CPA EXAM: REGULATION GET MORE POINTS AND PASS THE EXAM!

Transcription

1 CPA EXAM: REGULATION GET MORE POINTS AND PASS THE EXAM!

2 CPA EXAM: REGULATION GET MORE POINTS AND PASS THE EXAM!

3 REG: C-CORP

4 ANOTHER QUALITY BOOK FROM CPA-PLANET This book is for anyone studying for the CPA Exam, or even thinking of studying for the exam. It s for everyone who wants to learn about CPA Exam topics, and also wants that learning to be interesting, enjoyable, and fun! These lessons give you all the most important information as clearly, originally, and logically as possible. Yes, studying for the CPA Exam is a lot of work. Yes, it s not easy, and yes it takes time. But that doesn t mean you won t enjoy it. Reading your favorite series of books as a kid probably took hours and hours, over the course of many months or a year or more. Your favorite college class took so much of your time, but you loved it. That s how I hope this course is for you: a lot of work, a lot of time, but fascinating, enjoyable, and fun.

5 WHAT CPA-PLANET IS ALL ABOUT The mission of CPA-PLANET is to produce the highest quality lessons well explained, well presented, with lots of visual aids to make learning easier and more interesting. My colleagues and myself work our socks off to make studying for the CPA the best time of your life. You ll be sad when it s over All lessons are created by former CPA students, from the student s perspective. This is a very important point. The idea is to present materials in a way that the typical student can understand.

6 GET MORE POINTS ON THE CPA EXAM PASS THE EXAM!

7 Introduction TABLE OF CONTENTS SUMMARY Introduction Credits Formation Accumulated earnings Operation Alternative Minimum Tax (AMT) Income Depreciation Exclusions Taxation Rules Deductions Distributions, Liquidations, Reorgs

8 Introduction INTRODUCTION A C-Corp, is a taxable entity owned by shareholders. Other taxable entities include Individuals, Sole Proprietorships, Partnerships, and S-Corps. We will compare C-Corp taxation to these other entities. We are going to look at the following parts of a corporation: Formation Income Exclusions Deductions Credits Accumulated Earnings Alternative Minimum Tax (AMT) Depreciation (See Also Property Lessons) Distributions, Liquidations, Reorganizations Dividends

9 Introduction INTRODUCTION 3 Things To Know As You Study On almost every part of C-Corp taxes, you should know three things: Gain Loss Basis We will study these in various situations both their definitions and their interactions with each other.

10 Formation FORMATION OVERVIEW The corporation is formed by investors giving property, cash, or services in exchange for stock in the corporation. The Corp gives stock to investors, and Investors give cash, property or services to the Corp. Stock for Property What Is The Tax Consequence? Corporation gives stock, investors gives property Corp Tax Consequences Generally, there is no gain or loss recognized to the corporation issuing stock in exchange for property in the issuance of common stock during formation Corp Basis Consequences A C-Corp s basis in property given is the greater of NBV or Debt Assumed

11 Formation FORMATION OVERVIEW Stock for Services What Is The Tax Consequence? Stock is received in exchange for services Shareholder Income Tax Consequence The transferor has wage (ordinary) income equal to the fair market value of the stock received Shareholder Basis Consequence The transferor has basis equal to the fair market value of the stock received Corporation Gain Or Loss When Formed from Services The corporation does not realize any gain or loss on issuing stock. Corporation Expense Deduction? The corporation has a salary expense deduction (unless the services rendered were an educational expense)

12 Formation FORMATION FORMATION TAX CONSEQUENCES TO SHAREHOLDER Boot Received The following items represent taxable boot and will trigger gain recognition: Cash Withdrawn Boot received may generate gain to transferor Receipt of Debt Securities such as bonds C.O.D. (Cancellation Of Debt) When liabilities exceed the net book value of the assets transferred into the corporation this generates a gain. Gain Recognition Formula The net book value of assets are liabilities Any excess liabilities are considered boot

13 Formation FORMATION FORMATION TAX CONSEQUENCES TO SHAREHOLDER Shareholder s Basis of Common Stock Received The basis of stock received from a corp in the following situations will be: Basis if the shareholder exchanges cash for common stock The basis of the common stock received will be the amount of cash contributed Basis if the shareholder exchanges property for common stock The basis of the common stock received will equal: = adjusted basis of property (C.O.D.). + Taxable boot

