest a taxpayer can take advantage of the 75% gain exclusion (2015 for the 100% exclusion). Note: The maximum tax rate for most capital gains is 15% through With an effective tax rate of 14% for 50% exclusion QSBS, the benefit of the exclusion is greatly reduced, and only favors taxpayers with taxable income above the 15% bracket. For taxpayers qualifying for the 0% capital gains rate in 2012, the Section 1202 exclusion may create higher tax liability than if the exclusion had not been in place. However, should capital gains rates return to their pre-2003 Tax Act levels as they are scheduled to do on 1/1/13, the Section 1202 provisions may once again be beneficial, especially when the 75% exclusion (7% effective tax on higher-income individuals increasing Replacement Page 01/2013 rate) or 100% exclusion (no tax) applies. In addition, Section 1045 rollover remains a benefit of meeting the QSBS requirements (see Rollover of gain from sale of small business stock below). Alternative minimum tax. The excluded portion of gain on QSBS is a tax preference item in computing alternative minimum taxable income (AMTI). Seven percent of the amount of gain excluded under Section 1202 in 2012 is the preference amount [IRC 57(a)(7)]. However, for 100% gain exclusion QSBS acquired 9/28/10 12/31/11, none of the excluded gain is added back in computing AMTI. 12/31/13 Expired Provision Alert: It s possible Congress will extend the 100% gain exclusion for QSBS to 2012, but had not done so at the time of this publication. Similarly, unless extended, the 7% AMT preference rules apply to tax years beginning before 1/1/13, so in tax years beginning after 2012 the percentage of otherwiseexcluded gain that is a tax preference item in computing AMTI will be 28% (for stock acquired after 2000) or 42% (for stock acquired before 2001), unless it is 100% gain exclusion QSBS. 12/31/13 Empowerment zone businesses. The exclusion is 60% for stock acquired after 12/21/00 (75% for stock acquired from 2/18/09 9/27/10; 100% for stock acquired 9/28/10 12/31/11) for gains attributable to periods before 12/31/16 in corporations that conduct business within an empowerment zone, as designated by the Secretaries of Agriculture and HUD [IRC 1202(a)(2)]. The District of Columbia Empowerment Zone is not treated as an empowerment zone for purposes of the exclusion. Capital gain from the sale of qualified empowerment zone assets held for more than one year may be rolled over if new property in the same zone is purchased within 60 days of the sale. (IRC 1397B) through 12/31/18 Rollover of gain from sale of small business stock (IRC 1045). An election is available for tax-deferred rollover of gain from the sale of qualified small business stock (QSBS) held more than six months. The taxpayer must purchase new QSBS within 60 days to qualify for the election. The entire gain is deferred if the new stock costs at least as much as the amount realized from the sale of the old stock. If the new stock costs less than the amount realized, the difference is taxable up to the amount of gain. Basis of new stock is reduced by the amount of gain deferred. Holding period: The new stock must continue to meet the active business requirement for at least six months after purchase to qualify for Section 1045 rollover. (See Active business requirement on Page C-8.) For determining capital gain rates on a subsequent sale, the holding period of the new stock generally includes the holding period of the old stock. However, the holding period of the old stock does not count for meeting the six-month test. Regulations: For guidance on sales by partnerships (and partner distributees) of QSBS, see Regulation Section Qualified Small Business Stock (QSBS) C corporation. The stock must be issued by a C corporation with total gross assets of $50 million or less at all times after August 9, 1993, and before it issued the stock, and immediately after it issued the stock. The corporation cannot be a: 1) Domestic international sales corporation or former DISC, 2) Regulated investment company (RIC), 3) Real estate investment trust (REIT), 4) Real estate mortgage investment conduit (REMIC), 5) Cooperative or 6) Corporation electing the Puerto Rico and possessions tax credit or having a direct or indirect subsidiary so electing Tax Year Small Business Quickfinder Handbook C-7

