Quickfinder ®
Small Business Quickfinder® Handbook
(2012 Tax Year)
Updates for the American Taxpayer Relief Act of 2012
Replacement Pages for Two-Sided (Duplex) Printing
Instructions: This packet contains “marked up” changes to the pages in the Small
Business Quickfinder® Handbook that were affected by the American Taxpayer Relief
Act of 2012, which was enacted after the handbook was published.
This is a specially designed update packet for owners of the 3-ring binder version of the
handbook who have access to a printer that prints two-sided (duplex). Simply print the
entire PDF file (make sure to select two-sided or duplex printing), three-hole punch the
pages and then replace the pages in your handbook. It’s that easy.
TAX PREPARATION
Small
Business
Quickfinder
Handbook
®
2012 Tax Year
Form 1120
Forms 706 and 709
Corporation Tax Rate Schedule
—Quick Tax Method—
Estate and Gift Tax Rate Schedule
—Quick Tax Method—
For tax years beginning after December 31, 1992
TAXABLE INCOME
$
Forms: 1065, 1120,
1120S, 1041, 706,
709 and 990
0 – $
×
%
MINUS
$
$
For gifts made and estates of decedents dying in 2012
=
TAX
50,000
×
15%
minus
0
=
Tax
50,001 –
75,000
×
25%
minus
5,000
=
Tax
75,001 –
100,000
×
34%
minus
11,750
=
Tax
100,001 –
335,000
×
39%
minus
16,750
=
Tax
335,001 – 10,000,000
×
34%
minus
0
=
Tax
10,000,001 – 15,000,000
×
35%
minus
100,000
=
Tax
15,000,001 – 18,333,333
×
38%
minus
550,000
=
Tax
18,333,334 and over
×
35%
minus
0
=
Tax
$
Note: See Basics of Corporations on Page C-1 for exceptions to above tax rates
and an example of how to use the Quick Tax Method.
TAXABLE AMOUNT
×
%
MINUS
$
=
TAX1
0 – $
10,000
×
18%
minus
$
0
=
Tax
10,001 –
20,000
×
20%
minus
200
=
Tax
20,001 –
40,000
×
22%
minus
600
=
Tax
40,001 –
60,000
60,001 –
80,000
×
24%
minus
1,400
=
Tax
×
26%
minus
2,600
=
Tax
80,001 –
100,000
×
28%
minus
4,200
=
Tax
100,001 –
150,000
×
30%
minus
6,200
=
Tax
150,001 –
250,000
×
32%
minus
9,200
=
Tax
250,001 –
500,000
×
34%
minus
14,200
=
Tax
×
35%
minus
19,200
=
Tax
500,001 and over
Form 1041
1
Less applicable credit amount. See the charts at the beginning of Tab H.
2012 Fiduciary Tax Rate Schedule
—Quick Tax Method—
TAXABLE INCOME
$
0 – $ 2,400
×
%
MINUS
$
×
15%
minus
$
=
TAX
0.00
=
Tax
2,401 –
5,600
×
25%
minus
240.00
=
Tax
5,601 –
8,500
×
28%
minus
408.00
=
Tax
8,501 –
11,650
×
33%
minus
833.00
=
Tax
×
35%
minus
1,066.00
=
Tax
11,651 and over
2012 Exclusion Amounts
1
Estate Tax
Exclusion1
Gift Tax
Exclusion1
Annual Gift
Exclusion
$5,120,000
$5,120,000
$13,000
Plus the amount, if any, of deceased spousal unused exclusion amount—see
Tab H.
500,000
Note: The 10% tax bracket that applies to individuals does not apply to estates and trusts.
2012 Business Quick Facts
Filing Information
Tax Return
Return Due
Extensions
15th day of fourth month
following close of tax year.
Form 7004 extends deadline
five months.
Forms 1120/1120S: 15th day of third month
following close of tax year.
Corporation
Form 7004 extends deadline
six months.
15th day of fourth month
Form 1041:
Estates and Trusts following close of tax year.
Form 7004 extends deadline
five months.
Form 1065:
Partnership/LLC
Form 706: Estates
Nine months after date of
decedent’s death.