14 Formation FORMATION FORMATION TAX CONSEQUENCES TO SHAREHOLDER Basis if the shareholder exchanges service for common stock The shareholder receiving common stock for services rendered must recognize the fair market value of the service as ordinary income. Basis in the stock is equal to that same amount The corporation has a salary expense deduction (unless the services rendered were an educational expense) A shareholder who contributes only services is not counted as part of the control group for purposes of the 80% control discussed in basis of property received

15 Formation FORMATION SHAREHOLDER GAINS AND LOSSES DURING FORMATION No gain or loss is recognized to the shareholder during formation, if these conditions are met: The only property received from the corporation is stock. Not stock rights, warrants, or debt The group transferring property and receiving stock collectively owns at least 80% of the voting power and 80% of each non-voting class of stock Exception: Property With A Liability Causes Gain If property is given in exchange for stock, and that property has a liability which is in excess of the shareholder basis, then that excess liability is a gain which is taxable to the shareholder.

16 Formation FORMATION SHAREHOLDER GAINS AND LOSSES DURING FORMATION EXAMPLE TuppyShareholder transferred property to the Corp in exchange for stock. Property s basis = $100,000. FMV = $500,000. Property s liability = $225,000 Debt minus basis = $225,000 - $100,000 = $125,000. This amount is gain taxable to the Shareholder. EXAMPLE Goofy transferred land with an adjusted basis of $20,000 and FMV of $56,000 to Duckworks Corp, in exchange for 100% of Duck Corporation s only class of stock The land was subject to a liability of $26,000 which Duckworks assumed for legitimate business purposes. The FMV of Duckwork s stock at the time of the transfer was $30,000. What is the amount of Goofy s recognized gain? Amount realized $30,000 + $26,000 = $56,000 Adjusted basis: ($20,000) Realized gain: $36,000 Debt assumed: $26,000 Adjusted basis of assets contributed: ($20,000) Recognized gain: $6,000

17 Formation FORMATION SHAREHOLDER GAINS AND LOSSES DURING FORMATION Shareholder Gain When C-Corp Gives Boot to Investor If anything other than stock is received, this is boot. If boot is received, the gain recognized to the shareholder is the lower of realized gain or FMV of the boot received Corp Gains and Losses During Formation General Rule There is No Gain or Loss recognized when issuing stock in exchange for property in the following transactions: a) Formation: Issuance of Common Stock b) Reacquisition: Purchase of Treasury stock c) Resale: Sale of Treasury Stock

18 Formation FORMATION RECOGNITION OF GAIN / LOSS IN EXCHANGE OF PROPERTY FOR STOCK Recognition of Gain or Loss on Exchange for Stock The recognition of gain or loss on a contribution of property in exchange for stock is determined, in part, by the ownership levels of the contributing shareholders. Deferral Deferral of gain and loss is required for members of the control club. Control Club The group of individuals who participate in a transfer of property to a corporation and who are in control of the corporation immediately after the transfer. To be eligible for membership in the control club, property must be contributed Not services The property must be transferred solely in exchange for stock

19 Formation FORMATION BASIS Shareholder Basis in Stock A control group shareholder s basis in the corp stock = the adjusted basis in contributed property, adjusted for the boot received and the gain recognized. AB in contributed property Boot received Money, including liability (COD) Liability (corporation assumes or takes subject to) Property received FMV (other than above and the corporation s stock) + Gain recognized (by shareholder) = Basis in stock of issuing corporation All liability is treated as boot (though technically it is not) when computing stock basis. The holding period of the property exchanged for stock is added to the holding period of the stock.

20 Formation FORMATION BASIS C-Corp Basis Of Property The C-Corp s basis in property is the greater of: Shareholder s adjusted net book value in the property OR the debt assumed by corporation The corporation s initial carryover basis in property exchanged by a control group shareholder for its stock is an adjusted carryover basis.

