Presentation:
Corporate Taxation
Chapter One: Overview
Professors Wells
January 21, 2015
Relevance of this
Corporate Taxation Course
Federal income tax planning concerns:
1.
2.
3.
4.
5.
6.
Choice of business enterprise form
Capital structure, e.g., debt or equity (or both)
Dividend/profits distribution policy
Compensation policy
Disposition of corporate interests
Estate planning/wealth transfers
2 Business Entity Choices
Corporation – “C” or “S” status
Partnership – general or limited
Limited Liability Company (LLC)
Trust or Estate
Sole Proprietorship
Disregarded Entity (DRE)
RICs & REITS and other flow-throughs
3 Fundamental Corporate
Tax Technical Issues
1.  Contributions to the corporation – gain recognition to either
party?
2.  Arrangements between owners & the entity – e.g., “assignment
of income” permitted?
3.  Distributions of appreciated property.
4.  Corporate liquidations, including sales in conjunction with a
corporate liquidation.
5.  Corporate reorganizations – possible postponement of gain
recognition.
4 “Cradle to Grave” Approach
In This Course
1.  Formation of Corporations: §351
2.  Capital Structure – Debt vs. Equity. Is an interest expense
deduction available? Tax-free repatriation of debt available?
3.  Liquidating and Nonliquidating distributions
-Redemptions & partial liquidations
-Stock dividends & §306 stock
4.  Taxable complete or partial liquidation
5.  Corporate tax-free reorganizations & divisions
6.  Carryover of Corporate Tax Attributes
7.  Corporate Affiliated Groups
8.  S Corporations
5 Corporation/Shareholder Tax Policy Issues
“Slaying Dragons or Tilting At Windmills?”
Double taxation
Tax rates on ordinary income
Preferential capital gains rates.
Non-recognition for owner-shifts
Double Tax
1)
2)
3)
4)
Shareholder Tax
Corporate Tax
p.4
Shareholder
Corporation
6 Incidence of Corporate Tax
p.5
Who bears the burden of the corporate tax?
1)
2)
3)
4)
5)
6)
The corporation?
Shareholders/owners?
Employees?
Corporate managers?
Consumers of the corporation’s output?
Other investors?
7 Concepts of “Tax Common Law”
p.10
Non-codified federal income tax rules (particularly relevant in
the corporate income tax context):
1)
2)
3)
4)
5)
The “sham transaction” rule.
“Substance over form” analysis.
The “business purpose” doctrine.
The “step transaction” doctrine.
Codified §7701(o) – re: economic substance
8 Income Taxation of the Corporation
p.14
1)  Code §11 – graduated tax rate structure.
-Code §11(b)(1) – no lower initial brackets for personal
service companies.
2)  Determination of the corporation’s taxable income – no “above
the line” vs. “below the line”; why?
- capital gains & losses (no rate benefit but limits) §1211 & §1212
- dividends received deduction is available. §243 p.16
- deduction for domestic production - §199. p.17
3)  Accounting period – is the calendar year required? §441(b) & (i)
4)  Accrual method of accounting? §448(a). p.19
9 Income Taxation of the Corporation, Cont.
p.18 - 23
5)  Code §267 – limitations on loss transactions and timing
mismatches between corporation and its owners, i.e., potential
“gaps”. p. 18
6)  Corporate Alternative Minimum (ALTMIN) Tax – p. 19
repealed for small corporations.
7)  Multiple corporations - §1561 – p.22
Consolidated tax returns for an affiliated group of corporations
- §§1501-1504.
8) The “S” corporation alternative – p.23.