Form 709: Gift Tax April 15th following close of
tax year of gift.
Form 990: Exempt
Organizations
15th day of fifth month
following close of tax year.
Replacement Page 01/2013
Replacement Page 01/2013
Form 4768 extends deadline
six months.
Section 179 Deduction:
Maximum deduction....................................................................... $
Qualifying property limit..................................................................
SUV deduction limit........................................................................
2,000,000
Depreciation Limits (First Year):
Luxury autos—no bonus................................................................. $
Luxury autos—with bonus..............................................................
Light trucks and vans—no bonus...................................................
Light trucks and vans—with bonus.................................................
Business Standard Mileage Rate
January – December...................................................................... $
Depreciation component.................................................................
139,000
560,000
25,000
3,160
11,160
3,360
11,360
.555
. 23
Form 4868 or 8892 extends
deadline six months.
Form 8868 extends deadline
three months. A second Form
8868 extends three additional
months.
Copyright 2012 Thomson Reuters.
2012 Tax Year | Small
Quickfinder ® Handbook COV-1
AllBusiness
Rights Reserved.
Employer Identification Numbers (EINs)
Copyright 2012 Thomson Reuters.
All Rights Reserved.
ISSN 1945-2748
ISBN 978-0-7646-6232-5
PO Box 966, Fort Worth TX 76101-0966
Phone 800-510-8997
Fax 817-877-3694
Quickfinder.thomson.com
The Small Business Quickfinder® Handbook is published by Thomson Reuters.
Reproduction is prohibited without written permission of the publisher. Not assignable without consent.
The Small Business Quickfinder® Handbook is to be used as a first-source, quick
reference to basic tax principles used in preparing business tax returns. This
handbook’s focus is to present often-needed reference information in a concise,
easy-to-use format. The summaries, highlights, examples, tax tips and other
information included herein are intended to apply to the average small business
taxpayer only. Information included is general in nature and we acknowledge
the existence of many exceptions in the area of business taxes. The information
this handbook contains has been carefully compiled from sources believed to be
reliable, but its accuracy is not guaranteed. The author/publisher is not engaged
in rendering legal, accounting or other advice and will not be held liable for any
actions or suit based on this handbook. For further information regarding a specific
situation, see applicable IRS publications, rulings, regulations, court cases and
Code sections applicable to that situation. This handbook is not intended to be
used as your only reference source.
2012 Employer Retirement Plan Contribution Limits
Profit Sharing
401(k)
Employee Elective Deferral:
< Age 50
N/A
$17,000
≥ Age 50
N/A
$22,500
Employer Contribution:
Per
Lesser of:
Lesser of:
Participant
100% of comp 100% of comp
or $50,000
or $50,000
SIMPLE IRA
SEP
$11,500
$14,000
N/A
N/A
N/A
Total
Deductible
Contribution
25% of total
25% of total Either:
comp2 paid to comp2 paid to 1)100%
all participants all participants
match up
(excluding
to 3% of
employee
comp or
deferrals)
2) 2% of
comp2
1
20% of net SE income for self-employed.
2
Limited to $250,000 per participant.
Lesser of: 25%
of comp or
$50,000
1
25% of total
comp2 paid to all
participants
Payroll Deposit Deadlines (Form 941)
Type of
Depositor
Deposit
Due Dates
Reason
Classified
Monthly
Semiweekly
15th day of following
month
Payday on:
Due on:
Wednesday,
Following
Thursday, Friday
Wednesday
Payday on:
Due on:
Saturday, Sunday, Following Friday
Monday, Tuesday
Total federal payroll taxes were more
than $50,000 in the lookback period.
1) Total federal payroll
taxes were $50,000
or less in the
lookback period or
2) New employer.
Responsible Parties
All EIN applications (online, telephone, fax or mail) must disclose the name and
taxpayer identification number (TIN) (that is, an SSN, EIN or ITIN) of the true
principal officer, general partner, grantor, owner or trustor (responsible party).
