Chapter 2A. Corp. Tax Law Howard Godfrey, Ph.D., CPA Professor

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Chapter 2A.
Corp. Tax Law
Howard Godfrey, Ph.D., CPA
Professor of Accounting
Copyright © 2014
Edited January 10, 2014
C14-Chp-02-1A-Corp-Tax-Law-2014
A student should understand:
1. Various business forms – corp. etc. [Pg. 2]
2. Corporate tax (compare w/ individuals). [Pg. 8]
3. Fiscal years & accounting methods. [Pg. 10]
4. Capital gains (losses). Deprec. Recapture [Page 11+]
5. Passive Losses [Page 13]
6. Charitable contributions. [Page 14]
7. Domestic Production Activities [Page 16]
8. Net operating losses. [Page 17]
9. Dividends received deduction. [Page 17]
10. Organization & start-up expenses. [Page 20]
11. Tax Rates. Also Related Corporations [Page 21+]
12. Filing requirements, payments [24]
13. Tax and book income. Acct. for Tax [Page 25+]
14. Tax planning. Transactions w/ Owner. [Pg. 35+]
1. Compare
Business Forms.
[Page 2-2]
Sec. 1, 1(h), 11, 1201, 63
Lecture Outline
A corporation is a separate taxpaying entity.
This chapter discusses the rules for
determining a corp's taxable income and tax
liability. It also discusses how to file a
corporate tax return.
The corporations discussed in this chapter are
regular corporations or C corporations.
Corporations that are not classified as
domestic -- are foreign corporations.
Foreign corps are taxed somewhat like
domestic corporations if they conduct a trade
or business in the United States.
Sue owns 100% of Sue Corp. (C Corp), 100% of SueCorpS (S).
She is also a 50% partner in the Sue Partnership.
She receives a salary from the two corporations.
Sue Corp. SueCorpS. Sue Ptship Answer
Sue's Begin. Basis
$65,000
$65,000
$65,000
Revenue
$100,000 $100,000 $100,000
Salary to Sue
40,000
40,000
Other Expenses
10,000
50,000
30,000
Taxable income
50,000
Ordinary bus. Income
10,000
Taxable income
70,000
Total dividends paid
6,000
Total dividends paid
$4,000
Total distribution
$10,000
Sue's Ending Basis
Sue's gross income from these three entities?
Sections 61, 702, 705, 722,731, 1363, 1366, 1367, 1368
Sue owns 100% of Sue Corp. (C Corp), 100% of SueCorpS (S).
She is also a 50% partner in the Sue Partnership.
She receives a salary from the two corporations.
Sue Corp. SueCorpS. Sue Ptship Answer
Sue's Begin. Basis
$65,000
$65,000
$65,000
Revenue
$100,000 $100,000 $100,000
Salary to Sue
40,000
40,000
$80,000
Other Expenses
10,000
50,000
30,000
Taxable income
50,000
Ordinary bus. Income
10,000
$10,000
Taxable income
70,000 $35,000
Total dividends paid
6,000
$6,000
Total dividends paid
$4,000
Total distribution
$10,000
Sue's Ending Basis
$65,000
$71,000
$95,000
Sue's gross income from these three entities?
$131,000
Sections 61, 702, 705, 722,731, 1363, 1366, 1367, 1368
FICA Rates for 2013
A combined employee-employer social
security tax rate of 15.30% applies in 2013.
Employers and employees are each liable for
6.20% of old age security and disability
insurance tax or a total of 12.40% of the first
$113,700 of wages in 2013.
Employers & employees also are each liable
for a 1.45% Medicare hospital insurance tax
for a total of 2.90% of all wages.
7
You may find it helpful to get
copies of the income tax returns
for corporations, S corporations,
partnerships and
proprietorships, and enter the
information on the following
slides – on the tax forms. See
Text-Appendix B
8
Study the worksheet on the next slide. 2013
Same data can be used to compute entity & individual tax
with:
(1), C Corporation (2) S Corporation and
(3) Proprietorship.
Owner (Jan) is single with no dependent. Jan has itemized
deductions of $26,100. Exemption: $3,900
Jan invested $100,000 to start this business on January 1,
2014. With C or S Corp, Jan takes a salary of $70,000.
For C or S Corp, payroll tax of $20,000 includes payroll tax
for all salaries.
With proprietorship, Jan withdraws $70,000.
For proprietorship, payroll tax of $20,000 is applicable to
salary for others.
Self-Employment Tax: IRS Form 1040 SE.
C Corp. - 2013 [Fm 1120]
Single Person - Form 1040- 2013
Revenue
$
Cost of Sales
Gross Margin
Saary-Others
Salary -Owner
Payroll Taxes
Other Expenses
Total Expenses
Net Income
Income Tax
After-Tax Income
Retained Earnings:
Beginning Balance
After-Tax Income
Subtotal
Dividends Paid
End. Retained Earn.
Gross Income
Salary
Dividends
Flow through - entity
Total Income
Deductions for AGI:
800,000
500,000
300,000
100,000
70,000
16,000
54,000
240,000
60,000
10,000
50,000
-050,000
50,000
AGI [Adj. Gross Income]
Exemptions
Itemized Deductions
Total deduct. from AGI
Taxable Income
Income Tax
Self-Employment Tax
50,000
Total tax before credits
$ 70,000
70,000
70,000
3,900
26,100
30,000
40,000
None
S Corp. - 2013 [Fm 1120S]
Revenue
$
Cost of Sales
Gross Margin
Pay-Others
Pay -Owner
Payroll Taxes
Other Expenses
Total Expenses
Net Income
Income Tax
After-Tax Income
Retained Earnings:
Begin. Balance
After-Tax Income
Subtotal
Dividends Paid
End. Retained Earn.
800,000
500,000
300,000
100,000
70,000
16,000
54,000
240,000
60,000
None
60,000
-0-
Single Person - 1040- 2013
Gross Income
Salary
Dividends
Flow through - entity
Total Income
Deductions for AGI:
Adjusted Gross Income
Exemptions
Itemized Deductions
Total ded. from AGI
Taxable Income
Income Tax
Self-Employment Tax
Total tax before credits
3,900
26,100
30,000
None
S Corp. - 2013 [Fm 1120S]
Revenue
$
Cost of Sales
Gross Margin
Pay-Others
Pay -Owner
Payroll Taxes
Other Expenses
Total Expenses
Net Income
Income Tax
After-Tax Income
Retained Earnings:
Begin. Balance
After-Tax Income
Subtotal
Dividends Paid
End. Retained Earn.