21 Formation FORMATION BASIS Exception to General Basis Rule IF: the aggregate AB of property contributed to a Corp by all transferor / shareholders during a tax-free incorporation exceeds the FMV of the property transferred THEN: the Corp s basis in the property is limited to the aggregate FMV of the property. This prevents the transfer of property with built in losses to the corporation. AB in property to shareholder + Gain recognized by shareholder - debt assumed by corporation (transferor may recognize gain to prevent a negative basis). = Basis in property to corporation

22 Formation FORMATION EXAMPLE Let s do an example now Mickey, the sole owner of Disney Corp, transferred a building to Disney. Building had an adjusted basis of $35,000 and FMV of $100,000 In exchange for the building, Mickey received $40,000 in cash and common stock with FMV of $60,000. What amount of gain for Mickey? Amount realized: Cash: $40,000 Stock: $60,000 Total: $100,000 Less: Adjusted basis: ($35,000) = Realized gain: $65,000 Recognized gain Lower of Realized Gain or Boot Received Lower of $40,000 or $65,000

23 Holding Period HOLDING PERIOD The shareholder s holding period for the stock is determined as follows: Capital Asset or Section 1231 Asset transferred to Corporation: Property holding period is added onto stock holding period All Other Property Holding period of property does not tack on. Holding period for stock begins on the day after the transfer The Corporation's Holding Period The corporation s holding period in the property received always includes the period that the transferor held the property before the exchange.

24 Basis BASIS ISSUES The adjusted basis for qualifying c-corp property is a carryover basis. A. The corporation takes an adjusted basis in the property from the transferor plus any gain recognized by the transferor B. The corporation's basis in the property received is: Shareholder's basis in the property + Gain recognized by the shareholder C. The shareholder's stock takes the adjusted basis of the transferred property plus any gain recognized less any boot received.d. The shareholder's basis in the stock received from the corporation is: Basis of all property transferred to the corporation + Gain recognized by shareholder - Boot received by shareholder Liabilities assumed by corporations = shareholder s basis in stock

25 Basis BASIS Basis Adjustment for Loss Property If the total basis of the property transferred by a shareholder is greater than the fair market value of the property, a basis adjustment is required to prevent the shareholders and the corporation from both benefiting from this unrealized loss. The downward basis adjustment is allocated proportionately among all assets contributed by the shareholder that had a built-in loss. Note: The shareholder s stock basis can be reduced rather than the corporation s, if the shareholder and corporation elect to do that. Example As part of the process of forming Greek Corporation, Socrates contributes property with an adjusted basis of $100,000 and a FMV of $75,000. Greek s basis in this property will be reduced to $75,000, and Socrates s stock basis will be $100,000. Alternatively, Socrates and Greek could elect to leave the property s basis at $100,000 and reduce Greek s stock basis to $75,000.

26 Basis BASIS Debt Assumptions (opposite of C.O.D.) A contribution of encumbered property requires that the transferor reduce the basis of the stock by the amount of debt assumed by the corporation. Gain may be recognized in the following two circumstances if the corporation assumes the shareholders' debt: If the total liabilities assumed by the corporation exceed the total adjusted basis (AB) of property transferred by the shareholder then gain must be recognized as follows: Gain recognized = Liabilities Assumed - Basis of Property Transferred If the debt was not incurred by the shareholder for valid business reasons then the corporate assumption will cause ALL of the debt relief to be treated as BOOT. This will cause gain to be recognized, but only to the extent of the realized gain.

27 Operations, Taxation OPERATIONS, TAXATION Corporations are taxed in a manner similar to that of individual taxpayers. This is one of the main differences between corporations and pass through entities such as partnerships. Partnerships are not taxed at the entity level but instead pass their taxable income recognition onto their owners who then pay tax on it at their entity level (as a Corp, individual, trust, etc). However, Corporations pay tax at their own level; then, any income, such as wages and dividends, is taxed again at the individual owner s level. Many provisions are the same for both groups; however, some differences exist. Some of the principal differences are presented below.

28 Operations, Taxation OPERATIONS, TAXATION Gross Income The concept of gross income is very similar for both corporations and individuals. Gross income includes: Taxable cash received in advance Cash received in advance of accrual GAAP is includible in taxable income, such as: a) Interest income received in advance. b) Rental income received in advance. (Nonrefundable rent deposits and lease cancellation payments are rental income when received.) Non-Taxable GAAP Income Items Some GAAP income items are not includible as taxable income, such as: a) Interest income from municipal or state obligations/bonds. b) Proceeds from life insurance on officers' lives ("key person" policy) where the corporation is the beneficiary. c) Royalty income received in advance.

29 Deductions DEDUCTIONS Trade or Business Deductions (Ordinary and Necessary Expenses) All ordinary and necessary expenses paid or incurred during the taxable year in carrying on a business are deductible. "Ordinary and necessary" means that the expenses are common (or accepted) in the particular business or profession and that they relate to producing the current year's income. Domestic Production Deduction: (DPD) 9% of the lesser of: Qualified Production Activities Income (QPAI) OR Taxable Income (Disregarding the QPAI deduction) DPD Limit The DPD is limited to 50% of W-2 wages paid by the C-corp for that year.