This is the individual or entity that controls, manages or directs the applicant
entity and the disposition of its funds and assets. A nominee (someone given
limited authority to act on behalf of an entity, usually for a limited period of time
such as during formation) is not a responsible party, is not authorized by the IRS
to obtain EINs and should not be listed on the Form SS-4.
Online
To receive an EIN for immediate use, go to the IRS website at www.irs.gov and
click on “Apply for an EIN Online” under “Tools” in the center of the screen. The
online application process is available for all entities whose principal business,
office or agency, or legal residence in the case of an individual, is located in
the U.S. or its territories. Third party designees filing online applications must
retain a complete signed copy of the paper Form SS-4 and signed authorization
statement for each application filed.
Telephone
Call the IRS at 800-829-4933. (International applicants must call 267-941-1099.)
The hours of operation are 7:00 a.m. to 7:00 p.m. M-F for the 800 number.
Complete Form SS-4 before contacting the IRS. An IRS representative will use
the information from the Form SS-4 to establish the account and assign an EIN.
Fax
An EIN can be received by fax within four business days. Complete and fax
Form SS-4 to the IRS using the Fax-TIN number listed in the “Where to File Tax
Returns—Addresses Listed by Return Type” section of the IRS website.
Mail
Complete Form SS-4 and mail to the IRS using the addresses listed in the
“Where to File Tax Returns—Addresses Listed by Return Type” section of the
IRS website. Allow four weeks to receive the EIN from the IRS by mail.
Form 1041
2011 Fiduciary Tax Rate Schedule
—Quick Tax Method—
TAXABLE INCOME
×
%
MINUS
For tax years beginning in 2011
$
0 – $ 2,300
×
15%
minus
2,301 –
5,450
×
25%
minus
5,451 –
8,300
×
28%
minus
8,301 – 11,350
×
33%
minus
11,351 and over
×
35%
minus
$
$
= TAX
0.00
230.00
393.50
808.50
1,035.50
IRS Frequently Used Phone Numbers
Business and Specialty Tax Line
E-Help Desk
EFTPS Hotline
Electronic Funds Withdrawal (Direct Debit) Payments
Forms and Publications
Practitioner Priority Service
Refund Hotline
Report Tax Schemes
Tax-Exempt Organizations
Taxpayer Advocate
TeleTax Topic
If you have any questions
=
=
=
=
=
Tax
Tax
Tax
Tax
Tax
800-829-4933
866-255-0654
800-555-4477
888-353-4537
800-829-3676
866-860-4259
800-829-1954
866-775-7474
877-829-5500
877-777-4778
800-829-4477
Exceptions:
We welcome comments and questions from readers. However,
• Employer accumulates less than $2,500 in taxes during the current or preceding
our response is limited to verification of specific information prequarter: Deposit as above or send payment with quarterly tax return.
sented in the Quickfinder® Handbooks. We cannot give advice on
• Employer accumulates $100,000 or more in taxes during deposit period:
a client’s tax situation or provide information beyond the contents
Deposit due on next day (that is not a Saturday, Sunday or legal holiday) after
of this publication. Questions must be submitted in writing by mail,
the day on which the $100,000 threshold is reached.
fax or online at Quickfinder.thomson.com (Content Questions
• Employers notified by the IRS to file Form 944 that accumulate less than $2,500 in
taxes during the fourth quarter: Pay fourth quarter tax liability with Form 944.
on the Contact Us page). Research editors are not available to
• See IRS Pub. 15 for exceptions to the deposit penalties under Depositing
answer questions over the phone.
Taxes.
Copyright 2012 Thomson Reuters. All Rights Reserved. The Quickfinder logo and Quickfinder ® Handbooks are trademarks of Thomson Reuters.