800,000
500,000
300,000
100,000
70,000
16,000
54,000
240,000
60,000
None
60,000
Single Person - 1040- 2013
Gross Income
Salary
$ 70,000
Dividends
Flow through - entity
60,000
Total Income
130,000
Deductions for AGI:
-060,000
60,000
Adjusted Gross Income 130,000
Exemptions
3,900
Itemized Deductions
26,300
Total ded. from AGI
30,200
Taxable Income
99,800
Income Tax
Self-Employment Tax None
60,000
Total tax before credits
Schedule C on 1040 - 2013
Revenue
Cost of Sales
Gross Margin
Salary-Others
Salary -Owner
Payroll Taxes
Other Expenses
Total Expenses
Net Income
Income Tax
After-Tax Income
Capital Statement:
Beginning Balance
After-Tax Income
Subtotal
Drawing
End. Capital Balance
$ 800,000
500,000
300,000
100,000
Not App.
16,000
54,000
170,000
130,000
Not App.
Not App.
$ 100,000
Single Person-Form 1040- 2013
Gross Income
Salary
Not App.
Dividends
Flow through
Income-Schedule C
Total Income
Deductions for AGI:
One-half of SE Tax
Adjusted Gross Income
Exemptions
3,900
Itemized Deductions
26,100
Total ded. from AGI
30,000
Taxable Income
Income Tax
Self-Employment Tax
Total tax before credits
Schedule C on 1040 - 2013
Revenue
Cost of Sales
Gross Margin
Salary-Others
Salary -Owner
Payroll Taxes
Other Expenses
Total Expenses
Net Income
Income Tax
After-Tax Income
Capital Statement:
Beginning Balance
After-Tax Income
Subtotal
Drawing
End. Capital Balance
$ 800,000
500,000
300,000
100,000
Not App.
16,000
54,000
170,000
130,000
Not App.
Not App.
Single Person-Form 1040- 2013
100,000
Gross Income
Salary
Not App.
Dividends
Flow through
Income-Schedule C
130,000
Total Income
130,000
Deductions for AGI:
8,790
One-half of SE Tax
Adjusted Gross Income 138,790
Exemptions
3,900
Itemized Deductions
26,100
Total ded. from AGI
30,000
Taxable Income
108,790
Income Tax
17,580
Self-Employment Tax
100,000
Total tax before credits
$ 100,000
Tax Year - 2013
Ignore temp. rate reduction
Sch. C Net Income
$130,000
92.35%
Net. SE Income
$120,055
2.90%
$3,482
$113,700 12.40% $14,099
15.30%
Self-Employment Tax (1040-Line 57)
$17,580
50%
Income Tax Deduction (1040-Line 30)
$8,790
Tax Year - 2013 - Alternate Approach
Sch. C
Net Income
$130,000
92.35%
Net. SE Inc.
$120,055
$113,700 15.30% $17,396
$6,355
2.90%
$184
$120,055
Self-Employment Tax (1040-Line 57)
$17,580
50%
Income Tax Deduction (1040-Line 30)
$8,790
Corp-Big Picture
Gross Income - Sec. 61
Less:
Deductible expenses
Equals: Taxable income
Times: Corporate tax rate
Equals: Corporate income tax
Plus:
Additions to tax
Less:
Tax credits
Equals: Net corporate tax
Corporate Tax Rates
15% on first $50,000
25% on $50,001 - $75,000
34% on $75,001 - $100,000
39% (34% + 5% surtax) on $100,001 $335,000
34% on $335,001 - $10,000,000
35% on $10,000,001 - $15,000,000
38% (35% + 3%) on $15,000,001 - $18,333,333
35% on over $18,333,333
Double Taxation
The following slide shows the
impact of double taxation of
corporate earnings.
The corporation has taxable income
of $1,500,000 and distributes all
after-tax income to shareholders.
See Sec 301.
19
Corporation Distributes All After-tax Income
Shareholders are individuals
What is combined effective tax rate?
Corp. taxable income
Tax rate
$1,500,000
Corp. after-tax income
Shareholder tax rate
Total income tax
Total Tax as % of T.I. above
0.00%
Corporation Distributes All After-tax Income
Shareholders are individuals
What is combined effective tax rate?
Corp. taxable income
Tax rate
$1,500,000
34%
$510,000
Corp. after-tax income
Shareholder tax rate
$990,000
20%
Total income tax
Total Tax as % of T.I. above
198,000
708,000
47.20%
Corporation Distributes All After-tax Income
Assume 15%/20% dividend rate expires.
Shareholders are individuals
What is combined effective tax rate?
Corp. taxable income
Tax rate
$1,500,000
34%
$510,000
Corp. after-tax income
Shareholder tax rate
$990,000
40%
Total income tax
Total Tax as % of T.I. above
22
392,040
902,040
60.14%
2. Corporate tax law
(compare with
individuals).
[Page 2-8]
Sec. 1, 1(h), 11, 1201, 63
23
2. Fiscal years
and accounting
methods.
[Pg 2-10]
Sec. 441, 451
24
Corporate Year.
When a corp. is formed there are certain
elections that must be made.
A. Choosing a Calendar or Fiscal Year.
A new corp. may select either a calendar or
fiscal year by filing its first tax return for the
selected period.
The corp's tax year must be the same as its
annual accounting period that is used for
financial accounting purposes.
25
Corporate Year.
A corp's first tax year may not cover a full 12-month period.
In that case, a short-period tax return must be filed. A
corp's final year may also cover a short period.
Some corporations may be restricted in their ability to select
a tax year. A member of an affiliated group of corps that files
a consolidated return must use the same tax year as the
group's parent corporation.
A PSC may elect to use certain fiscal years even when there
is no business purpose.