8 Original issue stock. The stock must be acquired by the taxpayer at its original issue in exchange for money, property other than stock or as compensation for services. Note: The stock will not qualify if the corporation redeemed stock from the taxpayer or a related person during a four-year period beginning two years before the issuing date. Further, the stock will not qualify if the corporation redeemed more than 5% by value of its stock during a two-year period beginning one year before the issuing date. Active business requirement. During the taxpayer s holding period, the corporation must use at least 80% of its assets by value in the active conduct of one or more qualified trades or businesses. A qualified trade or business is any business other than those listed in Section 1202(e)(3). Businesses that do not qualify include professional service firms, financial businesses, farms, natural resource producers, hotels and restaurants. If the corporation owns more than 50% of another corporation, a pro rata share of that corporation s assets are included in the 80% test (a look-through rule). A corporation will not meet the active business requirement if more than 10% of (1) its assets total value consists of real estate that is not used in the active conduct of a qualified trade or business or (2) its assets total value (in excess of liabilities) consists of stock or securities in corporations, other than subsidiaries. Specialized small business investment companies (SSBICs). The active business requirement is waived for SSBICs. An SSBIC is any corporation licensed by the Small Business Administration under Section 301(d) of the Small Business Investment Act of 1958 as in effect on May 13, Distributions Corporations are separate entities from their owners. Corporate assets are not personal possessions of the shareholders. When a corporation distributes funds to a shareholder, the method of distribution determines the tax consequence. A corporation generally distributes money and property to a shareholder under one of the following methods: 1) Wages, 2) Fringe benefits, 3) Dividends and return of capital, 4) Loans, 5) Rent payments or 6) Royalties. Caution: Withdrawals from a corporation must be carefully structured to avoid reclassification by the IRS. For example, if a shareholder charges a corporation rent in excess of FMV for use of property, the IRS may classify the distribution as a taxable dividend. See Constructive Dividends on Page C-11. Dividends and Return of Capital Distributions made to shareholders out of the earnings and profits (E&P) of the corporation are generally considered taxable dividends. If property is distributed, the shareholder s taxable portion is the FMV of the property minus any liabilities assumed by the shareholder in connection with the distribution [IRC 301(b)]. Distributions that are considered a return of capital are not taxable. See the discussion of Earnings and Profits (E&P) on Page C-11. A distribution in excess of E&P is generally nontaxable to the shareholder. The amount of the distribution must first reduce the adjusted basis of the stock in the hands of the shareholder. Any amount in excess of the shareholder s adjusted basis will be treated as a gain from the sale or exchange of property. [IRC 301(c)] Tax Effects of Distributions A corporation does not recognize gain or loss when cash is distributed to a shareholder. When a corporation distributes appreciated property to its shareholders (other than its own stock or securities), the corporation recognizes gain as if it sold the property at FMV [IRC 311(b)]. For this purpose, FMV is the greater of the actual FMV or the amount of liabilities assumed by the shareholder in connection with the transaction. These rules also apply to distribution of property in satisfaction of a declared dollar dividend. A corporation will not recognize a loss on the distribution of property to a shareholder unless the transaction is part of a complete liquidation. See Corporate Liquidations on Page N-6. Distributions of cash or property will reduce a corporation s E&P but not its taxable income. E&P is generally reduced by the amount of the basis of the distributed property [IRC 312(a)]. Exception: On distributions of appreciated property, E&P increases by the amount of appreciation and decreases by the amount of FMV. See Earnings and Profits (E&P) on Page C-11 for more information. Nondividend Distributions Form 5452, Corporate Report of Nondividend Distributions, must be filed when nondividend distributions are made to shareholders. These include distributions that are fully or partially nontaxable because the corporation s E&P is less than the distributions. The form does not need to be filed for distributions of tax-free stock dividends or distributions exchanged for stock in liquidations or redemptions. A distribution of stock or right to acquire stock in a corporation is not a taxable distribution to the stockholder unless it is one of the following: [IRC 305(b)] 1) Distribution in lieu of money or other property, 2) Disproportionate distribution, 3) Distribution with respect to preferred stock, 4) Distribution of certain convertible preferred stock (there are exceptions) or 5) Distribution of common and preferred stock resulting in the receipt of preferred stock by some common shareholders and receipt of common stock by other common shareholders. Even if a distribution of stock or stock right falls into one of the above five categories, it will not be considered a taxable dividend