COV-2 2012 Tax Year | Small Business Quickfinder ® Handbook
Reference Materials and Worksheets

Tab A Topics
Where to File: Business Returns Filing
Addresses—2012 Returns....................................Page A-1
Principal Business Activity Codes—Forms
1065, 1120 and 1120S...........................................Page A-1
Business Quick Facts Data Sheet...........................Page A-1
Guide to Information Returns...................................Page A-2
Types of Payments—Where to Report....................Page A-4
S Corporation Shareholder’s Adjusted
Basis Worksheet....................................................Page A-5
Partner’s Adjusted Basis Worksheet........................Page A-6
Tax Info for Partnership, Corporation, LLC
and LLP Returns....................................................Page A-7
Transferor’s Section 351 Statement........................Page A-9
Tax Info Sheet for Gift Tax Returns........................Page A-10
Estate Inventory Worksheet................................... Page A-11
Reconciliation of Income Reported on
Final Form 1040 and Estate’s Fiduciary
Return (or Beneficiary’s Return)..........................Page A-12
Depreciation Schedule...........................................Page A-13
Allocation of Indirect Costs to Ending Inventory
Under Section 263A............................................Page A-14
Business Valuation Worksheet..............................Page A-15
Foreign Asset Reporting—Forms 8938 and
TD F 90-22.1.......................................................Page A-16
Types of Foreign Assets and Whether They
are Reportable.....................................................Page A-16
Where to File: Business Returns Filing Addresses—2012 Returns
Note: At the time of publication, the IRS had not released the 2012 filing addresses for business returns. This information will be posted to the Updates section of Quickfinder.
com when available. See Where to File 2012 Form 1040 in Tab 3 of the 1040 Quickfinder® Handbook for filing addresses for individuals.
Principal Business Activity Codes—Forms 1065, 1120 and 1120S
Note: At the time of publication, the IRS had not released the 2012 principal business activity codes for business returns. This information will be posted to the Updates
section of Quickfinder.com when available.
Business Quick Facts Data Sheet1
2013
Maximum earnings subject to tax:
Social Security tax
Medicare tax
Maximum tax paid by:
Employee—Social Security
SE—Social Security
Employee or SE—Medicare
2012
2011
$ 113,700
No Limit
$ 110,100
No Limit
$ 106,800
No Limit
$ 106,800
No Limit
$ 106,800
No Limit
$ 7,049.40
14,098.80
No Limit
$ 4,624.20
11,450.40
No Limit
$ 4,485.60
11,107.20
No Limit
$ 6,621.60
13,243.20
No Limit
$ 6,621.60
13,243.20
No Limit
$ 500,000
25,000
2,000,000
$ 500,000
25,000
2,000,000
11,160
3,160
11,360
3,360
$ 500,000
25,000
2,000,000
11,060
3,060
11,260
3,260
$ 500,000
25,000
2,000,000
11,060
3,060
11,160
3,160
$ 250,000
25,000
800,000
10,960
2,960
11,060
3,060
$ 11,500
14,000
$ 11,500
14,000
$ 11,500
14,000
$ 11,500
14,000
17,000
22,500
50,000
250,000
200,000
165,000
115,000
16,500
22,000
49,000
245,000
195,000
160,000
110,000
16,500
22,000
49,000
245,000
195,000
160,000
110,000
16,500
22,000
49,000
245,000
195,000
160,000
110,000
FICA/SE Taxes
Business Deductions
Section 179 deduction—limit
Section 179 deduction—SUV limit (per vehicle)
Section 179 deduction—qualifying property phase-out threshold
Depreciation limit—autos (1st year with special depreciation)
Depreciation limit—autos (1st year with no special depreciation)
Depreciation limit—trucks and vans (1st year with special depreciation)
Depreciation limit—trucks and vans (1st year with no special depreciation)
2
2
2
2
Retirement Plans
SIMPLE IRA plan elective deferral limits:
Under age 50 at year end
Age 50 or older at year end
401(k), 403(b), 457 and SARSEP elective deferral limits:
Under age 50 at year end
Age 50 or older at year end
Profit-sharing plan/SEP contribution limits
Compensation limit (for employer contributions to profit-sharing plans)
Defined benefit plans—annual benefit limit
Key employee compensation threshold
Highly compensated threshold
$ 12,000
14,500
17,500
23,000
51,000
255,000
205,000
165,000
115,000
Estate and Gift Taxes
2010
2009
Estate tax exclusion
$ 5,250,0003
$ 5,120,0003
$ 5,000,0003
$ 5,000,0004 $ 3,500,000
3
3
3
1,000,000
1,000,000
Gift tax exclusion
5,250,000
5,120,000
5,000,000
5,120,000
5,000,000
5,000,000
3,500,000
GST tax exemption
5,250,000
14,000
13,000
13,000
13,000
13,000
Gift tax annual exclusion
1
See Tab 3 in the 1040 Quickfinder® Handbook for an expanded Quick Facts Data Sheet.