A new PSC may elect to use a September 30, October 31, or
November 30 year-end provided that it meets minimum
distribution requirements to employee-owners during the
deferral period.
Corporate Year.
A personal service corporation (PSC) is defined
for this purpose as a corporation whose
principal activity is the performance of
personal services.
A corporation is not a PSC unless its employeeowners own more than 10% of the stock (by
value) on any day of the year and the personal
services are substantially performed by the
employee-owners.
Corporate Year.
A corporation wishing to change its accounting
period must secure the prior approval of the
IRS unless a change is specifically authorized
under the Regulations. A request for change is
filed on Form 1128 on or before the fifteenth
day of the second calendar month following
the close of the short period.
The change will be granted if there is a
substantial business purpose.
Corporate Change of Year.
A corporation may change its tax year without the prior
approval of the IRS if:
1. the corporation has not changed its accounting period
within the last ten years;
2. the resulting short period does not have a net operating
loss.
3. the taxable income of the short period is, if annualized, at
least 80% of the corporation's taxable income for the tax
year preceding the short period.
4. the corporation had a special status (i.e. personal holding
company or exempt status) for the short period or the tax
year prior to the short period, it has the same status for
both tax years; and
5. the corporation does not elect S corporation status in the
year following the short period.
Accounting Methods.
A new corp. must select the method
of accounting it will use to keep its
books and records.
The same method must be used to
compute financial accounting income
and taxable income.
(At least that is what Sec. 446(a) says,
but….)
Accrual Method. Income is reported when earned and
expenses are reported when incurred.
C corporations are accrual except:
a. A family farming business.
b. A qualified personal service corp. where
substantially all of its activities involve …services
in the fields of health, law, engineering,
…accounting, …;
and where substantially all of the stock is held
by current (or retired) employees performing
the services, their estates, or certain
persons who inherited their stock.
c. Corps with gross receipts of $5 million or less.
d. S corporations.
Cash Method.
Income is reported when received and
expenses are reported when paid. This
method may not be used if inventories are a
material income-producing factor.
Hybrid Method.
The corporation uses the accrual method of
accounting for sales, cost of goods sold,
inventories, accounts receivable, and accounts
payable.
The cash method of accounting is used for all
other income and expense items.
Cash and Accrual Method.
On 5-1-2014, Tom, (Cash basis), leased an office from
Downtown Plaza (Cash basis) for 5 years starting on
6-1-14, for $1,000 per month.
On 6-1-14, Tom paid $30,000, half of the lease
amount, to Downtown (for 30 months).
Tom made no payment during 2014.
Tom’s rent deduction (in 2014):
a. $-0- b. $6,000 c. $12,000 d. $30,000
Downtown (accrual basis) reports 2014 rental income:
a. $-0- b. $6,000 c. $12,000 d. $30,000
Discuss: Downtown is on Accrual Basis?
Sec. 451, 1.451-1
§1.451-1., General rule for taxable
year of inclusion
(a) General rule. –…..Under an accrual
method …, income is includible in
gross income when
all the events have occurred which fix
the right to receive such income and
the amount thereof can be
determined
with reasonable accuracy.
§1.451-1., General rule for taxable year of inclusion
(a) General rule. …
Under the cash receipts and disbursements
method .., such an amount is includible in
gross income when actually or constructively
received. Where an amount of income is
properly accrued on the basis of a reasonable
estimate and the exact amount is subsequently
determined, the difference, if any, shall be
taken into account for the taxable year in
which such determination is made.
Nare, an accrual-basis taxpayer, leased a building
to Pine under a five-year lease on 11-1-2014.
Pine paid Nare $10,000 rent for 2 months of
November and December, 2014, and $5,000 for the
last month's rent.
How much should Nare report as rental income for
2014?
a. $10,000 b. $15,000
c. $40,000 d. $45,000
Sec. 451, 1.451-1
36
Nare, Cont’d
The answer is $15,000.
An accrual basis taxpayer recognizes
income with all events have occurred to
establish the right to receive the
income.
Nare has the right to receive $15,000,
even though only $10,000 has been
earned during the taxable year.
On March 1, 2014, Sharon, a cash basis sole
proprietor, leased a dance studio from
Shelby Rentors
for 3 years at $1,200 per month.
In 2014, Sharon paid $28,800 and
in 2015 she paid $6,000 on the lease.
She paid the remainder of the lease
payment in 2016.
What is Sharon’s deduction for 2015?
a. $6,000 b. $11,600
c. $14,400 d. $20,400
38
Sharon must capitalize
the payments for rent for
future years and write off
the cost on a monthly
basis.
Answer: $14,400
39
A consulting firm started in 2014 and
adopted the accrual method.
The firm had gross income of $90,000 and
expense payments of $60,000 for 2014.
The firm owed salaries payable of $5,000 to
employees (non-owners) for December,
which were not recorded at 12-31-14.
These salaries were paid in January, 2015.
How much is taxable income for 2014?
a. $25,000 b. $30,000
c. $35,000 d. Other (CPA)
40
A consulting firm- continued.
The firm reported net income of
$30,000, but failed to deduct an expense
for salaries earned but not paid.
On the accrual basis, such salaries will
be deducted for the year in which the
employees earned those salaries, if paid
early in next year.
This reduces net income to $25,000.
41
Mark, who gives music lessons, is a
calendar year taxpayer using the accrual
method of accounting.
On 11-2-2014, he received $10,000 for a
one-year contract beginning on that date
to provide 10 lessons.
He gave 2 lessons in 2014.
How much should Mark include in income
in 2014?
a. $--0-b. $2,000
c. $8,000
d. $10,000
42
Mark-Continued.
This is income received in advance
and would normally be reported
entirely in the year of receipt.
However, this qualifies as an
exception, and the taxpayer can
report the income as earned, not
when payment is received in
advance.
43
Hall Co., (accrual basis) leases offices with
rent received in advance on the first
day of each month.
Not all tenants make timely payments.
Hall's records at end of its first year show :
$40,000
Cash from Tenants
10,000
Expenses Paid
$30,000
Net Income
$6,000
Rental Receivable
Net income should Hall report for the year?
a. $24,000 b. $30,000 c. $36,000 d. Other (CPA)
How would your analysis change if this
is not the first year of operations?