30 Deductions DEDUCTIONS QPAI Calculation Sum of gross receipts from items which are: Manufactured Produced Constructed Grown Extracted Engineering Services Architectural Services Example Qualified Domestic Production Activity Income = $250,000 Taxable Income = 320,000 Wages paid = $40,000 What is the Business Production Deduction? The lesser of QPAI or TI. This is 9% of $250,000 = $22,500 50% of Wages is $40,000 x 50% = $20,000 Therefore the deduction would be $22,500 - but it is limited to $20,000 $20,000 is the answer.

31 Deductions DEDUCTIONS Executive Compensation A publicly held corporation may not deduct compensation expense in excess of $1,000,000 paid to the CEO or the four other most highly compensated officers. Bonus Accruals (Non-Shareholder / Employees) Bonus accruals are deductible if they are paid to non-shareholders or non-employees. They must be paid within 2.5 months after year end (usually March 15) Bad Debts Specific Charge-Off Method Under the accrual basis of accounting, the allowance method is used for bad debt expense. However, for this deduction, use specific charge-off method Under the cash basis, a taxpayer has not included the amount in gross income, and therefore bad debt cannot be deducted

32 Deductions DEDUCTIONS Business Interest Expense Interest Used For Business if it is both incurred & paid, then deduct Interest Used For Investment Deduct up to investment income For investment expense, first deduct regular expense, then deduct interest expense up to investment income, Any carry-over interest expense will carry forward to future years. If Interest is used for buying a non-taxable investment, then Interest will be non-deductible.

33 Deductions DEDUCTIONS Charitable Contributions Limited to 10% of AGI Any accrual must be paid within 2.5 months to get deduction Corporation Taxable Income Is calculated prior to these deductions: Charitable Contribution Deduction U.S Production Activity Deduction Dividend Received Deduction Net Operating Loss Carryback Net Capital Loss Carryback

34 Deductions DEDUCTIONS Amortization, Depreciation, and Depletion Goodwill, covenants not to compete, franchises, trademarks, and trade names must be amortized on a straight-line basis over a 15-year period beginning with the month acquired. Acquired after August 10, 1993 For depreciation and depletion, corporations use the same rules as individuals Note: GAAP does not amortize purchased goodwill over 15 years. Instead it tests for impairment Life Insurance Premiums (Expense) If the Corp or owner is beneficiary (key person)= Not Deductible If employee is beneficiary (a fringe benefit) = Deductible

35 Deductions DEDUCTIONS Business Losses or Casualty Losses Related to Business 100% deductible if not reimbursed by insurance Exceptions: If the property is partially destroyed, the loss is limited to the lesser of : Decline in value of the property (change in FMV) OR Adjusted basis of the property immediately before the casualty (NBV). If the property is fully destroyed, the loss = adj. basis of the property immediately before the casualty (NBV). Difference from individual casualty deduction: Corp deduction does not have a $100 reduction and 10% AGI threshold, as the individual deduction does

36 Deductions DEDUCTIONS Organizational Expenditures and Start-Up Costs $5,000 deduction in the year cost incurred Any excess amortized over 15 Years (180 Months) Allowable Organizational Expenditures Legal services in drafting the Corp charter, bylaws, minutes Accounting costs Fees paid to state. Excluded Costs Cost of issuing & selling stock (raising capital) Commissions Underwriter fees Offering material and cost incurred to transfer assets to a Corp

37 Deductions DEDUCTIONS Example On July 1, year 1 organizational and start up costs are $10,000 Deduction for Year 1 will be: The $5,000 allowed for the first year + 6 months of amortization = $5,000 x 6/180 = $ Total $5, GAAP difference from Taxation Deduction Rules Under GAAP, organizational costs are immediately expensed In a tax return, the rule is $5,000 + amortization portion, as seen above

38 Deductions DEDUCTIONS Business Gifts Deductible up to a maximum of $25 per recipient per year. Business Meals and Entertainment 50% deductible There are some exceptions to this rule Penalties and Illegal Activities Not Deductible Payments for penalties and illegal activities are nondeductible