10 Problem (a)
C Corporation Scenario
p.26
(a)  Determining corporate level gross income:
Inventory Sales
Capital Gains
2,600,000
200,000
2,800,000
Exclusion under §103 for $10,000 muni-bond interest
continued
11 Problem (a)
Deductions Against Gross Income
p.26
Operating Expenses
800,000
Depreciation
800,000
Capital Loss (limit $220,000 to gain) 200,000
Total Deductions
1,800,000
continued
12 Problem (a)
Determining Tax Liability
p.26
§11(b)(1) tax calculation on $1 million taxable income
(2.8 less 1.8):
15% of 50,000
25% of 25,000
34% of 925,000
Plus: Lesser of $45,000
(5% of 900,000) or 11,750
Total Tax Liability
7,500
6,250
314,500
11,750
340,000
13 Problem (b)
Dividend Distribution
p.27
Distribution of $660,000 after-tax profit
§61(a)(7) dividend income
20% percent of $660,000
Total taxes: (340+132)
Amount for shareholders:
Effective tax rate:
=
$132,000
$472,000
$528,000
47.2 percent
(Is a 47.2% effective tax rate too much?)
14 Problem (c)
Deductible (?) Payments
p.27
1)  $500,000 salaries each paid – to eliminate all corporate level
income. Reasonable compensation amount? Consequences are
zero corporate tax but $400,000 individual taxes leaving $600,000
after-tax (compare this to $528,000) in Problem (b)) 2)  Other corporate level deductions available for this purpose?
§79 - group term insurance
§§105 & 106 – health benefits
15 Definition of “Corporation”
Code §7701(a)(3)
p.27
§7701(a)(3) defines a “corporation” to include associations, joint
stock companies, and insurance companies.
Choices of business entities:
1.
2.
3.
4.
5.
6.
7.
Regular corporation
S corporation
Foreign corporation
Limited liability company – LLC
Limited partnership, including “MLP”
General partnership
Sole proprietorship (& the “tax nothing”)
16 Prior Entity Classification Criteria –
Tax Regs.
1)
2)
3)
4)
5)
6)
p.27
Associates
Business objective
Continuity of life
Centralization of management
Limited liability for debts of entity
Free transferability of interests – but buy-sell agreement not
limiting transferability.
Regs. had bias towards partnership status.
17 “Check The Box”
Regulations
p.29
Premise: Regulations make the choice of entity optional to the
taxpayer.
1)  But, automatic classification of certain entities as corporations –
per se treatment; including enumerated foreign corporations.
2)  Default partnership status – an “eligible entity” may elect to the
contrary (not in foreign context, where one party much have
unlimited liability; or both must consent).
18 Additional Entity
Classification Issues
p.30
1)  The “tax nothing” or disregarded entity
2)  What tax effect of a change in the number of members of an
entity? p.31
3)  What income tax effect of elective changes in tax
classification of the entity? p.31
a) Partnership (or DE) to corporation?
b) Corporation to partnership?
19 The “Publicly Traded Partnership”
p.32
Corporate treatment of a “publicly traded partnership”? IRC §7704.
What is “publicly traded”?
Purpose of the exception from corporate status where 90% or more
of entity’s income is “passive”, including income from natural
resource activities? See §7704(d)(1)(E).
20 Corporations vs. Partnerships vs. Trusts
p.33
Reg. §301.7701-4 – Purpose of a trust is to “protect or conserve”
property, but not to conduct business. If so, partnership or
corporate status.
Types of trusts:
-  Personal wealth management
-  Oil royalty trusts
-  Equipment leasing/airplane trusts
21 Trust Income Taxation
Subchapter J
p.33
1)  Grantor trusts: Subchapter J, Subpart E, §671 et. Seq, treated
as “owner”
- income taxation to the grantor
2)  Nongrantor trusts: Subparts A-D taxation of (a) trust (if no
distribution) or (b) beneficiaries to the extent of actual
distributions (or required distributions), applying the DNI
concept.
22 Commissioner v. Bollinger
p.34
FACTS: Corporation holding title to real property.
Issue: Is the corporation the earner of the income or is it merely the shareholder’s “agent”?
Holding: Agency status permitted &, therefore, losses were directly allowable to the
individual investors as individuals – (also being shareholders of the corporate agency).
Bollinger
National Carbide Factors
1)  Corporation operates in the name and
for the account of the principal;
Citizen’s
Creekside 2)  Corporation binds the principal;
Loan
(as
agent
for
B)
Fidelity /
3)  Transmits money to the principal;
Mass. Mutual Life
4)  Income attributable to services of the
employees of the principal:
Creekside
5)  Relations with the principal must not be
Apts
dependent upon the fact that it is owned
by the principal; (See Bollinger case
discussion) and,
6)  Business purpose must be the carrying
on of the normal duties of an agent.