unless there is sufficient E&P. Form 1099-DIV A corporation must report distributions made to its stockholders on Form 1099-DIV. Distributions reported on Form 1099-DIV include taxable dividends, capital gain distributions, nontaxable distributions and distributions in liquidation. Note: See Guide to Information Returns on Page A-2. Wages for Shareholders Shareholders who perform services for a corporation are treated as employees, and are paid wages subject to employment tax and other withholding. Corporate officers are specifically identified as employees under Sections 3401(c) and 3121(d)(1). Since wages are deductible by a corporation, the incentive exists to pay the highest wage possible to C corporation shareholders in order to avoid the double taxation that occurs with dividend distributions. Note: This is in contrast to an S corporation, where the incentive exists for a shareholder to take as low a wage as possible to avoid employment taxes. C Tax Year Small Business Quickfinder Handbook

9 Fringe Benefits Fringe benefits such as health insurance, medical reimbursement, travel, education, group term-life insurance, etc., can be tax-saving tools for corporate owners. Costs that would otherwise be nondeductible personal expenses can be converted into tax deductions. See Fringe Benefits (Fringes) on Page K-1 for more information about employee benefit plans. Employer-Provided Meals and Lodging As long as the provisions of Section 119 are met, a corporation can provide tax-free living accommodations to an employee even if the employee is the sole shareholder. This allows a business deduction for housing costs while the shareholder receives the accommodations tax free. The IRS may argue that the housing costs are a disguised benefit rather than a business necessity, but court decisions have favored the taxpayer. Court Case: In J. Grant Farms (TC Memo ), the Tax Court ruled a corporation was entitled to deduct living expenses for a shareholder because his duties required him to live on-site. The court in Maschmeyer s Nursery, Inc. (TC Memo ) came to a similar conclusion. For more information see Fringe Benefits (Fringes) on Page K-1. Constructive Dividends If a corporation with E&P makes a distribution to a shareholder and does not report the payment as a taxable dividend, the IRS will often reclassify the distribution as a constructive dividend. The distribution is taxed as a regular dividend up to the E&P of the corporation. See Dividends and Return of Capital on Page C-8. The problem of constructive dividends most commonly affects closely held corporations. Recordkeeping is often inadequate and leaves the corporation vulnerable in a dispute with the IRS. Indirect benefit. Constructive dividends may occur not only as the result of a direct payment, but also as a result of a transaction that gives an indirect economic benefit to the shareholder. Transactions that may result in constructive dividends include: Unreasonable compensation is paid for a shareholder s services. The owner-employee should be compensated based on what the corporation would expect to pay a nonowner employee for similar services. See Wages for Shareholders on Page C-8. If a corporation pays rent to a shareholder in excess of FMV for the use of property, the excess could be treated as a constructive dividend. If the corporation makes excessive improvements to the rented or leased property, especially on a short-term lease, constructive dividends may result. Personal use of corporation property (auto, airplane, entertainment facilities, etc.) may result in constructive dividends. Closely held corporations often have incentive to obtain working capital in the form of long-term debt rather than in stockholders equity, because interest paid on debt is tax deductible. However, purported interest payments to shareholders may be reclassified as nondeductible dividends if the loans are (1) not bona fide or (2) excessive in relation to equity. Similarly, a loan from the corporation to the shareholder may be considered a constructive dividend if it is not a bona fide loan. A sale of property to a corporation may result in constructive dividends if the sale price is more than the property s FMV. Personal expenses, such as auto, travel or entertainment, paid by a corporation to or for an owner-employee may result in constructive dividends. A constructive dividend may be imposed when a stockholder purchases property below FMV from a corporation. Expense reimbursements. In Revenue Ruling , the IRS clarifies that arrangements recharacterizing taxable wages as nontaxable reimbursements do not satisfy the business con nection requirement to be excluded from wages under an accountable plan. Employers are considered to be recharacterizing wages if they (1) temporarily reduce taxable wages and substitute nontaxable reimbursements until total expenses are reimbursed, then increase wages to the prior level, (2) pay