Chapter 15
Corporate Taxation
“Corporations don’t pay taxes, they collect
them.”
-- Paul H. O’Neill
McGraw-Hill Education
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LO #1 Corporate Formation and
Filing Requirements
• Corporations are legal entities formed
under the laws of a state.
• Corporations can use the cash-basis of
accounting if average gross receipts <=
$5 million or if inventory is not a material
factor.
15-2
LO #1 Corporate Formation and
Filing Requirements
• Corporations are not limited to a
calendar year fiscal year. They can
choose any fiscal year in their first year
of operation.
• Corporations file a Form 1120.
• Tax returns are due 2.5 months after the
fiscal year-end
– Can obtain an automatic 6-month extension
using Form 7004.
15-3
LO #1 Corporate Formation and Filing
Requirements – Concept Check 15-1
1. A corporation can use either the cash or
accrual method of accounting. True or False?
False
2. Corporate tax returns are due ________ if no
extension is requested.
2.5 months after the end of the fiscal year
3. The tax year of a corporation must end on
December 31. True or False?
False
15-4
LO # 2 - Basis
• On formation of a corporation,
transferors are exchanging cash and/or
property for stock.
• Generally, on corporate formation, no
gain is recognized by the transerors if,
immediately after the transfer, the
transferors control 80% or more of the
corporation.
15-5
LO # 2 - Basis
• Two cases in which gain may be
recognized by the transferor(s):
– 1. If shareholder contributes an asset
subject to a liability and the relief of liability
is greater than basis then the gain
recognized will be equal to the excess.
– 2. Cash or other property received (boot)
triggers gain equal to the lesser of the boot
received or the gain
15-6
LO # 2 - Basis
• Basis of the contributed property to the
corporation (inside basis)
– Equal to the basis in the hands of the
shareholder plus any gain recognized by
the shareholder
15-7
LO # 2 - Basis
• Basis of the stock to the shareholder
(outside basis)
– Equal to the basis of the property
contributed, plus any gain recognized,
minus any boot received (boot includes any
relief of liability).
• Unless shareholder increases or
decreases his or her proportionate
ownership, outside basis generally does
not change.
15-8
LO # 2 – Basis
Concept Check 15-2
1. When forming a corporation, if the transferors control
at least 80% of the corporate entity, then the
formation will generally be tax free. True or False?
True
2. The basis to the corporation of property received is
equal to _______________.
Shareholder basis plus gain recognized by shareholder.
3. Arturo contributed land with a fair value of $100,000
and basis of $40,000 to a newly-formed corporation in
exchange for 90% of the stock. Arturo’s basis in the
stock is ______________.
$40,000
15-9
LO #3 – Taxable Income & Tax
Liability
• Determination of taxable income
generally follows the rules associated
with a trade or business (Chapter 6).
– For corporations, the notion of AGI does
not exist.
15-10
LO #3 – Taxable Income & Tax
Liability
• Capital gains and losses are netted
together.
• Net capital losses are not permitted.
– If a corporation has a net capital loss, it can
carry it back three years and then forward
five years.
• Only offsets net capital gains in the carryback or
carryforward periods.
• Net capital gains are included in income
and are taxed at ordinary rates.
15-11
LO #3 – Taxable Income & Tax
Liability
• Charitable contributions are limited to
10% of taxable income before charitable
contributions, DRD, and carrybacks.
– Excess is carried forward five years.
• Contribution amount for “ordinary
income property,” such as inventory, is
limited to basis.
15-12
LO #3 – Taxable Income & Tax
Liability
• Corporations receive a Dividends
Received Deduction (DRD) for dividends
from other domestic corporations.
– DRD is 70% if ownership is < 20%
– DRD is 80% if ownership => 20% or < 80%
– DRD is 100% ownership => 80%
• DRD may be limited.
15-13
LO #3 – Taxable Income & Tax
Liability
• Organizational expenses and start-up
expenses can be amortized and
deducted over 180 months
– Corporation must make affirmative election.
– Some org expenses and/or startup
expenses may be immediately deductible.
15-14
LO #3 – Taxable Income & Tax
Liability
• Taxable income is subject to tax rates of
up to 35%.
