Chapter 3
Corporations: Special Situations
Corporations, Partnerships,
Estates & Trusts
Copyright ©2010 Cengage Learning
Corporations, Partnerships, Estates & Trusts
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Domestic Production
Activities Deduction (slide 1 of 5)
• The American Jobs Creation Act of 2004 created a
new deduction based on the income from
manufacturing activities
– The domestic production activities deduction (DPAD)
is based on the following formula:
• 6% × 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
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Domestic Production
Activities Deduction (slide 2 of 5)
• A phase-in provision increases the
applicable rate for the production activities
deduction as follows:
Rate
Years
3%
2005-2006
6%
2007-2009
9%
2010 and thereafter
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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
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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
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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
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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
quasi-flat tax rate applied to a corporation’s
economic income
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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)
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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
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AMT Formula for Corporations
(slide 1 of 2)
Regular Taxable Income Before NOL Deduction
± AMT Adjustments (except ACE adjustment)
+ Tax preferences
= AMTI before AMT NOL deduction and ACE adjust.
± ACE adjustment
= AMTI before AMT NOL
– AMT NOL (limited to 90% of above amount)
= Alternative minimum taxable income (AMTI)
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AMT Formula for Corporations
(slide 2 of 2)
Alternative minimum taxable income (AMTI)
– Exemption
= Tentative minimum tax base
× 20% rate
= Tentative minimum tax before AMT foreign tax credit
– AMT foreign tax credit
= Tentative minimum tax
– Regular tax liability before credits minus reg FTC
= Alternative minimum tax (AMT) if positive
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Adjustments for AMT
(slide 1 of 2)
Adjustments for AMT:
• 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
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Adjustments for AMT
(slide 2 of 2)
Adjustments for AMT (cont’d):
• 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
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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”
• Percentage depletion in excess of the adjusted
basis of property
• Certain intangible drilling costs for “integrated oil
companies”
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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
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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)
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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
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Impact of Certain
Transactions on ACE (slide 1 of 2)
Transaction
Effect on
Unadjusted
AMTI in Arriving
at ACE
Tax exempt income (less expenes)
Add
Federal income tax
No Effect
Dividends received deduction (70%) Add
DRD (80% and 100%)
No Effect
Exemption ( up to $40,000)
No Effect
Key employee insurance proceeds
Add
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Impact of Certain
Transactions on ACE (slide 2 of 2)
Transaction
Effect on
Unadjusted
AMTI in Arriving
at ACE
Excess capital losses
No effect
Excess charitable contributions
No Effect
Disallowed travel/entertainment
Penalties and fines
No effect
No effect
Deferred gains on installment sales
Add
Loss between related parties
Build-up of value of life insurance
No Effect
Add
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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
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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
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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)]
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AMT Example (slide 1 of 4)
Moreland Co. has the following income, etc. in 2009:
Taxable income
Depreciation adjustment
Installment gain (not on inventory sale)
Federal income tax provision on
financial stmts.
Penalties and fines
Private activity bond interest income
Other tax-exempt interest
$100,000
18,000
80,000
75,000
2,000
25,000
20,000
– The depreciation adjustment is an AMT adjustment and the private
activity bond interest is a tax preference for AMTI.
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AMT Example (slide 2 of 4)
Calculation of AMTI before ACE:
Taxable income
Plus: private activity bond income
Plus: depreciation adjustment
AMTI
Corporations, Partnerships, Estates & Trusts
$100,000
25,000
18,000
$143,000
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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)
Corporations, Partnerships, Estates & Trusts
$143,000
80,000
20,000
$243,000
143,000
$100,000
75%
$75,000
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AMT Example (slide 4 of 4)
Calculation of AMT:
AMTI before ACE
$143,000
Plus: ACE Adjustment
75,000
AMTI
$218,000
Less: Exemption
23,000
Tentative minimum tax base
$195,000
20% rate
× 20%
Tentative minimum tax
$ 39,000
Less: regular tax
(22,250)
AMT(TMT-Regular tax)
$ 16,750
Total cash paid = Regular tax + AMT = $ 39,000
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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
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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
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Accumulated Earnings Tax
(slide 3 of 5)
• An accumulated earnings credit is allowed
even when accumulations are beyond
reasonable business needs
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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)
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Accumulated Earnings Tax - Reasonable
Needs Of The Business (slide 5 of 5)
• Legitimate reasons
• Invalid Reasons
– Business expansion
– Capital asset
replacement
– Working capital needs
– Product liability loss
– Loans to suppliers or
customers
Corporations, Partnerships, Estates & Trusts
– Loans to shareholders
– Unrealistic
contingencies
– Investment in unrelated
business assets
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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
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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, or 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)
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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
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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
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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
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