higher wages to employees when they don t receive nontaxable reimbursements and lower wages when they do or (3) routinely pay nontaxable reimbursements to employees who haven t incurred bona fide business expenses. Amounts paid under such arrangements are included in employees income. Earnings and Profits (E&P) See Net Income per Books vs. Taxable Income on Page O-11 Corporate E&P is not the same as taxable income. The amount of E&P determines taxation of corporate distributions to shareholders. Taxable distributions of a C corporation come first from current E&P and then from accumulated prior-year E&P. [IRC 316(a)] Distributions in excess of E&P are nontaxable to the shareholder to the extent of stock basis; those in excess of the shareholder s stock basis are taxable as a capital gain. [IRC 301(c)] A corporation must file Form 5452, Corporate Report of Nondividend Distributions, whenever nontaxable distributions are made to shareholders. Section 312 lists several transactions that affect E&P, but does not give a complete definition. In general, E&P may be described as the amount available to the corporation to pay a dividend without depleting its capital. The effect on the E&P account can be determined by considering whether the transaction increases or decreases the corporation s ability to pay a dividend. E&P is initially increased by the taxable income of a corporation. The following transactions add to amount of current E&P: Tax-exempt income. [Reg (b)] Life insurance proceeds in excess of premiums paid. Deduction of excess charitable contribution in succeeding tax year. Percentage depletion over cost. [Reg (c)] Accelerated depreciation in excess of straight line (SL), units-ofproduction or machine-hours depreciation. [IRC 312(k)] Deferred gain on installment sale. [IRC 312(n)(5)] Long-term contract reported on completed contract method. [IRC 312(n)(6)] Intangible drilling costs deducted currently. [IRC 312(n)(2)] Mine exploration and development costs deducted currently. [IRC 312(n)(2)] Dividend-received deduction. The following transactions reduce amount of current E&P: Federal income taxes. Loss on sale between related parties. Life insurance premiums in excess of cash surrender value. Excess charitable contribution (over 10% limit). Amortized intangible drilling costs deducted over 60 months. [IRC 312(n)(2)] Amortized mine exploration and development costs deducted over 120 months. [IRC 312(n)(2)] Expenses relating to tax-exempt income. Excess of capital losses over capital gains. Corporations can set up their books to show net income based on E&P rather than tax return net income. This allows the accumulation of E&P (for purposes of determining how much is 2012 Tax Year Small Business Quickfinder Handbook C-11

10 available for dividend distributions) to be recorded in the retained earnings account on the corporation balance sheet. The difference between book net income (E&P) and tax return net income is reconciled on Schedule M-1 or M-3, Form See Corporation Example on Page C-17. E&P Example Beginning balance sheet of WSP Corporation: Assets: Cash... $ 6,000 Inventory... 8,000 Total assets... $ 14,000 Liabilities and Equity: Total liabilities... $ 0 Common stock... $ 1,000 Retained earnings (E&P)... 13,000 Total equity... 14,000 Total liabilities + equity... $ 14,000 Corporation transactions during the tax year: Gross sales receipts... $ 90,000 Taxable interest income Tax-exempt interest income Merchandise purchases... 30,000 Advertising expenses... 5,000 Wages... 20,000 Office expenses... 13,500 Purchase of equipment... 25,000 Estimated federal tax payments... 2,700 Ending inventory... 8,600 Ending balance sheet: Assets: Cash... $ 550 Inventory... 8,600 Equipment... 25,000 Minus accumulated depreciation... < 1,250 > Total assets $ 32,900 Liabilities and Equity: Federal tax payable (total liabilities)... $ 154 Equity Common stock... $ 1,000 Retained earnings (E&P) (13, ,746) 31,746 Total equity... $ 32,746 Total liabilities + equity... $ 32,900 Ending E&P calculation: Beginning E&P balance... $ 13,000 Plus taxable income... 19,027 Plus tax-exempt interest Plus accelerated depreciation in excess of SL ($3,573 - $1,250)... 2,323 Minus federal income taxes... < 2,854 > Minus dividend distributions... < 0 > Equals ending E&P... $ 31,746 Tax Effect of Tax-Exempt Income Although a C corporation does not pay tax on earnings from taxexempt income such as municipal bond interest, the income will increase E&P. Thus, the amount of taxable dividends available to shareholders is increased by tax-exempt income. Nondeductible expenses such as penalties, fines, capital losses in excess of capital gains, etc. reduce E&P and the amount of taxable dividends available for distribution to shareholders. Corporation tax return: Gross sales... $ 90,000 Beginning inventory... $ 8,000 Accumulated Earnings Tax A C corporation that accumulates earnings beyond reasonable Minus ending inventory... < 8,600> Cost of goods sold... $ 29,400 business needs is assumed to be accumulating earnings for the Gross profit... $ 60,600 purpose of tax avoidance, unless the taxpayer can Interest income prove otherwise [IRC 533(a)]. The accumulated Total income... $ 61,100 earnings tax (AET) is not reported on the tax Advertising... $ 5,000 return; it is a penalty imposed after an IRS Wages... 