US Taxation- A Primer

Transcription

1 WIRC of the ICAI- Seminar Series on Global Updates- I US Taxation- A Primer Presented by : 7 th May, 2011 CA. Shishir Lagu

2 Session Overview Introduction Corporate Tax Overview Federal Income Tax State and Local Income Taxes Some Advanced Issues Individual Tax Overview US Tax- Best Practices Tax Calendar Various IRS /States Publication

3 Introduction When a law becomes so impossible to understand that the ordinary citizen must look to the "super expert," the law becomes a trap and not a viable guideline. For years, the income tax and gift and estate tax laws have been modified and amended to the degree that only tax lawyers and accountants could really make any sense out of them. Now, with the advent of the Tax Reform Act of 1976 and all of its cross implications, not even the tax lawyers and accountants are so sure of themselves. - ROBERT S. TAFT, New York Law Journal, Dec. 30, 1976

4 Corporate Tax - Overview Three Tier system of Corporate income tax: The federal level The State level e.g. NY,NJ,CA. Certain localities e.g. NYC, Philadelphia. Domestic Corporation v/s Foreign Corporation Tax year Generally 12 months or 52/53 weeks long / Short tax year. Tax Losses 20 years carry forward and 2 years carry back. Entity Classification Federal Corporate Income Tax imposed at graduated rates. Corporate Income Tax is based on Net Taxable Income. Tax Forms.

5 Entity Classification Election to be taxed at the entity or as flow through entities. Exceptions : Some US Corporation and certain foreign entities Check the- Box regulations- Form LLCs. Some entities are taxed at member level : S Corporations Regulated Investment Companies (RICs), commonly referred to as mutual funds. Real estate Investment Trust (REITs)

6 Corporate Tax Rates Federal Tax Rates for Corporations: Slab ($) % on Excess 0 50, ,001 75, , , ,001 to 335, ,001 10,00, ,00,001 15,00, ,00,001 18,333, Over 18,333, This rate structure produces a flat 34% tax rate on incomes from $335,000 to $10,000,000, gradually increasing to a flat rate of 35% on incomes above $18,333,333.

7 Corporate Taxable Income The basic corporate tax computation sheet is as follows: Particulars Gross Income Less : Deductions Ordinary Special Taxable Income Tax Liability Less : Credits Tax Due Amount xxx xxx xxx xxx xxx xxx xxx

8 Corporate Taxable Income Gross Income Revenues are recognized using the accrual basis of accounting except in case of certain revenues collected in advance like, rent received in advance which are taxed on a cash basis Deductions All reasonable business expenses may be claimed by a corporation

9 Corporate Taxable Income Business deductions : All normal business expenses. Employee compensation costs except those not paid within 2 ½ months after year end. Bad debts written off are allowed, allowance for doubtful debts is not allowed. 50% of the cost of entertainment and meals State and local income taxes. Corporate Life Insurance premium is disallowed if Employer is the beneficiary. Depreciation for tax purposes generally calculated as per MACRS. Concept of Section 179 Deduction ( 100% w/off for assets with upper cap of $ 500,000) and Bonus Depreciation ( 100% w/off introduced by IRS for additions post 8 th Sept, 2010 as and additional incentive). Certain G&A expenses capitalized to inventory as IRC 263A cost.

10 Corporate Taxation Forms Type Forms C Corporation Form 1120 S Corporation Form 1120S Foreign Corporation, such as Branch Office. Form 1120F

11 Tax Forms Some Key Aspects Schedule M-1 or Schedule M-3 Government is seeking greater transparency with regard to differences between taxable income and financial accounting income. M-1or Schedule M-3 refers to the schedule used to reconcile GAAP income to taxable income on a tax return. Domestic corporations with total assets equal to or exceeding $10 million on the last day of the tax year need to file Schedule M-3. Temporary difference- a tax adjustment that will eventually reverse itself (For example depreciation or expense accruals). Permanent difference-a tax adjustment that never reverses (For example officers life insurance premiums or penalties).

