Chapter 3
Corporations: Special
Situations
Corporations, Partnerships,
Estates & Trusts
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
The Big Picture (slide 1 of 2)
Determining DPGR for the Domestic Production Activities
Deduction
• Mocha, Inc., produces and sells its ice cream to food stores
and restaurants.
– Mocha also operates snack shops next to its facilities where it sells ice
cream, coffee, and other snacks to the general public.
•
Mocha has gross receipts of $42 million from the wholesale
sale of its ice cream and $5 million from the operation of the
snack shops.
– What receipts are considered to be domestic production gross receipts
(DPGR) for the domestic production activities deduction (DPAD)?
• What planning tip might you give to Mocha?
– Read the chapter and formulate your response.
The Big Picture (slide 2 of 2)
Who Pays the alternative minimum tax (AMT)?
• Carmine, Inc., has a tentative minimum tax base of $7
million and average gross receipts for this year and
the prior 3 years of < $7.5 million.
• Taupe, Inc., has a tentative minimum tax base of $7.1
million and average gross receipts for this year and
the prior 3 years of < $7.5 million.
• Carmine is not subject to the AMT, but Taupe is.
• How can this happen?
– Read the chapter and formulate your response.
Domestic Production
Activities Deduction (slide 1 of 5)
• The American Jobs Creation Act of 2004 created a
new deduction, the domestic production activities
deduction (DPAD)
– Based on income from manufacturing activities
– Calculated using the following formula:
• 9% × Lesser of
– Qualified production activities income
– Taxable income (or modified AGI) or AMTI
– The deduction cannot exceed 50% of an employer’s W–2
wages properly allocable to domestic production gross
receipts
Domestic Production
Activities Deduction (slide 2 of 5)
• A phase-in provision increased the
applicable rate for the production activities
deduction as follows:
Rate
Years
3%
2005-2006
6%
2007-2009
9%
2010 and thereafter
Domestic Production
Activities Deduction (slide 3 of 5)
• Eligible taxpayers include:
– Individuals, partnerships, S corporations, C
corporations, cooperatives, estates, and trusts
• For a pass-through entity (e.g., partnerships, S
corporations), the deduction flows through to the
individual owners
• For sole proprietors, a deduction for AGI results
• For C corporations, the deduction is included with other
expenses in computing corporate taxable income
Domestic Production
Activities Deduction (slide 4 of 5)
• Qualified production activities income is the
excess of domestic production gross receipts
over:
– Cost of goods sold (CGS)
– Direct costs
– Allocable indirect costs
Domestic Production
Activities Deduction (slide 5 of 5)
• Domestic production gross receipts (DPGR) include
receipts from:
– Lease, rental, license, sale, exchange, or other disposition
of qualified production property (QPP) that was
manufactured, produced, grown, or extracted in the U.S.
– Qualified films largely created in the U.S.
– Production of electricity, natural gas, or potable water
– Construction performed in the U.S.
– Engineering and architectural services for domestic
construction
Disallowed Production ActivitiesPreparation of Food & Beverages
• DPGR does not include gross receipts
from the sale of food & beverages
prepared by a taxpayer at a retail
establishment
– There is a 5 percent de minimis safe harbor
The Big Picture – Example 20
DPGD – 5% De Minimis Rule
• Return to the facts of The Big Picture on p. 3–2.
• Suppose that Mocha has the following sales:
– $42 million from the wholesale sale of its ice cream, and
– Only $2 million from the snack shops next to its facilities
where it sells ice cream to the general public.
• The full $44 million is DPGR
– The $2 million falls under the de minimis safe-harbor
exception
– $2 million is less than 5% of $44 million ($42 million + $2
million).
Alternative Minimum Tax
(slide 1 of 3)
• Designed to ensure that corporations with
substantial economic income pay at least a
minimum amount of federal taxes
• Essentially, a separate tax system with a quasiflat tax rate applied to a corporation’s
economic income
Alternative Minimum Tax
(slide 2 of 3)
• If tentative alternative minimum tax > regular
corporate income tax, corporation must pay
regular tax plus the excess, the alternative
minimum tax (AMT)
Alternative Minimum Tax
(slide 3 of 3)
• For tax years beginning after 1997, many small
corporations are not subject to AMT
– A small corporation has average annual gross
receipts of $5 million or less for the preceding
three-year period
– Small corporation continues to qualify as long as
average gross receipts for the preceding three-year
period do not exceed $7.5 million
The Big Picture – Example 25
Small Corporation Exemption
• Return to the facts of The Big Picture on p. 3–2.
• Suppose that Carmine, Inc., had gross receipts
of $3.7 million, $4.8 million, and $4.6 million
for tax years 2008, 2009, and 2010,
respectively, for an average of $4.37 million.