20,000 audit. The tax applies regardless of the Office expenses... 13,500 number of shareholders. Depreciation ($25, %)... 3,573 The AET is currently 15% of accumulated taxable income (IRC Total operating expenses... $ 42, ). The 15% rate is scheduled to expire for tax years beginning Net taxable income... $ 19,027 after December 31, 2012, at which time the AET will be imposed Federal income tax ($19,027 15%)... 2,854 at the highest individual tax rate. Merchandise purchases... 30,000 Minus estimated tax... < 2,700> Accumulated taxable income is the corporation s taxable income Balance due... $ 154 for the year reduced by items such as federal tax, excess charitable Book income for purposes of E&P: contributions, dividends paid deduction and the accumulated Gross sales... $ 90,000 earnings credit. [IRC 535(a)] Beginning inventory... $ 8,000 The accumulated earnings credit represents the amount Merchandise purchases... 30,000 accumulated for reasonable business needs. If audited, the burden Minus ending inventory... < 8,600 > of proof is on the corporation to demonstrate that an accumulation Cost of goods sold... $ 29,400 is reasonable [IRC 533(a)]. Note: Businesses that function as Gross profit... $ 60,600 mere holding or investment companies are assumed to operate Interest income with a tax avoidance motive [IRC 533(b)]. Such businesses Total income... $ 61,350 are allowed a minimum credit, but are not allowed additional Advertising... $ 5,000 accumulation for reasonable business needs. Wages... 20,000 Minimum credit. Retained earnings of $250,000 or less [$150,000 Office expenses... 13,500 for personal service corporations (PSCs)] are considered to be Depreciation ($25, %)... 1,250 within reasonable business needs. [IRC 535(c)(2)] Total operating expenses... $ 39,750 Reasonable business needs are analyzed in Regulation Net income before tax... $ 21,600 Sections and Items identified include: Minus federal income tax per tax return... < 2,854> Expansion. Includes purchase of assets, acquisition of another Net income after tax (E&P)... $ 18,746 business enterprise or plant replacement. Example continued in the next column Paying off business debts. For tax years beginning after C Tax Year Small Business Quickfinder Handbook December 31, 2012, the AET rate is 20%. Replacement Page 01/2013

11 Section 303 redemptions. A corporation can accumulate earnings in anticipation of a need to redeem stock from a deceased shareholder s estate. Supplier or customer needs. A corporation can accumulate earnings to provide for investments or loans to suppliers or customers if necessary to maintain the business of the corporation. Working capital. A corporation may need an amount of working capital to conduct business. For example, a supermarket needs $4 million of inventory on hand to operate. The corporation can accumulate earnings to obtain inventory. Providing for contingencies such as the payment of reasonably anticipated product liability losses, actual or potential lawsuits, loss of a major customer, or self insurance. Appropriated retained earnings account. If a corporation needs to accumulate earnings, the board of directors should discuss the need and the discussion should be reflected in the corporation s minutes. This will help the taxpayer demonstrate that the accumulation is for reasonable business needs in the event of IRS audit. The financial statements should also reflect the need to accumulate earnings so shareholders will know the appropriate amount of earnings available for dividends. Corporations commonly reflect such business needs by establishing an appropriated retained earnings account. Not reasonable business needs. The following purposes are not considered reasonable business needs: Accumulating income to avoid dividend distributions. Providing loans to shareholders. Paying expenses for the personal benefit of shareholders. Providing loans that have no reasonable relation to the conduct of the business. Providing loans to related corporations or shareholders. Investments unrelated to business activities. Providing for unrealistic hazards. Court Case: A corporation subject to the accumulated earnings tax argued that it should be able to reduce accumulated taxable income by the amount of tax accrued on an installment sale of real estate. The taxpayer also argued that it should be able to deduct a contested tax liability it had paid. The Tax Court ruled against the taxpayer on both counts. The court did not allow a reduction for tax accrued against installment sale income that had