39 Deductions DEDUCTIONS Taxes State Income Tax City Income Tax Federal Payroll Tax Federal Income Tax Taxes Deductible Deductible Deductible NOT Deductible (Add back to income) Lobbying and Political Expenditures Lobbying expenses which attempt to influence legislation are not deductible Lobbying expenses related to local government are deductible Political contributions are not deductible. Capital Gains and Losses Capital losses deduction: Not allowed. Can only offset capital gains This is in comparison to the $3,000 deduction per year which is allowed for individuals

40 Deductions DEDUCTIONS Capital Loss Carryover Capital losses are carried back 3 and 5 Forward. Carried over as 'Short Term Capital Losses Applied against capital gains. Capital Gains Tax Calculation Taxed at the same rate as ordinary corporate income Net Operating Losses Same rules as Individuals Carry back 2 years and carry forward 20 Years (2/20) Also note: Charitable contribution deduction not allowed in calculating the NOL. DRD is allowed to be deducted before calculating the NOL.

41 General Business Credit GENERAL BUSINESS CREDIT General Business Credit Included Credits The general business credit consists of a combination of: Investment credit Work opportunity credit Alcohol fuels credit Increased research credit Low-income housing credit Other infrequent credits

42 General Business Credit GENERAL BUSINESS CREDIT Formula: The credit may not exceed: "Net Income Tax Less the greater of: 25% of regular tax liability above $25,000 OR Tentative minimum tax for the year Unused Credit Carryover Unused business credits can be carried back one year and forward twenty years. Also see the CREDITS Lesson

43 Dividends Received Deduction DIVIDENDS RECEIVED DEDUCTION Domestic corporations are allowed a dividends received deduction. The purpose is to prevent triple taxation of earnings. The amount of the dividends received deduction allowed is dependent upon the percentage of the investee corporation owned by the investor corporation. The percentage allowed may be either 70%, 80%, or 100%. The corporate shareholder must own the investee stock for more than 46 days during the 91-day period beginning on the date 45 days before the ex-dividend date of the stock to qualify for the dividends received deduction. Below are the percentage deductions based upon stock ownership:

44 Dividends Received Deduction DIVIDENDS RECEIVED DEDUCTION Percentage Ownership Dividend Received Deduction 0% to < 20% 70% Deduction of Dividend 20% to < 80% 80% Deduction of Dividend 80% or More 100% 100% Deduction of Dividend Example: Microsoft owns 30% of Flying Cars Limited Flying cars gave $10,000 dividend Income to Microsoft for year 1 The Dividend deduction is 80%, or $8,000 Microsoft will recognize dividend Income of $10,000 - $8,000 Entities Not Permitted to take Dividend Received Deduction (DRD) Personal Service Corporations Personal Holding S-Corps

45 Dividends Received Deduction DIVIDENDS RECEIVED DEDUCTION Exception to Taxable Income Limitation: The taxable income limitation above does not apply if, after taking into account the full dividends received deduction, the result is a net operating loss (NOL). Cowboys Corp owns 40% of Western Union Corp. The 80% deduction applies. Here are possible situations

46 Dividends Received Deduction DIVIDENDS RECEIVED DEDUCTION Dividends Received Deduction A B C D E Gross Income Operations $450 $400 $350 $250 $250 Dividends Received $100 $100 $100 $100 $100 Total $550 $500 $450 $350 $350 Deductions Total including charitable contributions ($200) ($220) ($280) ($200) ($260) 1. Calculate Tentative DRD and Percentage Limit TI Before DRD $350 $280 $170 $150 $90 Tentative DRD 80% * $100 $80 $80 $80 $80 $80 Percentage Limit 80% of TI $280 $224 $136 $120 $72

47 Dividends Received Deduction DIVIDENDS RECEIVED DEDUCTION 2. Calculate DRD 2a. Assuming there is not NOL DRD: Limited to lesser of 80% of DR or TI ($80) ($80) ($80) ($80) ($72) 2b. But, if there is NOL, no limit on DRD TI Before DRD minus Initial DRD $270 $200 $90 $70 $10 If TI Before DRD minus DRD =NOL, then there is not a limit on DRD DRD in cases where there is NOL 2c. Choose DRD from above, depending on whether there is NOL or not ($80) ($80) ($80) ($80) ($72) Taxable Income $270 $200 $90 $70 $18

48 Deduction DEDUCTION 100% Dividends Received Deduction Affiliated Corporations 100% Dividends from affiliated corporations (80% or more common ownership) that file consolidated returns qualify for a 100% deduction. Small Business Investment Corporations (SBICs) 100% A 100% deduction is allowed for dividends received by a small business investment company. An SBIC makes equity and long-term credit available to small business concerns. Depreciation See Depreciation Section.