– Tax rate schedule is progressive, but the
benefit of lower rates for lower income is
recaptured as taxable income increases.
15-15
LO #3 – Taxable Income & Tax
Liability
• Corporations must make estimated
payments
– Payment is lesser of 100% of tax due for
the year or 100% of the tax for the prior
year.
– Due on 15th day of fourth, sixth, ninth, and
twelfth months of fiscal year.
– Underpayment penalty applies if payments
are not sufficient.
15-16
LO #3 – Taxable Income & Tax
Liability
• If a corporation has a net operating loss,
it can be carried back two years and
then carried forward 20.
– Corporations can make an irrevocable
affirmative election to carry the NOL only
forward.
15-17
LO #3 – Taxable Income & Tax
Liability – Concept Check 15-3
1. Corporations follow the same tax rules for
capital gains as do individuals. True or
False?
False
2. The tax liability of a corporation with taxable
income of $520,000 is ___________.
$176,800
15-18
LO #3 – Taxable Income & Tax
Liability – Concept Check 15-3
3. A corporation reported taxable income
of $390,000 before charitable
contributions. The corporation made
charitable contributions of $50,000. Its
permitted deduction for charitable
contributions in the current tax year is
________.
$39,000
15-19
LO #3 – Taxable Income & Tax
Liability – Concept Check 15-3
4. Organizational expenses are automatically
deductible over 180 months. True or False?
False
5. Corporate net operating losses from 2012
can be carried back ____ years and forward
____ years.
2 years, 20 years
15-20
LO #4 – Transactions with
Shareholders
• Corporations have earnings and profits
(E&P). It is similar, but not identical, to
retained earnings
– E&P is based on tax law, not accounting
rules
• Distributions of cash or property from
E&P are dividends
– Taxable to shareholders
– Not deductible by the corporation
15-21
LO #4 – Transactions with
Shareholders
• Distributions in excess of E&P
– Nontaxable to shareholder to the extent of
shareholder basis in the stock
– A capital gain to the extent the distribution
exceeds basis.
15-22
LO #4 – Transactions with
Shareholders
• Distribution of property with FMV in
excess of basis
– Corporation reports gain (write-up to FMV)
– Amount of distribution to shareholder is
based on FMV.
15-23
LO #4 – Transactions with
Shareholders
• Distributions in full liquidation
– Corporation records all assets and liabilities
at FMV and records gain or loss
– Shareholder reports capital gain or loss
equal to the FMV of the distribution
compared to stock basis.
15-24
LO #4 – Transactions with
Shareholders – Concept Check 15-4
1. Dividends are always taxable to a shareholder. True
or False?
True
2. If a corporation pays a dividend in property, the
stockholder will have a dividend equal to the
corporate basis in the property. True or False?
False
3. A corporation has earnings and profits of $10,000
and makes a cash distribution to its sole shareholder
in the amount of $11,000. The amount of taxable
dividend to the shareholder is ______________.
$10,000
15-25
LO #5 – Schedules L, M-1 and M-3
• Schedules L, M-1, and M-2 are all on
page 5 of the Form 1120.
– Small corporations are not required to
complete these schedules.
• Schedule L is a beginning and ending
balance sheet reported in accordance
with the financial accounting method of
the corporation.
15-26
LO #5 – Schedules L, M-1 and M-3
• Schedule M-1 is a reconciliation from
book income to taxable income (not the
other way around).
• Schedule M-1 sets forth all book/tax
differences for the year, whether
permanent or temporary.
15-27
LO #5 – Schedules L, M-1 and M-3
• Some items that are a positive
adjustment (added back) from book
income to taxable income:
– Income tax expense per books
– Excess capital losses
– Disallowed current year charitable
contribution
– Book depreciation in excess of tax
depreciation
– 50% of travel and entertainment expense
15-28
LO #5 – Schedules L, M-1 and M-3
• Some items that are a negative
adjustment (subtracted) from book
income to taxable income:
– Life insurance proceeds
– Tax exempt interest
– Tax depreciation in excess of book
depreciation
– Charitable contributions in excess of 10%
limit in prior year
15-29
LO #5 – Schedules L, M-1 and M-3
• Schedule M-3 is a comprehensive
book/tax reconciliation for large
corporations.