2
2013 amount not yet released by IRS. These have been left blank and can be filled in later.
3
Plus the amount, if any, of deceased spousal unused exclusion amount—see Tab H.
4
For decedents who died in 2010, executors could elect for the estate not to be subject to estate tax and have the modified carryover basis rules apply to estate assets.
Replacement Page 01/2013
2012 Tax Year | Small Business Quickfinder ® Handbook A-1
The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.
Guide to Information Returns
If any date shown falls on a Saturday, Sunday or legal holiday, the due date is the next business day.
Source: 2012 General Instructions for Forms 1097, 1098, 1099, 3921, 3922, 5498, and W-2G.
(Page 1 of 2)
Guide to Information Returns (If any date shown falls on a Saturday, Sunday, or legal holiday, the due date is the next business day.)
Due Date
Form
1042-S
Title
What To Report
Foreign Person’s U.S. Income such as interest, dividends, royalties, pensions and annuities, etc.,
Source Income
and amounts withheld under Chapter 3. Also, distributions of effectively
Subject to Withholding connected income by publicly traded partnerships or nominees.
1097-BTC
Bond Tax Credit
Tax credit bond credits to shareholders.
1098
Mortgage Interest
Statement
Mortgage interest (including points) and certain mortgage insurance
premiums you received in the course of your trade or business from
individuals and reimbursements of overpaid interest.
1098-C
Contributions of Motor Information regarding a donated motor vehicle, boat, or airplane.
Vehicles, Boats, and
Airplanes
1098-E
Student Loan Interest Student loan interest received in the course of your trade or business.
Statement
1098-T
Tuition Statement
Qualified tuition and related expenses, reimbursements or refunds, and
scholarships or grants (optional).
1099-A
Acquisition or
Abandonment of
Secured Property
Information about the acquisition or abandonment of property that is security
for a debt for which you are the lender.
1099-B
Proceeds From
Broker and Barter
Exchange
Transactions
Sales or redemptions of securities, futures transactions, commodities, and
barter exchange transactions.
Cancellation of Debt
Cancellation of a debt owed to a financial institution, the Federal
Government, a credit union, RTC, FDIC, NCUA, a military department, the
U.S. Postal Service, the Postal Rate Commission, or any organization having
a significant trade or business of lending money.
1099-C
1099-CAP
Changes in Corporate Information about cash, stock, or other property from an acquisition of control
Control and Capital
or the substantial change in capital structure of a corporation.
Structure
1099-DIV
Dividends and
Distributions
Distributions, such as dividends, capital gain distributions, or nontaxable
distributions, that were paid on stock and liquidation distributions.
1099-G
Certain Government
Payments
Unemployment compensation, state and local income tax refunds,
agricultural payments, and taxable grants.
1099-H
Health Coverage Tax Health insurance premiums paid on behalf of certain individuals.
Credit (HCTC)
Advance Payments
1099-INT
Interest Income
Interest income.
1099-K
Merchant Card and
Third-Party Network
Payments
Merchant card
Long-Term Care and
Accelerated Death
Benefits
Payments under a long-term care insurance contract and accelerated death
benefits paid under a life insurance contract or by a viatical settlement
provider.
*The due date is March 31 if filed electronically.