49 Reconciliation Book Vs. Taxable RECONCILIATION BOOK VS. TAXABLE Book Income Vs Taxable Income ----> Goes to Schedule M-1 or M-3 Nondeductible expenses are added to book income. Examples: federal tax expense net capital loss expenses in excess of limits Income that is taxable but not included in book income is added to book income. For example Prepaid income included in taxable income Nontaxable income that is included in book income is subtracted from book income. For example, Municipal interest Life insurance proceeds. Tax deductions which are not expenses from book income are subtracted from book income. For example DRD

50 Reconciliation Book Vs. Taxable RECONCILIATION BOOK VS. TAXABLE Example Totley Towers Corp is an accrual-basis calendar year corporation. It reported book income of $500,000. Included in that amount was $40,000 muni bond interest income, $90,000 federal income tax expenses, and $122,000 interest expense on the debt incurred for the muni bonds. What amount should Totley s taxable income be as reconciled on the M1? Book Income: $500,000 Income adjustments: Muni interest: ($40,000) Prelim Income 1: $460,000 Expense adjustments: Federal income tax expense: -($90,000) Muni-related interest expense: -($22,000) Adjusted Income: $460,000 + $112,000 = $572,000

51 Reconciliation Book Vs. Taxable RECONCILIATION BOOK VS. TAXABLE Example A corporation had net income of $36,000 per books. Included in this were deductions for charitable contributions of $10,000, a net capital loss of $5,000, and federal income taxes paid of $9,000. What is the TI? Example Details Net income Per Books After Tax $36,000 Non-Deductible Net Capital Loss + $5,000 Federal Income Tax Expense + $5,000 Charitable Contributions + $5,000 Taxable Income Before CC + $5,000 CC (limited to 10% of $60,000) + $5,000 Taxable Income + $5,000

52 Taxation Rules TAXATION RULES Filing Requirements File Form 1120 by the 15th Day of 3rd Month If calendar year, then due date would be March 15th. Extension May file by Form 7004 for 6 months Accrual vs Cash Basis Accrual Basis Accrual method taxpayers must use the specific charge-off method (direct write-off method) for tax purposes. Thus, most taxpayers will write-off bad debts as they become worthless or partially worthless. (The allowance method is still required for financial accounting purposes, but is not allowed for calculating the tax deduction.) Cash Basis A very important point for purposes of the CPA exam is to be aware of bad debts of cash-basis taxpayers. Because a cash-basis taxpayer has not included the amount in gross income, a bad debt is not deductible, except in the case of an uncollectible check that has been deposited and recorded as income.

53 Taxation Rules TAXATION RULES Estimated Payment of Corporate Tax Large Corp Income of >= $1 Million in any of the 3 preceding years Estimated Payment is 100% of the tax as shown on the current year return Not Large Corp 100% of the tax shown on the return for the current year OR 100% of the tax shown on the return for the preceding year (Can t use this option If $0 taxes in preceding year)

54 AMT AMT Just like individuals, Corporations potentially need to pay an AMT tax, if their tax falls below certain thresholds. The AMT amount is 20% of Alternative Minimum Tax Income (AMTI), less an exemption amount.. AMT CORP Exemptions Certain C-Corps whose annual average gross receipts from the previous 3 periods are $7.5 million or less are exempt The CPA Exam frequently focuses on the following four areas: 1. Distinguishing between a) Adjustment b) Preference c) Adjusted Current Earnings (ACE) 2. The Exemption Formula 3. Credits Available to reduce the minimum Tax 4. The Minimum Tax Credit carryforward - To Reduce Future Regular Tax

55 AMT AMT OVERVIEW OF ALL STEPS OF AMT AMT All Steps Overview Taxable Income + / - Adjustments + Preferences = Unadjusted AMTI + / - ACE Adjustment = AMT Income (AMTI) - Exemption = AMT Tax Base * 20% = Tentative Minimum Tax OR Regular Tax Pay Greater Of Tentative Min. Tax or Regular Tax

56 AMT AMT Preferences (PPP): Add preferences back to AMTI. This increases AMTI 1. Private Activity Bond (Issued Post '86) a. This is tax-exempt interest income" 2. Percentage Depletion 3. Pre '87 ACRS Excess Depreciation a. ACRS is Accelerated Cost Recovery System) Adjusted Current Earnings "ACE" Increase or Decrease to Unadjusted AMTI Negative adjustment is limited to prior-years positive amounts