– Total assets of $10 million or more.
15-30
LO #5 – Schedules L, M-1 and M-3 –
Concept Check 15-5
1. Completion of Schedule L is required of all
corporations. True or False?
False
2. Schedule M-1 reconciles book income to taxable
income. True or False?
True
3. A corporation’s depreciation expense is lower on the
financial statements than it is on the tax return.
Would this difference be a negative or positive item
on Schedule M-1?
Negative
15-31
LO #6 – Other Corporate Issues
• Parent-subsidiary group
– A common parent owns, directly or
indirectly, at least 80% of one or more other
corporations.
– Can elect to file a consolidated return.
– If elected, the election is irrevocable for all
future tax years.
15-32
LO #6 – Other Corporate Issues
• Brother-sister group
– Five or fewer persons own two or more
corps
• Total ownership test – group owns at least 80%
of the voting shares
• Common ownership test – group has common,
identical, ownership of at least 50% of share
value
– Must disclose to IRS.
15-33
LO #6 – Other Corporate Issues
• Larger corporations are subject to AMT
– Start with taxable income, add or subtract tax
adjustments, add tax preference items, subtract
exemption amount.
– Preferences similar to individuals
• Additional corporate item is the adjusted current earnings
(ACE) adjustment
– Exemption amount is $40K
• Phased out 25 cents on the dollar for AMT income over
$150K. Exemption is totally phased out for AMT income
of $310K or more.
– AMT rate is 20%
15-34
LO #6 – Other Corporate Issues
Concept Check 15-6
1. To be considered a parent/subsidiary group, the
parent corporation must own, directly or indirectly, at
least ____ percent of the subsidiary corporation.
80%
2. A brother-sister group may exist if ______ or fewer
persons own two or more corporations.
Five
3. For AMT purposes, the corporate exemption amount
is $________.
$40,000
15-35
LO #7 – Subchapter S Corporations
• Subchapter S corporations are “regular”
corporations that affirmatively elect to be
taxed in a manner similar to a
partnership
• File a Form 1120S
• Filing deadlines and extension rules are
the same as Subchapter C corporations
15-36
LO #7 – Subchapter S Corporations
• Must meet four tests to elect Sub S
status:
– Be a domestic corporation
– Have 100 or fewer shareholders
– Have one class of stock
– Have shareholders who are U.S. citizens or
resident aliens.
15-37
LO #7 – Subchapter S Corporations
• Sub S corporations report taxable
income and separately stated items
– Separately stated items are very similar to
those reported by a partnership
• Sub S corporation does not pay tax.
The shareholders do.
15-38
LO #7 – Subchapter S Corporations
• Shareholder basis is determined similar
to a partnership except corporate debt
does not affect shareholder basis.
• Basis increased by:
– Net income
– Separately stated positive items
– Capital contributions
– Loans from the shareholder to the
corporation
15-39
LO #7 – Subchapter S Corporations
• Basis is decreased by:
– Net losses
– Separately stated negative items
– Distributions from the corporation at FMV
• Basis cannot go below zero.
– If negative basis is implied, the amount is
carried forward.
15-40
LO #7 – Subchapter S Corporations
• Subchapter S distributions are not
taxable to shareholders
– Shareholders have already been taxed on
the income
– Similar to a partnership in that income is
taxed and distributions are generally not
taxed.
15-41
LO #7 – Subchapter S Corporations
Concept Check 15-7
1. Corporations with fewer than 100
shareholders are automatically considered
Subchapter S corporations. True or False?
False
2. A Subchapter S corporation is taxed in a
manner similar to a partnership. True or
False?
True
3. Subchapter S corporations file a Form
______.
1120S
15-42
LO #7 – Subchapter S Corporations
Concept Check 15-7
4. Alyssa is a shareholder in a Subchapter S
corporation and has a basis of $1,000 in her
stock. The corporation gives her a $200 cash
dividend. Is this dividend taxable or not
taxable to Alyssa?
Not taxable
5. Similar to a partnership, shareholders of a
Subchapter S corporation increase the basis
of their stock by their share of corporate
debts. True or False?
False
15-43