Accounting Methods
Hall Co., -Continued
The rent receivable of $6,000 must be
included in revenue – using the
accrual method.
Corrected computations:
Revenue
$46,000
Expenses
$10,000
Taxable Income
$36,000
(Before Depreciation)
45
Timing of Deductions
• Accrual method – expenses deductible
when:
– “All events” have occurred that fix liability and
– “Economic performance” occurs (property or
services provided or used)
• Cash basis taxpayer - expenses deductible
when paid:
–Date check is mailed
–Date charged on credit card
46
Accrual Accounting-1
Reg §1.446-1. ..methods of accounting
…a liability is incurred, …, [when]
all events have occurred that establish the
liability,
the amount of the liability can be
determined with reasonable accuracy, and
economic performance has occurred with
respect to the liability.
47
Accrual Accounting-1
• Automobile manufacturer sells an auto to dealer
for a wholesale price of $30,000.
• Dealer sells it later that year for $40,000.
• Manufacturer warrants the auto for five years and
estimates that the warranty cost over five years
will be $4,000 per auto.
• Is the manufacturer permitted to recognize an
expense in the year of sale and set up a “reserve”
for future warranty costs (equal to $4,000 per auto
sold this year)?
See Reg earlier.
Accrual Accounting-2
Manufacturer provides a 3-year warranty.
Financial statement for its first year:
Sales
$1,000,000
Cost of sales
600,000
Expenses
300,000
Net income before taxes
$100,000
Expenses include a reserve of
$20,000
[Reserve for future repair costs
on units sold in the current year.]
What is taxable income for current year?
a. $100,000 b. $80,000 c. $120,000
49
Accrual Accounting-3
Manufacturer provides a 3-year warranty.
Financial statement for its first year:
Sales
$1,000,000
Cost of sales
600,000
Expenses
300,000
Net income before taxes
$100,000
Accrued warranty liability
Taxable Income
$20,000
$120,000
What is taxable income for current year?
a. $100,000 b. $80,000 c. $120,000
Accrual Accounting-4
Manufacturer provides a 3-year warranty.
Financial statement for its first year:
Sales
$1,000,000
Cost of sales
600,000
Expenses
300,000
Net income before taxes
$100,000
Expenses include a reserve of
$20,000
[Reserve for future repair costs on units
sold in the current year.] Tax Rate 40% .
What is the balance in the deferred tax
asset or liability account at end of Year 1?
Accrual Accounting-5
Manufacturer provides a 3-year warranty.
Financial statement for its first year:
Sales
$1,000,000
Cost of sales
600,000
Expenses
300,000
Net income before taxes
$100,000
Accrued warranty liability
Taxable Income
Timing difference
Tax rate
Deferred tax asset
$20,000
$120,000
$20,000
40%
$8,000
Compute taxable income for Hurd, Inc.
Hurd, Inc. reported for year:
Info.
Book income before taxes
$900,000
Records show:
Interest on municipal bonds
70,000
Depreciation on tax return in
excess of deprec. per books 130,000
Warranty exp.- accrual basis
40,000
Actual warranty expenditures
60,000
Taxable income
Tax Rate
40%
Tax liability
Return
$900,000
40%
53
Compute taxable income for Hurd, Inc.
Hurd, Inc. reported for year:
Info.
Return
Book income before taxes
$900,000 $900,000
Records show:
Interest on municipal bonds
70,000 ($70,000)
Depreciation on tax return in
excess of deprec. per books 130,000 ($130,000)
Warranty exp.- accrual basis
40,000
40,000
Actual warranty expenditures
60,000 ($60,000)
Taxable income
680,000
Tax Rate
40%
40%
Tax liability
$272,000
54
Formula For Corporate Tax Liability.
Each year a corporation computes its
regular tax liability.
A corporation may owe the alternative
minimum tax, AMT, and possibly the
accumulated earnings tax or personal
holding company tax, PHC.
The total tax liability equals the sum of the
two primary corporate tax liabilities plus
the amount of any special levies that are
owed.
55
Corporate Taxable Income
• In defining gross income,
Section 61 does not explicitly distinguish
between individuals
and corporations.
• What “individual types” of income are
rarely if ever realized by a corporation?
(e.g. alimony, etc.)
• What “individual types” of exclusions from
income are rarely if ever realized by a
corporation? (gift)
56
Similarities with Individuals. Page 8
Gross Income of a corporation and individual
are very similar
Includes compensation for services,
income from trade or business, gains from
property, interest, dividends, etc.
Corp taxpayers have fewer exclusions.
Nontaxable exchange treatment is similar
Depreciation recapture applies to both but
corp may have recapture under §291.
57
Dissimilarities with Individuals
–Different tax rates apply
–All deductions of corp are business
deductions
• Corp does not calculate AGI
• Corp does not deduct standard
deduction, itemized deductions, or
personal and dependency exemptions
• Corp does not reduce casualty and theft
loss by $100 statutory floor and 10% of
AGI.
4. Capital gains (losses)
&
depreciation recapture.
[Page 11]
Sec. 11, 1201, 1211, 1212
1231, 1245, 1250
Indiv. Capital Gains & Losses
Net short-term gainsregular tax rates.
Net long-term gains- Max.
tax rate of 15%. (20%-2013+)
Net capital losses
deductible up to $3,000
& remainder carried forward.
Corp. Capital Gains & Losses
Capital gains taxed
as ordinary income.
Capital losses can only
offset capital gains.
Net loss carried back 3 years
as short-term capital loss and
forward up to 5 years.
Losses not used in
carryover periods are lost.
61
Corporation had taxable income
from business operations: $36,000
Corporation also had:
Short term capital gain $8,600
Short term capital loss ($9,600)
Long term capital gain $1,500
Long term capital loss ($3,500)
What is taxable income?
a. $35,000 b. $33,000 c. $36,000
d. $35,500
CPA - Nov. 1995
62
Corporation had taxable income
from business operations: $36,000
Corporation also had:
Short term capital gain $8,600
Short term capital loss ($9,600)
Long term capital gain $1,500
Long term capital loss ($3,500)
What is taxable income?
a. $35,000 b. $33,000 c. $36,000
d. $35,500
CPA - Nov. 1995
63
Big Corp's taxable income before
capital gains & losses
$100,000
Big had the following:
Long-term capital gain
$3,000
Short-term capital loss
($9,000)
Taxable income?