12 Tax Forms Some Key Aspects Form 5471 and Form 5472 Form 5471 is used by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations. Form 5472 is used to provide information when reportable transactions occur during the tax year of a reporting corporation with a foreign or domestic related party.

13 State and Local Income Taxes State and Local Income Taxes are imposed in addition to Federal Income Tax. State Income tax is imposed at a fixed or graduated rate on the taxable income. The rates vary by state. Taxable income conforms closely to Federal taxable income in most states, with limited modifications. E.g. Several states require different lives and methods be used by businesses in computing the deduction for depreciation especially with regards to 179 depreciation or bonus depreciation.

14 State Tax Rates For Corporations States Rates Delaware 8.70% New York 7.50% New Jersey 9.00% California 8.84% Maryland 8.25% Nevada No state taxes

15 Certain States -Gross Receipt Tax Trend among states to adopt a gross receipts tax reporting regime including Ohio, Texas and Michigan. Michigan follows the Modified Gross Receipts Tax which is imposed on the modified gross receipts tax base, after allocation and apportionment, at the rate of 0.8%. Commercial Activity Tax (CAT) is an annual tax imposed on the privilege of doing business in Ohio, measured by gross receipts from business activities in Ohio. Businesses with Ohio taxable gross receipts of $150,000 or more per calendar year must register for the CAT file all the applicable returns, and make all corresponding payments. Texas has a Franchise Tax based on "taxable margin", generally defined as sales less either cost of goods sold or compensation.

16 State Tax- Nexus Determination Nexus Agenda Nexus describes the amount and degree of business activity that must be present before a State can tax an entity s income. Factors considered for determining nexus : Income Rental / Property Payroll Capital Employed

17 State Income Tax There are three methods of dividing the income tax base of a multi-state corporation amongst the states in which it is taxable Separate Accounting : Separate accounting is used less frequently than formula apportionment. Maybe applied when a business is able to accurately separate incomeproducing activities and income sources within a particular state from incomeproducing activities and income sources in other states. Specific Allocation : This method is used only in case of Non Business Income such as rents and royalties from real or tangible personal property, capital gains, interest, dividends or patent or copyright royalties. Formulary Apportionment : All 45 states which impose an income tax rely primarily on formulas to apportion a corporation's income among those states in which the corporation does business. Apportionment formulas attribute income to the states on the basis of factors which produce the income. The factors most commonly used are property, payroll and sales.

18 State Income Tax Example of formulary apportionment for state of MD : Factors Maryland (a) Everywhere in US (b) Decimal factor (a)/(b)= (c) Weights (d) Weighted Decimal Factor (c) * (d) Receipts $ 417,289 $ 2,204, Property $ 565 $ 3,216, Payroll $ 188 $ 1,569, Total Maryland apportionment factor is =

19 Some Advanced Issues Interest Income/ Deduction Consolidated Tax Returns Non Taxable Corporate events such as Formations and Re-organizations. Acquisition related issues such as Section 338(h)(10) election, Section 382 limitation. Foreign Corporation Branches General Anti Avoidance Rules(GAAR).

20 Interest Income /Deduction Specific aspects in Interest Income/ Expense Section 7872(a) - Treatment of loans with below-market interest rates Section Allowability of interest in respect of payment to foreign related parties. Section 163(j) - Thin Capitalization rules for Corporate Interest Expense.

21 Interest Income /Deduction Example of Section 163(j) Particulars Year 1 Year 2 Debt/Equity Ratio 2:1 2:1 Adjusted Taxable Income (ATI) Exempt Related Person Interest Expense (ERPIX) Net Interest Expense(NIX) Excess of NIX over 50% of ATI (A) Disallowed Interest= Lower of ERPIX & (A) 20 Nil Disallowed Interest Carryover Allowance out of PY disallowance - 10

22 Consolidated Returns Tax Consolidation treats a group of wholly owned or majority-owned companies and other entities as a single entity for tax purposes Common Parent must own 80% or more of their subsidiaries to file a consolidates return. Certain transactions between group members may not be recognized until the occurrence of events for other members For example, if Company A sells goods to sister Company B, the profit on the sale is deferred until Company B uses or sells the goods. All members of a consolidated group must use the same tax year.