– For 2011 AMT purposes, Carmine is considered to
be a small corporation.
AMT Formula for Corporations
AMT Adjustments (slide 1 of 2)
• The starting point for computing AMTI is taxable
income before any NOL deduction
– Certain adjustments must be made to this amount
• Tax preference items are always additions to taxable
income
• AMT adjustments may either positive or negative
– Positive adjustments result from timing differences
• Added to taxable income in computing AMTI
– When AMT adjustments reverse, they are
deducted from taxable income to arrive at AMTI
AMT Adjustments (slide 2 of 2)
• AMT adjustments may either increase or
decrease taxable income
– e.g., The deduction for domestic manufacturing
activities (DPAD) is available for AMT purposes
• DPAD for AMT is limited to the smaller of qualified
production income as determined for the regular income
tax or for AMTI before the manufacturing deduction
Adjustments for AMT (slide 1 of 2)
• A portion of depreciation on property placed in
service after 1986
• Difference between gain (loss) on sale of
property for regular tax and AMT purposes
• Passive activity losses of certain closely held
corporations and personal service corporations
• Mining exploration and development costs in
excess of allowed AMT 10 year amortization
Adjustments for AMT (slide 2 of 2)
• Difference between percentage of completion
and completed contract income
• Amortization claimed on certified pollution
control facilities
• Difference between installment gain and total
gain on certain dealer sales
• A portion of the difference between “ACE”
and unadjusted AMTI
Tax Preference Items
• Accelerated depreciation on real property in excess of
straight-line for property placed in service before
1987
• Tax-exempt interest on “private activity bonds”
– Interest on such bonds issued in 2009 and 2010 is not
treated as a tax preference
• Percentage depletion in excess of the adjusted basis
of property
• Certain intangible drilling costs for “integrated oil
companies”
ACE Adjustment
(slide 1 of 3)
• Ace adjustment = 75% of difference between
unadjusted AMTI and ACE
– Can be positive or negative
– Negative adjustment is limited to aggregate
positive adjustments less previous negative
adjustments
ACE Adjustment
(slide 2 of 3)
• Starting point for determining ACE is AMTI
– AMTI is defined as regular taxable income after
AMT adjustments and tax preferences (other than
the NOL and ACE adjustments)
ACE Adjustment
(slide 3 of 3)
• AMTI is adjusted to arrive at ACE
– These adjustments include:
• Exclusion items—Income items that will never be
included in regular taxable income or AMTI
• Disallowed items – e.g., dividends received deduction
of 70% (less than 20% ownership)
• Other adjustments items including, for example,
intangible drilling costs, circulation expenditures,
organization expense amortization, LIFO inventory
adjustments, installment sales, other items
Impact of Certain
Transactions on ACE
Transaction
Effect on
Unadjusted
AMTI in Arriving
at ACE
Tax exempt income (less expenes)
Add
Federal income tax
Dividends received deduction (70%)
No Effect
Add
DRD (80% and 100%)
No Effect
Exemption ( up to $40,000)
No Effect
Key employee insurance proceeds
Add
Exemption
• Exemption amount for a corp = $40,000
– Reduced by 25% of excess of AMTI over
$150,000
– Exemption is totally phased-out when AMTI
reaches $310,000
Minimum Tax Credit (slide 1 of 2)
• AMT paid in one year can be used as a credit
against future regular tax liability that exceeds
its tentative minimum tax
– Indefinite carryforward
– Cannot be carried back
– Cannot offset any future minimum tax liability
Minimum Tax Credit (slide 2 of 2)
• Small corporations (no longer subject to AMT)
with unused minimum tax credits after 1997
may use them against regular tax liability
• Limit = regular tax – [25% × (regular tax –
$25,000)]
AMT Example (slide 1 of 4)
Moreland Co. has the following income, etc. in 2011:
Taxable income
$100,000
Depreciation adjustment
18,000
Installment gain (not on inventory sale)
80,000
Federal income tax provision on
financial stmts.
75,000
Penalties and fines
2,000
Private activity bond interest income
(issued 2008)
25,000
Other tax-exempt interest
20,000
– The depreciation adjustment is an AMT adjustment and the private
activity bond interest is a tax preference for AMTI.