$100,000
Carryover of Corp. Capital Losses
Corp. had these capital gains & (losses):
2009
2010
2011
2012
2013
$30,000 ($20,000) $15,000 ($30,000) $60,000
($20,000) $20,000
$10,000
($10,000)
($15,000) $25,000
($5,000)
$5,000 ($5,000)
$0
Net capital gain for 2013 is:
$55,000
Asset - Section 1245
Machine
Owner
Individual
Selling Price
$290,000
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
Gain
Section 1245 Gain
Section 1231 gain (CG?)
Asset - Section 1245
Machine
Owner
Individual
Selling Price
$290,000
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
240,000
Gain
50,000
Section 1245 Gain
50,000
Section 1231 gain (CG?)
Asset - Section 1245
Machine
Owner
Individual
Selling Price
$320,000
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
Gain
Section 1245 Gain
Section 1231 gain (CG?)
Asset - Sec. 1245
Machine
Owner
Individual
Selling Price
$320,000
Cost
300,000
Accum. Deprec. (S/L) (60,000)
Additional Dep. DDB
Adjusted Basis
240,000
Gain
80,000
Section 1245 Gain
60,000
Section 1231 gain (CG?)
20,000
Asset - Section 1250
Apartment
Owner
Individual
Selling Price
$ 250,000
Cost
300,000
Accum. Deprec. (S/L) (80,000)
Additional Dep. DDB
0
Adjusted Basis
220,000
Gain
30,000
Section 1245 Gain
Section 1250 gain
Section 1231 gain (CG?)
30,000
Unrecaptured 1250 gain
How is answer different for a corporation?
Asset - Section 1250
Apartment
Owner
Individual
Selling Price
$ 250,000
Cost
300,000
Accum. Deprec. (S/L) (80,000)
Additional Dep. DDB (40,000)
Adjusted Basis
180,000
Gain
70,000
Section 1245 Gain
Section 1250 gain
40,000
Section 1231 gain (CG?)
30,000
Corp. Income Tax
Gross receipts of
$450,000
Cost of goods sold of
145,000
Deductible bus. expenses 276,000
Gain on sale of machine
20,000
Interest on Virginia bonds
500
What is its tax liability?
a. $4,900 b. $7,350
c. $10,000 d. None of these
72
Corporate Income Tax - Problem
A corporation has
Gross receipts
Cost of goods sold
Facts
$450,000
$145,000
Return
$450,000
$145,000
Deductible bus. exp. $276,000
Gain-sale of machine $20,000
Interest- VA bonds
$500
Taxable Income
Fed. income tax liability at 15%
73
Corporate Income Tax - Solution
A corporation has
Gross receipts
Cost of goods sold
Facts
$450,000
$145,000
Deductible bus. exp. $276,000
Gain-sale of machine $20,000
Interest- VA bonds
$500
Taxable Income
Fed. income tax liability at 15%
Return
$450,000
$145,000
$305,000
($276,000)
$20,000
$49,000
$7,350
74
Computing a Corporation's Taxable Income.
If Sec. 1250 property is sold at a gain, the
gain will be reported as ordinary income to
the extent that accelerated depreciation
exceeds straight-line depreciation. This is
known as "Sec. 1250 depreciation recapture."
(The recognition of Sec. 1250 gain has been almost
eliminated since the MACRS rules were introduced in 1987
that restricted depreciation on realty to the straight-line
method.)
Corp. must recapture as ordinary income an
additional amount equal to 20% of the
additional ordinary income that would have
been recognized on a sale, exchange, or other
disposition of the property if it had been Sec.
1245 property rather than Sec. 1250 property.
6. Charitable
contributions.
[Page 14]
Sec. 170
76
Gross income
Less:
Deductions:
Except: charity, Div. Rec.,
NOL & C-Loss Carryback
Equals Taxable Income- For Charity Limit [170(b)(2)]
Less: Charitable Cont. < = 10% of Tax.Inc. Above
Equals Taxable Income- Before Div. Rec'd Ded.
Less: Dividend Received Deduction [243+]
Equals Taxable Income- Before carrybacks
Less: NOL & Cap. Loss carrybacks [172(b), 1212(a)]
Equals Taxable
Income
Big Corporation, First Year
Sales
$2,000,000
GAAP Expenses
(1,200,000)
GAAP Net Income Before Taxes
800,000
Contributions made this year
(90,000)
Contributions deductible - Year 1
Taxable Income
Big Corporation, First Year
Sales
$2,000,000
GAAP Expenses
(1,200,000)
GAAP Net Income Before Taxes
800,000
Contributions made this year
(90,000)
Contributions deductible - Year 1
(80,000)
Taxable Income
$720,000
Charitable Contributions - 1
• Overall limit 10% of taxable income before
–Charitable contribution deduction
–Dividend received deduction
–NOL or capital loss carryback. §170(b)(2), (c)
• Excess carried forward up to 5 years.
§170(d)(2)
• Accrual basis corporation can deduct
contributions in year accrued if
–Payment authorized by board before year
end
–Payment made by 15th day of 3rd month aftter
close of tax year in which accrued. §170(a)(2)
Charity Deductions-2
Amount deductible for property
contributions depends on type of
property contributed §1.170A-1(c)
Long-term capital gain property
deduction = FMV of property
–Exception: Corporation may only
deduct basis if tangible personal
property contributed and not used by
charity in its exempt function.
Charity Deductions-3
Long-term capital gain property
deduction = fair market value of
property (cont’d)
–Exception: Deduction for
property contribution to certain
private nonoperating foundations
is limited to basis in property
82
Charity Deductions-4
Ordinary income property
deduction = basis in property.
§170(e)
–Exception: Basis plus 50% of
appreciation can be deducted if
inventory or scientific property
is contributed which is used by
charity as required by Code
Charity –Code -5
170(b)(2) Corporations. In the case of a
corporation, the total deductions under
subsection (a) for any taxable year shall not
exceed 10 percent of the taxpayer's taxable
income computed without regard to
(A) this section,
(B) part VIII (except section 248),
(C) any net operating loss carryback to the
taxable year under section 172, and
(D) any capital loss carryback to the taxable year
under section 1212(a)(1).