23 Consolidated Returns Four main advantages of filing consolidated returns: losses in one group company reduce profits in other group companies assets can be transferred between group companies without triggering tax on any gain dividends can be paid between group companies without tax liabilities arising tax attributes (for example imputation credits) of one group company can be used by other group companies Complex rules to deal with the acquisition of companies with tax losses (SRLY Rules).

24 Non Taxable Corporate Events Formation The formation of corporation may be non taxable event The transfer of assets and liabilities solely in exchange of common stock. The tax attributes of assets and liabilities are transferred to the new corporation. Reorganizations corporations may change key aspects of their legal identity, capitalization, or structure in a tax free manner Examples of reorganizations that may be tax free mergers liquidations of subsidiaries share for share exchanges mere change in identity, form, or place of organization

25 Acquisition Related Issues Section 382 limitation The rules of Section 382 apply to limit a corporation's ability to utilize existing net operating loss ("NOL") carryovers once the corporation experiences an "ownership change. Ownership change means more than 50 percentage points in aggregate during the applicable testing period (generally, the shorter of (a) the 36-month period preceding the testing date or (b) the period of time since the most recent ownership change of the corporation).. Section 382 limitation = Value of the old loss corporation x federal long-term taxexempt rate (FLTER) for month in which transfer takes place. FLTER is published by IRS every month. The same is 4.55% for May 2011.

26 Acquisition Related Issues Section 338(h)(10) election : The purchasing corporation (P) and the seller (S) (selling consolidated group, selling affiliate or S corporation shareholders) may make a joint election under section 338(h)(10) to treat the sale of target stock (T) as if T sold all of its assets in a single transaction and accordingly T recognizes gain or loss on the same. Stepped up basis for the assets in hands of P. Recognition of Goodwill and same is amortizable over 15 years as S.197 intangible. Waiver by P of Net Operating Losses of T.

27 Acquisition Related Issues Example of analysis of Section 338(h)(10) election : A Inc B Inc X Inc Tax Basis of Assets = $100 FMV of assets on Transfer = $130 Sale Consideration paid by X to A purchase of B = $200 Section 382 Limitation for X Inc to use Losses of B Inc = $ 2 per year & hence possible permanent loss is $ 40. X Inc has to weigh the benefits Benefits Foregone Benefits - Additional Depreciation due to - Forgo losses which are subjected to Stepped up basis in assets of $ limitation being $ Year Amortization on acquired Goodwill of $ 70

28 Foreign Corporation Branches The IRS taxes foreign (i.e., non-u.s.) corporations differently than domestic corporations. Taxed on current year effectively connected income in same manner as resident corporation. Same rate of tax as of the resident corporation. Branch Profit Tax on remittance or deemed remittance. Section 884(a) imposes a 30% branch profits tax on the after-tax earnings of a foreign corporation s U.S. trade or business that are not reinvested in a U.S. trade or business by the close of the tax year, or are disinvested in a later tax year Dividends, interest, royalties, and certain other income are subject to withholding tax at 30% which may be reduced or eliminated by tax treaties. SOME A

29 General Anti Avoidance Rules (GAAR) General Anti Avoidance Rules (GAAR) Meaning : The general anti-avoidance rule (GAAR) stipulates that when a person is involved in an "avoidance transaction" taxes will be adjusted to deny the benefit that would have resulted from the transaction(s). GAAR applies when there is a misuse or abuse of the provisions of the ITA. Governing Statute : Code Section 7701(o) of the Internal Revenue Code, The common law economic substance doctrine provides that the tax benefits of a transaction are not allowed if the transaction does not have economic substance or lacks a business purpose.