57 AMT AMT 1. Municipal Interest income: Add back 2. Organizational Amortization Expense: Add back 3. Life Insurance proceeds on Key Employees: Add back 4. Amount that AMT Depr. Is higher then ACE Depreciation: Add back 5. Dividend Received Deduction (70% / Under 20% Ownership: Add Back 6. Amount that AMT Depr is lower then ACE Depreciation: Subtract ACE Adjustment Calculation: ((ACE After Adjustments) - Unadjusted AMTI)) x 75% Adjustments to AMT Additions or Subtractions from AMT: a) Long Term Contracts b) Installment Sales c) Depreciation Adjustment for property put in service after 1986 & before 1999 Difference between regular depreciation and AMT Depreciation If regular depreciation is higher, then add back the difference to AMTI

58 AMT AMT The Exemption Formula Exemption Amount is $40,000 less 25% of AMTI in excess of $150,000 Credits Available to reduce the Alternative Minimum Tax (AMT) Foreign Tax Credits Minimum Tax Credit (MTC) carryforward - To Reduce Future Regular Tax Minimum Tax Credit (MTC) may be carried forward indefinitely. But it may NOT be Carried Back.

59 Accumulated Earnings ACCUMULATED EARNINGS The government, being a government, believes Corp profits should ultimately result in as much taxation as possible. However, if a Corp accumulates earnings and does not pay them out in dividends, this means less taxable revenue for the government, because dividends generate taxable revenue for the government. Therefore, The Accumulated Earning Tax is imposed on C-Corps who the government thinks should be distributing more dividends. Specifically, if Retained Earnings (Accumulated Earnings) are in excess of $250,000, and if they are "Improperly retained, this tax is instituted. What is NOT an Unreasonable Accumulation of Earnings? If there is: A specific, definite, and feasible plan for the use of accumulation; or Need to redeem stock included in a deceased stockholder's estate.

60 Accumulated Earnings ACCUMULATED EARNINGS Accumulated Earnings Tax Rate The Accumulated Earnings tax rate is a flat 20%. This is the same as the dividend tax rate. Personal Service Corporations AET Obligation Personal service corps, such as accounting, engineering, architecture, etc., may accumulate up to only $150,000 of accumulated earnings. Any amount beyond that will be subject to AET. PHC, Tax-Exempt Orgs, Passive Foreign Investment Corps: no AET These corps are do not have to pay the AET

61 Accumulated Earnings ACCUMULATED EARNINGS AET Calculation: Accumulated Taxable Income Taxable Income + Dividends Received Deduction + NOL Deduction - Federal Income Taxes - Excess Charitable Contributions - Net Capital Loss Adjusted Taxable Income - Dividends Paid - Accumulated Earnings Credit Accumulated Taxable Income * Tax Rate on Dividend Income = Accumulated Earnings Tax

62 Personal Holding Company (PHC) PERSONAL HOLDING COMPANY (PHC) Personal Holding Companies are corporations that: Are owned 50% or more by 5 or fewer individual And have 60% of Adjusted Ordinary Income from: a) Dividend from Unrelated domestic Corporation (0-20% Owned) b) Interest Income (Taxable ONLY) c) Net Rent d) Royalties The additional tax rate for PHCs is 20% Same as dividend tax rate Undistributed PHC Income Note PHCs must deduct federal income taxes and long term capital gain (net of tax) to determine Undistributed PHC Income Prior to the Dividend Paid Deduction.

63 Personal Holding Company (PHC) PERSONAL HOLDING COMPANY (PHC) Personal Holding Companies are corporations that: Are owned 50% or more by 5 or fewer individual And have 60% of Adjusted Ordinary Income from: a) Dividend from Unrelated domestic Corporation (0-20% Owned) b) Interest Income (Taxable ONLY) c) Net Rent d) Royalties The additional tax rate for PHCs is 20% Same as dividend tax rate Undistributed PHC Income Note PHCs must deduct federal income taxes and long term capital gain (net of tax) to determine Undistributed PHC Income Prior to the Dividend Paid Deduction.

64 GREAT JOB! Great job studying the C-Corp information for the CPA Exam! Study this course several times, and do practice questions, and you will get all the C-Corp points on the CPA Exam See you in the next lesson!