84
Cable-Charity Deductions-6
In 2013, Cable Corp., contributed $80,000 to
charities. Cable also had carryover
contributions of $10,000 from 2012.
Cable's 2013 taxable income (after a $40,000
DRD [(Div. Rec. Deduction)- owned 25% of
stock] but before Charity deduction was
$820,000.
Cable’s 2013 charity deduction is?
a. $80,000 b. $82,000
c. $86,000 d. $90,000
CPANov1995
85
Cable-Charity Deductions-7
In 2013, Cable Corp., contributed $80,000 to
charities. Cable also had carryover
contributions of $10,000 from 2012. Cable's
2013 taxable income (after a $40,000 DRD)
before charity deductions was $820,000.
Cable’s 2013 charity deduction is?
$86,000 (Charity limit is computed before
DRD)
86
Cable - Charitable Contribution Deduction-8
1
2
Operating Income
Dividend Income (40% owned)
810,000
50,000
3
4
Subtotal
Dividends Received Deduction
860,000
5
Taxable income after div. received deduct.
but before charitable contribution deduct.
Contributions made this year
Carryover from last year
6
7
8 Total contribution including carryover
9 Cont. deductible - current yr(10% of line 3)
10 Taxable Income
87
86,000
Cable- Charitable Contribution Deduction-9
1
Operating Income
810,000
2
Dividend Income (40% owned)
3
Subtotal
860,000
4
Dividends Received Deduction
(40,000)
50,000
Taxable income after div. received deduct.
5
but before charitable contribution deduct.
820,000
6
Contributions made this year
80,000
7
Carryover from last year
10,000
8
Total contribution including carryover
90,000
9
Cont. deductible - current yr(10% of line 3)
86,000
10 Taxable Income
88
$ 734,000
Big Corp. taxable income
2012 is first year for Big Corp.
Sales
Cost of sales
Gross Margin
Net capital gains
Net cap. losses (over cap. gains)
Capital loss brought forward
Salaries
Rent paid, payroll taxes, deprec.
Taxable income before charity
Charitable contributions paid
Charitable contributions deducted
Charitable cont. carryover
Taxable income
Dividends paid
2012
Facts
$200,000
(100,000)
100,000
0
(3,000)
(30,000)
(31,000)
(6,000)
$5,000
Big Corp. taxable income
2012 is first year for Big Corp.
Sales
Cost of sales
Gross Margin
Net capital gains
Net cap. losses (over cap. gains)
Capital loss brought forward
Salaries
Rent paid, payroll taxes, deprec.
Taxable income before charity
Charitable contributions paid
Charitable contributions deducted
Charitable cont. carryover
Taxable income
Dividends paid
2012
Facts
$200,000
(100,000)
100,000
0
(3,000)
(30,000)
(31,000)
39,000
(6,000)
(3,900)
(2,100)
$35,100
$5,000
Big Corp. taxable income
2012 is first year of operations
Sales
Cost of sales
Gross Margin
Net capital gains
Net cap. losses (over cap. gains)
Capital loss carryover
Salaries
Rent paid, payroll taxes, deprec.
Taxable income before charity
Charitable contributions paid
Charitable cont. carryover
Charitable contributions deducted
Taxable income
Dividends paid
2012
Facts
$200,000
(100,000)
100,000
2013
Facts
$300,000
(150,000)
150,000
5,000
(3,000)
(30,000)
(31,000)
39,000
(6,000)
(2,100)
(3,900)
$35,100
$5,000
(3,000)
(30,000)
(31,000)
91,000
(5,000)
(2,100)
(7,100)
$83,900
$15,000
Maple Corp. had the following for 2012:
$340,000
Gross Sales
$150,000
Cost of Goods Sold
60,000
Depreciation - Books
10,000
Charitable Contribution
130,000
Salaries
20,000
Meals & entertainment
370,000
Total Expenses
($30,000)
Net income (loss) per books
Maple’s tax deprec. for 2012 will be $75,000.
Taxable income for 2012?
a. $(5,000) b. $(35,000) c. $(25,000) d. $(20,000)
92
Maple Corp. - 2012
Facts
Gross Sales
Cost of Goods Sold
Depreciation - Books
Depreciation - Tax
Charitable Contribution
Salaries
Meals & entertainment
Total Expenses
Net income (loss)-books
Taxable income?
$340,000
150,000
60,000
Return
10,000
130,000
20,000
370,000
($30,000)
93
Maple Corp. - 2012
Gross Sales
Cost of Goods Sold
Depreciation - Books
Depreciation - Tax
Charitable Contribution
Salaries
Meals & entertainment
Total Expenses
Net income (loss)-books
Taxable income?
Facts
Return
$340,000 $340,000
150,000 150,000
60,000
75,000
10,000
130,000 130,000
20,000
10,000
370,000 365,000
($30,000)
($25,000)
94
7. Net operating
losses.
[Page 17]
Sec. 172
Net Operating Losses (NOLs). An NOL is the
amount by which a corporation's deductions
exceed its gross income. In computing an NOL, no
deduction is allowed for a carryover or carryback
of an NOL from a preceding or succeeding year. If
the corporation has an NOL, it also would not be
allowed a U.S. production activities deduction
because it has no positive taxable income. For tax
years beginning after August 5, 1997, an NOL may
be carried back two years and forward 20 years.
Alternatively, the corporation may elect to forgo
the carryback period.
96
Net operating loss of individual and
corporation may be:
–Carried back two years
–Unused portion carried
forward 20 years
§172
97
Owner of C Corp. has asked for advice.
Corporation was started in 2012.
Actual Actual Actual Plan
Amounts ($000)
Revenue
Expenses
Taxable income (loss)
1.
2.
3.
4.
2012
$100
2013
2014
2015
$200
$200
$300
(98)
(173)
(225)
(225)
$2
$27
($25)
$75
Can the corp. benefit from the loss in 2014?