30 General Anti Avoidance Rules (GAAR) Transaction would be treated as having economic substance only if the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer's economic position, and the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into such transaction. Penalty : 20 % penalty will be imposed for an underpayment attributable to any disallowance of claimed tax benefits by reason of a transaction lacking economic substance. The penalty is increased to 40 % for an underpayment attributable to a "nondisclosed non-economic substance transaction."

31 Individual Tax Return Category of Filers : Single Married Filing Jointly or qualified Widow(er) Married Filing separately Head of Household Tax Forms : 1040 In Due Dates : April 15 Automatic 6 Months Extension Automatic 2 Months Extension for taxpayers who are out of the country.

32 Individual Tax Return (Slab Rates) Slab Rates : Year 2010 Marginal Tax Rate Single Married Filing Jointly or Qualified Widow(er) Married Filing Separately Head of Household 10% $0 $8,375 $0 $16,750 $0 $8,375 $0 $11,950 15% $8,376 $34,000 $16,751 - $68,000 $8,376 -$34,000 $11,951 $45,550 25% $34,001 $82,400 $68,001 $137,300 $34,001 $68,650 $45,551 $117,650 28% $82,401 $171,850 $137,301 $209,250 $68,651 $104,625 $117,651 -$190,550 33% $171,851 $373,650 $209,251 $373,650 $104,626 -$186,825 $190,551 -$373,650 35% $373,651+ $373,651+ $186,826+ $373,651+

33 Individual Tax Return Alternatively an individual can claim for either of the following : Standard Deductions For 2011, the standard deduction was as follows : $5,800 for single individuals $11,600 for a married couple $8,500 for a head of household Itemized Deductions Medical expenses in excess of 7.5% of adjusted gross income, State, local, and foreign taxes, Home mortgage interest, Contributions to charities, Losses on non business property due to casualty, and Deductions for expenses incurred in the production of income in excess of 2% of adjusted gross income.

34 US Tax Best Practices Pay estimated taxes Comply with the tax calendar Have a transfer pricing policy that captures the essence of functions performed Respond to IRS notices and communications on a timely basis Have a tax preparer Maintain complete and accurate documentation US GAAP basis of accounting

35 Tax Calendar Particulars (Return) Fiscal Year End Calendar Year end Federal Corporate Income Tax Return June 15 March 15 Federal Corporate Income Tax Return (With Extension) Due Date for State Corporate Income Tax return (Normally) Due Date for State Corporate Income Tax return (Normally) With Extension December 15 September 15 June 15 March 15 December 15 September 15

36 Tax Calendar Particulars (Current Year Estimated Taxes) Fiscal Year End 1 st Quarter Estimated Taxes July 15 April 15 2 nd Quarter Estimated Taxes September 15 June 15 3 rd Quarter Estimated Taxes December 15 September 15 4 th Quarter Estimated Taxes March 15 December 15 Calendar Year end

37 IRS / Publications of IRS The Internal Revenue Service (IRS) is the revenue service of the United States federal government. Official website of IRS : IRS issues publications which can be valuable source of information, even for those who hire someone else to prepare their taxes. For e.g. Publications Publication 15 Publication 463 Publication 501 Publication 515 Publication 525 Publication 535 Title Publication 15 (2011), (Circular E), Employer's Tax Guide Travel, Entertainment, Gift, and Car Expenses Exemptions, Standard Deduction, and Filing Information Withholding of Tax on Nonresident Aliens and Foreign Entities Taxable and Nontaxable Income Business Expenses

38 State Income Tax Every states has its own website/publications which provides information to business taxpayers and individual taxpayers such as tax forms tax rates due dates claiming refunds Below is the link for certain state websites for any valuable information : - New York - Delaware - New Jersey

39 Question /Answer

40 Contact us Shishir Lagu E: M: Presence INDIA USA UK FRANCE NETHERLANDS SWITZERLAND Website