not yet been reported. With regard to the adjustment for the contested tax liability, the taxpayer relied on Regulation Section (a)(1), which states, In computing the amount of taxes accrued, an unpaid tax which is being contested is not considered accrued until the contest is resolved. The court found that in this case, the fact that the taxpayer had paid the contested liability did not mean the contested liability could be accrued. [Metro Leasing and Development Corporation, 119 TC 8 (2002). On appeal, the 9th Circuit agreed with the Tax Court. (94 AFTR 2d )] Bardahl Formula A method commonly used to substantiate reasonable accumulation of earnings by a business is called the Bardahl Formula. The IRS assessed accumulated earnings tax on Bardahl Manufacturing Corporation. The Tax Court held that accumulation of earnings by Bardahl was not unreasonable and accepted the company s stated method of computing necessary operating capital. The formula calculates the amount needed to fund inventory by analyzing the average number of days in an operating cycle, average inventory, average accounts receivable and average accounts payable, and then comparing the current working capital needs with actual accumulations of earnings. (Bardahl Manufacturing Corp.,TC Memo ) Corporate Income and Expenses See also Organizational and Start-Up Costs on Page M-6 Computation of gross income for a corporation is similar to the computation of gross income for an individual taxpayer. In general, business income, gains from property transactions, interest, rents, royalties and dividends are included in corporate income [IRC 61(a)]. Certain exclusions, such as municipal bond interest, are allowed for both individuals and corporations. Gains and losses from property transactions are handled in the same manner. Section 1221 makes no distinction between corporate and noncorporate taxpayers in defining a capital asset. Corporations and individuals are similar in the areas of like-kind exchanges (IRC 1031) and involuntary conversions (IRC 1033). Corporation business deductions also parallel those of an individual. Ordinary and necessary rules of Section 162(a) apply for both. Many tax credits are also available to both individuals and corporations. See Business Tax Deductions on Page O-1 and Tax Credits on Page O-7, which generally apply to both individuals and corporations. This section covers some of the basic rules for income and expenses of corporations that differ from those for individuals. Dividends-Received Deduction Qualified dividends received from domestic corporations are partially deductible by C corporations. This deduction is meant to reduce the negative effects of the double tax on C corporation profits distributed to shareholders as dividends. Dividend income is reported, and the dividends-received deduction is computed, on Schedule C of Form A corporation may, subject to limitations, deduct 70% of the dividends received from a domestic corporation if the receiving corporation owns less than 20% of the distributing. (IRC 243) If a corporation owns 20% or more of the corporation distributing dividends, the receiving corporation may, subject to certain limits, deduct 80% of the dividends received. Exceptions. The dividends received deduction does not apply to dividends received from certain banks and savings institutions, real estate investment trusts, public utilities, regulated investment companies, tax-exempt corporations, cooperatives and DISCs. [IRC 243(d) and 246] Taxable income limit. The otherwise allowable 70% and 80% deductions are generally limited to a percentage of the recipient s taxable income [IRC 246(b)]. The taxable income percentage limitation is the same as the dividends received deduction percentage (70% or 80%). For example, if the recipient corporation owns 30% (by vote and value) of the payor corporation s stock, the basic deduction amount is 80% of any dividend received, limited to an amount not exceeding 80% of the recipient s taxable income. The preceding limits are figured without regard to NOL, domestic producers or dividends-received deductions; nontaxable portion of an extraordinary dividend or capital loss carrybacks. When a corporation sustains an NOL, the above 80% or 70% limitation of taxable income does not apply. Example #1: BNG Corporation sustains a $30,000 loss from operations. It received $90,000 in dividends from a 20%-owned corporation. Its taxable income is $60,000 ($90,000 $30,000) before the deduction for dividends received. By claiming the full dividends-received deduction of $72,000 ($90,000 80%), BNG Corporation calculates its NOL as follows: Operating losses... < $ 30,000> Dividend income... 90,000 Dividends-received deduction... < 72,000> NOL... < $ 12,000> Since BNG has an NOL, the 80% of taxable income limitation does not apply and it is entitled to a full dividends-received deduction of $72, Tax Year Small Business Quickfinder Handbook C-13