Is there a choice regarding the 2014 loss?
Compute the savings under two options.
How do you apply present value methods here?
9. Dividends
received
deduction.
[Page 17]
SPECIAL DEDUCTIONS- CORPS
241 Allowance of special deductions
243 Dividends received by corps
244 Dividends received - pref. stock
245 Dividends received - foreign corps
246 Rules -dividends received deduct.
246A DRD - certain debt financed stock
247 Dividends paid – public utilities
248 Organizational expenditures
249 Limit- bond prem. on repurchase
Dividend Received Deduction
To relieve burden of multiple taxation
DRD based on % ownership in paying corp
100% DRD for 80% or more owned affiliate
80% DRD for ownership of 20% up to 80%
70% DRD for ownership less than 20%
DRD limited to percentage times
lesser of taxable income or dividend income
Unless deducting DRD % x dividend
income creates or increases NOL
101
Grant, Inc. acquired 30% of South Co.’s voting stock
for $200,000 on January 1, 2014. Grant’s 30%
interest in South gave Grant the ability to exercise
significant influence over South’s operating and
financial policies.
In 2014, South earned $80,000 and paid dividends
of $50,000.
What amount of income should Grant include in its
2014 Federal income tax return as a result of the
investment?
a. $15,000 b. $24,000 c. $35,000
d. $50,000 e. $80,000 CPA Nov. 1995.
102
Dividend Received-Green Corp -1
Green Corp. owns 25% of Cande Corp. In
2014, Green received $10,000 dividends
from the Cande stock.
Assuming no other limitations apply,
Green’s
dividends-received deduction is:
a. $7,000. b. $8,000.
c. $2,000. d. $ - 0 -.
103
Div. Received- Green Corp– 2
Green Corp. owns 25% of Cande Corp.
In 2014, Green received $10,000 dividends
from the Cande stock.
Assuming no other limitations apply, Green’s
dividends-received deduction is:
a. $7,000. b. $8,000.
c. $2,000. d. $ - 0 -.
104
Local Corp - 1. had the following:
Revenue - operations
Operating expenses
$500,000
(490,000)
Operating income (loss)
Dividends from IBM
10,000
50,000
Net income before DRD
Dividend rec. deduction
60,000
Dividends Received Deduction
Limit 1:
Dividends Received
$ 50,000
DRD Percentage
70%
Deduction limit - 1
35,000
Limit 2:
Taxable income (Adj) $ 60,000
DRD Percentage
70%
Deduction limit - 2
42,000
Div. Rec. Deduction
35,000
Local Corp - 2. had the following:
Revenue - operations
Operating expenses
$ 500,000
(510,000)
Operating income (loss)
Dividends from IBM
(10,000)
50,000
Net income before DRD
Dividend rec. deduction
40,000
Dividends Received Deduction
Limit 1:
Dividends Received
$ 50,000
DRD Percentage
Deduction limit - 1
Limit 2:
Taxable income (Adj) $ 40,000
DRD Percentage
Deduction limit - 2
Div. Rec. Deduction
Dividends Received Deduction
Limit 1:
Dividends Received
$ 50,000
DRD Percentage
70%
Deduction limit - 1
35,000
Limit 2:
Taxable income (Adj) $ 40,000
DRD Percentage
70%
Deduction limit - 2
28,000
Div. Rec. Deduction
28,000
Local Corp - 3. had the following:
Revenue - operations
Operating expenses
$ 500,000
(520,000)
Operating income (loss)
Dividends from IBM
(20,000)
50,000
Net income before DRD
Dividend rec. deduction
30,000
Dividends Received Deduction
Limit 1:
Dividends Received
$ 50,000
DRD Percentage
70%
Deduction limit - 1
35,000
Limit 2:
Taxable income (Adj) $ 30,000
DRD Percentage
70%
Deduction limit - 2
21,000
Div. Rec. Deduction
35,000
Dividends Received Ded-Code
246(b)(1) General Rule. --…
deductions allowed by sec. 243(a)(1), 244(a),
and subsection (a) or (b) of sec. 245 shall not
exceed the percentage determined under
paragraph (3) of the taxable income
computed
without regard to the deductions allowed by
sec. 172, 243(a)(1), 244(a), subsection (a) or
(b) of sec. 245, and 247, without regard to
any adjustment under sec, 1059, and
without regard to any capital loss carryback
to the taxable year under section 1212(a)(1).
112
Div. Received Ded-Code
246(b)(1) General Rule. …
(2) Effect of Net Operating Loss. -Paragraph (1) shall not apply for
any taxable year for which there
is a net operating loss
(as determined under §172).
113
Page Corp. Div. Received Ded.
Page owns 15% of company
Gross Profit
$200,000
Expenses
($300,000)
Operating loss
($100,000)
Dividends Received
$180,000
Tax. Inc. before DRD
DRD
Net operating loss
Page Corp. Div. Received Ded.
Page owns 15% of company
Gross Profit
$200,000
Expenses
($300,000)
Operating loss
($100,000)
Dividends Received $180,000
Tax. Inc. before DRD $80,000
DRD
($126,000)
Net operating loss
($46,000)
Spring Corporation
Spring Corp. has income from business
of $500,000 & expenses of $750,000.
Spring also received dividends from the
Acme Corp. of $100,000.
Spring owns 25% Acme.
What is Spring’s NOL for the year?
a. ($150,000) b. ($0).
c. ($220,000) d. ($230,000).
116
Spring Corp. Div. Received Ded.
Spring owns 25% of company
Gross Profit
$500,000
Expenses
(750,000)
Operating loss
(250,000)
Dividends Received
100,000
Tax. Inc. before DRD
DRD
Net operating loss
Spring Corp. Div. Received Ded.
Spring owns 25% of company
Gross Profit
$500,000
Expenses
(750,000)
Operating loss
(250,000)
Dividends Received
100,000
Tax. Inc. before DRD (150,000)
DRD
(80,000)
Net operating loss
(230,000)
Spring Corporation
Spring Corp. has income from business
of $500,000 & expenses of $750,000 for
the year.
Spring also received dividends from the
Acme Corp. of $100,000.
Spring owns 25% Acme.
What is Spring’s NOL for the year?