23 Corporation/Shareholder
Tax System Integration
p.39
U.S. has a classical tax system, i.e., taxation both on (1) corporation
and (2) shareholder.
Who pays the corporate tax:
The corporation or shareholders?
The full integration option: complete flow-through, e.g., the ALI
proposal of:
(1)  Imputation and (2) withholding (for U.S. Treasury cash flow
acceleration).
In December 2014, the staff of Senator Hatch released
“Comprehensive Tax Reform for 2015” that sets forth an extended
discussion and endorsement of corporate integration efforts.
24 Partial Corporate Shareholder
Integration
1.  Shareholder credit for tax previously paid on the dividend
amount-subject to an income “gross-up” requirement.
2.  Deduction available to the distributing corporation for the
dividend paid.
3.  Shareholder gross income exclusion for all or part of corporate
dividend.
2003 Act – reduce individual dividend tax to 20%
Dividends from certain foreign corporations located in treaty
jurisdiction are eligible for reduce dividend rate. See §1(h)(11)
(C)(i)(II)
25 Special Concerns About
Integration Proposal
p.42
1.  Extension of corporate tax preferences to shareholders.
2.  Treatment of tax-exempt shareholders (e.g., §401 deferred
compensation plans).
3.  Treatment of foreign shareholders (only through tax treaty?) –
under 2003 Act.
4.  Treatment of foreign taxes paid by the U.S. corporation. Not
creditable?
26 partnerships passes through to the owner or partner in whose hands it is subject to tax.
Distortions Tilting Towards
Non-Corporate Status
Figure 2. Number of C Corporation Returns Compared to the Sum of
S Corporation and Partnership Returns, 1978-2009
8,000,000
7,000,000
6,000,000
TRA 1986
Passthrough
Entities
5,000,000
Number of Returns
1)  Higher effective
income tax rate on
corporate taxable
income motivates
pass-through entities
Figure 2, below, reports the trend over the past 32 years of the number of C corporation
returns filed compared to the sum of S corporation and partnership returns.8 1986 was the last
year in which the number of C corporation returns exceeded the number of returns from
passthrough legal entities. As Figure 2 reports, while the number of C corporations has generally
declined in the United States since 1986 by a third, the number of passthrough entities has nearly
tripled.
2)  Higher corporate tax
rate motivates
finance with debt
(since deductible
interest reduces net
tax amount).
3)  Higher corporate tax rate motivates not paying dividends but
distribute earnings as salary or some other form of deductible
payment. Taxing qualified dividends at same rate as capital gains
takes away advantage of using excess cash for stock buy-backs.
4,000,000
3,000,000
2,000,000
C Corporations
1,000,000
0
Year
Source: Internal Revenue Service, Statistics of Income, published and unpublished data.
8
The data reported in this section comparing C corporations and partnerships are derived from entity-level
returns filed with the Internal Revenue Service. Some partnerships are partnerships of C corporations, some are
partnerships of other partnerships, and some are partnerships of individuals and C corporations or other partnerships
For this reason subsequent comparisons based either on asset size or gross receipt size includes some double
counting of assets or gross receipts as such items would be passed through to the returns of a C corporation partner
or partnership partner.
6
27 Framework for Business Tax Reform
1.  Obama Administration’s
3.  Chairman Ryan’s Tax Reform
Framework for Business Tax
Act of 2014: reduce corporate
Reform: reduce corporate tax
tax rate to 25%
rate to 28%
2.  Simpson/Bowles National
Commission on Fiscal
Responsibility: reduce
corporate tax rate to
23%-29%
4.  Staff of Senator Hatch’s
Comprehensive Tax Reform
for 2015: ? (29%?)
Implication: If corporate tax rates are below 30% whereas the top
individual rate stays at 39.6%, there will be a strong incentive for
individuals to conduct ongoing business activity within C and
attempt to bail-out earnings at capital gains rates. As you will soon
learn, we are going “back to the future!!!”
28