AMT Example (slide 2 of 4)
Calculation of AMTI before ACE:
Taxable income
Plus: private activity bond income
Plus: depreciation adjustment
AMTI
$100,000
25,000
18,000
$143,000
AMT Example (slide 3 of 4)
Calculation of ACE Adjustment:
AMTI before ACE
Plus: deferred installment gain
Plus: other tax-exempt income
Adjusted current earnings
Less: AMTI
Base amount for Ace Adjustment
Times rate:
ACE Adjustment (positive)
$143,000
80,000
20,000
$243,000
143,000
$100,000
75%
$75,000
AMT Example (slide 4 of 4)
Calculation of AMT:
AMTI before ACE
Plus: ACE Adjustment
AMTI
Less: Exemption
Tentative minimum tax base
20% rate
Tentative minimum tax
Less: regular tax
AMT(TMT-Regular tax)
$143,000
75,000
$218,000
23,000
$195,000
× 20%
$ 39,000
(22,250)
$ 16,750
Total cash paid = Regular tax + AMT = $ 39,000
Accumulated Earnings Tax
(slide 1 of 5)
• Penalty tax designed to discourage the
retention of corporate earnings unrelated to the
business needs of the company
Accumulated Earnings Tax
(slide 2 of 5)
• Tax of 15% is imposed on accumulated taxable
income (ATI), determined as follows:
• ATI = Taxable income ± Adjustments - Dividends
paid - Accumulated earnings credit
• Adjustments to taxable income generally pertain to a
corporation’s ability to pay a dividend
– Thus, deductions include the corporate income tax and
excess charitable contributions, while additions include the
NOL and dividends received deductions
Accumulated Earnings Tax
(slide 3 of 5)
• An accumulated earnings credit is allowed
even when accumulations are beyond
reasonable business needs
Accumulated Earnings Tax
(slide 4 of 5)
• The accumulated earnings credit is the greater
of:
– Current E&P needed to meet “reasonable needs”
of the business, or
– Amount by which $250,000 ($150,000 for service
companies) exceeds Accumulated E&P as of close
of preceding tax year (the minimum credit)
Accumulated Earnings Tax -Reasonable Needs
Of The Business (slide 5 of 5)
• Legitimate reasons
–
–
–
–
–
Business expansion
Capital asset replacement
Working capital needs
Product liability loss
Loans to suppliers or
customers
• Invalid Reasons
– Loans to shareholders
– Unrealistic contingencies
– Investment in unrelated
business assets
Personal Holding Company Tax
• Personal Holding Company (PHC) tax is
designed to discourage sheltering of certain
types of passive income in corporations
– Like the accumulated earnings tax, the purpose is
to force the distribution of corporate earnings to
shareholders
Definition of PHC
• A company is a PHC if:
– More than 50% of the value of stock is owned by 5 or
fewer individuals during the last half of the year
• Broad constructive ownership rules apply in determining stock
ownership
– 60% or more of gross income (as adjusted) must consist of
personal holding company income (PHCI)
• Examples are dividends, interest, rents, royalties, and certain
personal service income
• Rents or royalties may be excluded if they are significant in amount
(i.e., comprise more than 50% of the adjusted gross income)
Calculation of PHC Tax
• Once classified as a PHC, the tax base must be
calculated
– Penalty tax rate = 15%
– Tax base is undistributed Personal Holding
Company income (UPHC income)
• Amount is taxable income plus or minus certain
adjustments, minus the dividends paid deduction
Dividends Paid
• Dividend payments reduce both ATI and
undistributed PHCI
– As these are the bases on which the § 531 tax or
the § 541 tax is imposed, either tax can be
completely avoided by paying sufficient dividends
Refocus On The Big Picture (slide 1 of 4)
• Determining DPGR for the DPAD
• The $42 million gross receipts from the
wholesale sale of Mocha’s ice cream are
considered DPGR.
– However, the de minimis safe-harbor 5%
exception does not apply to include the gross
receipts from the snack shops
• $5 million ÷ $47 million = 10.6%.
Refocus On The Big Picture (slide 2 of 4)
• The sales from the snack shops could qualify as
DPGR if Mocha were to restrict snack shop sales.
– For example, keeping snack sales at around $2.2 million
would satisfy the 5 % exception.
• Thus, Mocha will have to decide whether the 9 %
DPAD is worth forgoing the profit on the snack sales.
• Keep in mind that the DPAD is allowed for the AMT.
Refocus On The Big Picture (slide 3 of 4)
• Who Pays the AMT?
• Carmine, Inc., has met several gross receipts
tests, including initially qualifying as a ‘‘small
corporation.’’
• To qualify as a ‘‘small corporation,’’ the
business must have had average gross receipts
of $5 million or less in the preceding 3 years.
Refocus On The Big Picture (slide 4 of 4)
• Once qualified as a ‘‘small corporation’’ it will
continue to be exempt from the AMT as long
as its average gross receipts for the 3 preceding
taxable years do not exceed $7.5 million.
• Unfortunately, Taupe, Inc., did not meet the
initial $5 million test, so it does not fall within
the $7.5 million exemption.
If you have any comments or suggestions concerning this
PowerPoint Presentation for South-Western Federal
Taxation, please contact:
Dr. Donald R. Trippeer, CPA
trippedr @oneonta.edu
SUNY Oneonta
© 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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