($230,000)
119
Pack Corporation
This year, Pack Corp. had gross income from
operations of $350,000 and operating
expenses of $400,000.
Pack received dividends of $100,000 from
Smith Inc., of which Pack is a 20% owner.
The NOL carryover from last year is $20,000.
What is Pack's NOL for this year?
a. $50,000 b. $30,000
c. $20,000 d. $10,000
120
Pack Corporation
This year, Pack Corp. had gross income
from operations of $350,000 and
operating expenses of $400,000. Pack
received dividends of $100,000 from
Smith Inc., of which Pack is a 20% owner.
The NOL carryover from last year is
$20,000.
What is Pack's NOL for current year?
$30,000
121
Pack Corp. Net Operating Loss
Gross Profit
$350,000
Expenses
(400,000)
Operating loss
(50,000)
Dividends Received
100,000
Tax. Inc. before DRD
50,000
DRD (80% )
(80,000)
Net operating loss
($30,000)
122
10. Organization &
start-up expenses.
[Page 20]
Sec. 248, 195.
Organizational Expenditures.
Organizational expenses must be
capitalized unless an election is made
under Sec. 248 to amortize them. If the
election is made a corp. can deduct the
first $5,000 of organizational expense.
A corporation must reduce the $5,000
by the amount by which cumulative
organizational expenditures exceed
$50,000, although the $5,000 cannot be
reduced below zero.
Organizational Expenditures.
Remaining organizational expenditures can
be amortized over a 180-month period
beginning in the month it begins business.
The election must be made in a statement
attached to the tax return for the year in
which the corporation began to conduct
business.
If the election is not made, the organizational
expenses cannot be deducted until the
corporation is liquidated.
125
Organ. Expenses-1
Costs of issuing or selling
stock and transferring assets
to the corporation reduce the
amount of capital raised and
are not deductible
126
Organ. Expenses-2
Which of the following costs are
amortizable organizational expenditures?
a. Professional fees to issue the corporate
stock.
b. Printing costs to issue the corporate stock.
c. Legal fees for drafting the corporate
charter.
d. Commissions paid by the corporation to
an underwriter.
CPA Nov. 1994
127
On 1-1-2013, ABC Corp.
was organized. On that
date, Bell paid $23,000 to
its attorney for organizing
the corporation. What
is deducted for 2013?
a $6,000 b. $5,120
c. $6,200 d. $23,000
128
ABC Corporation - Continued
Organization costs
Threshold
Excess
First-Year write-off Amt $5,000
Less: excess above
Write-off
Amount to be amortized
Amort. period- Months
Amortization per month
Number of months
Amortization for year
Deduction & amort.
$23,000
50,000
0
ABC Corporation - Continued
Organization costs
Threshold
Excess
First-Year write-off Amt $5,000
Less: excess above
0
Write-off ($5,000 or less)
Remainder to be amortized
Amort. period- Months
Amortization per month
Number of months
Amortization for year
Deduction & amort.
$23,000
50,000
0
5,000
18,000
180
100
12
$1,200
5,000
$1,200
$6,200
On Jan. 1, 2014, Bell Corp.
was organized. On that
date, Bell paid $90,000 to
its attorney for organizing
the corporation. What
is deducted for 2014?
a $6,000
b. $5,120
c. $5,000
d. $6,800
131
Start-up expenditures are ordinary and
necessary business expenses that are paid or
incurred to investigate the creation or
acquisition of an active trade or business, to
create an active trade or business, or to
conduct an activity engaged in for profit or
the production of income before the time
the activity becomes an active trade or
business. The expenditures must be such
that they would be deductible if they were
incurred in conduct of a trade or business.
132
Start-Up Expenditures.
Under Sec. 195, a corporation may elect to deduct
the first $5,000 of start-up expenditures. However,
this amount is reduced (but not below zero) by the
amount by which the cumulative start-up costs
exceed $50,000. The remainder of the start-up
costs can be amortized over a 180-month period
beginning in the month it begins business. [For
2010, $5,000 was changed to $10,000 and $50,000
to $60,000.]
What is the difference between an organization
expenditure and a start-up expenditure?
Organization and Startup-New rules
Example: New business incurs $53,000 of
startup costs and $50,000 of organization
costs on January 1, 2012.
Two immediate deductions
-$2,000 for startup costs and
-$5,000 for organization costs
Startup costs of $51,000 amortized over 15
years. $3,400
Organization costs of $45,000 amortized over
15 years. $3,000
Costs of Investigating Potential Business
Already in New Business New Business
that type of is started or is NOTstarted
Business
acquired
or acquired
Yes
No
Deduct
this year
Deduct
Rev. Rul. 99-23
this year
Amortize over
Never
180 Months
Sec. 195
135
Deductible
Pine Corporation
Pine Corp. has opened for business in
2014 and has elected to amortize its
startup expenses.
What is the minimum number of
months over which the start up costs
can be amortized?
a. 60 Months. b. 180 Months.
c. 6 Months. d. 36 Months.
136
12+. Tax liability
Computations. 2-22
Reconcile Book to tax.
[Page 21+]
Tax Planning.
Owner transactions. [Pg.38+]
137
Joe owns 100% of the stock of two
corporations: § 1561(a)
(1) The Furniture Place in Gastonia.
(2) The Appliance Place in Monroe. Each
corporation has taxable income of
$100,000 (total of $200,000). How much
total federal income tax is paid by these
two corporations for the year?
a. $30,000 b. $35,000 c. $61,250
Furniture
$100,000
Appliance
100,000
$200,000
$ 50,000
15%
$7,500
25,000
25%
6,250
25,000
34%
8,500
100,000
39%
39,000
$200,000
$61,250
Transactions with
related parties.
Sec. 267
140
X, a calendar year accrual basis
corp., accrued in 2014 (but did not
pay) a year-end bonus of $10,000 to
President & 100% owner, & $20,000
to the Treasurer who owns no stock.
Both were paid in February, 2010.
How are these bonuses deducted?
2014 2015
2014 2015
$0
a. $30,000
b. $20,000 $10,000
$0 $20,000
c. $10,000 $20,000 d.
See Sec. 267.
The
End
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