A-2 To IRS
To Recipient
(unless indicated
otherwise)
See form instructions
March 15
March 15
All amounts
February 28*
On or before the
15th day of the 2nd
calendar month after
the close of the
calendar month in
which the credit is
allowed
$600 or more
February 28*
(To Payer/Borrower)
January 31
Gross proceeds of more
than $500
February 28*
(To Donor)
30 days from date of
sale or contribution
$600 or more
February 28*
January 31
See instructions
February 28*
January 31
All amounts
February 28*
(To Borrower)
January 31
All amounts
February 28*
February 15**
$600 or more
February 28*
January 31
Over $1000
February 28*
(To Shareholders)
January 31
$10 or more, except
$600 or more for
liquidations
February 28*
January 31**
$10 or more for refunds
and unemployment
February 28*
January 31
All amounts
February 28*
January 31
$10 or more ($600 or
more in some cases)
February 28*
January 31**
$20,000 or more and
200 or more
transactions
February 28*
January 31
All amounts
February 28*
January 31
All amounts
Third-party network payments.
1099-LTC
Amounts To Report
**The due date is March 15 for reporting by trustees and middlemen of WHFITs.
2012 Tax Year | Small Business Quickfinder ® Handbook
Court Case #1: Two individuals agreed to pay business expenses out of their
personal funds in exchange for stock in a corporation. Even though the resulting capital contributions were made over a period of time, the court ruled that
the amounts were a direct purchase of the stock, relying in large part on the
original intent of the shareholders. The Tax Court overruled a previous IRS
determination and allowed the taxpayers to treat the entire amount paid as
basis under Section 1244. (Miller, TC Memo 1991-126)
Court Case #2: In another case, the court determined that the amount originally
paid for stock ($7,500) was the only amount allowable under Section 1244.
Subsequent contribution of capital of $189,000 was considered “allocable to
stock which is not Section 1244 stock.” (Bledsoe, TC Memo 1995-521)
 Strategy: Careful planning of stock purchases can preserve the
benefits of Section 1244 for shareholders. Especially if there
is a significant risk of loss on investment in Section
1244 stock, the purchaser should make sure additional shares are issued for each contribution
made to capital. If shares are purchased over
time, as in the case of agreement to pay corporate
expenses in exchange for stock, a written plan should be drafted
and carefully followed.
Partners and S corporation shareholders. If a partnership
acquires Section 1244 stock and later sells at a loss, an ordinary
loss deduction may be claimed only by individuals who were
partners when the stock was issued. However, loss incurred by an
S corporation on the sale of Section 1244 stock cannot be passed
on to the shareholders as an ordinary loss [Reg. §1.1244(a)-1(b)].
They must treat the loss as a capital loss.
Small Business Stock
IRC §1202 and §1045
Options by Holding Period for Small Business Stock
1 Yr or less
Over 6 Months
Over 1 Yr
Over 5 Yrs
Short-term
capital gain
Section 1045
rollover gain
Long-term
capital gain
Section 1202
gain exclusion
Individuals may be able to (1) exclude up to 50% (75% for stock
acquired 2/18/09–9/27/10; 100% for stock acquired 9/28/10–
12/31/11) of gain or (2) defer gain from the sale of qualified small
business stock (QSBS).
12/31/13
Exclusion of gain from the sale of small business stock
(IRC §1202). An individual may exclude 50% (75% for stock
acquired 2/18/09–9/27/10; 100% for stock acquired 9/28/10–
12/31/11) of the gain from sale of qualified small business stock
(QSBS). The stock must have been issued by a C corporation
after August 10, 1993, and held more than five years. The exclusion may not exceed 10 times the taxpayer’s basis or $10 million,
whichever is greater. Gain remaining after the exclusion is taxed at
a maximum rate of 28%, resulting in an effective tax rate of 14%,
for example, for 50% exclusion gain.
with
N Observation: Because of the five-year holding period requirement, 2014 will be the earliest a taxpayer can take advantage of
the 75% gain exclusion (2015 for the 100% exclusion).
 Note: The maximum tax rate for most capital gains is 15%
through 2012. With an effective tax rate of 14% for 50% exclusion
QSBS, the benefit of the exclusion is greatly reduced, and only
favors taxpayers with taxable income above the 15% bracket.
For taxpayers qualifying for the 0% capital gains rate in 2012, the
Section 1202 exclusion may create higher tax liability than if the
exclusion had not been in place. However, should capital gains
rates return to their pre-2003 Tax Act levels as they are scheduled
to do on 1/1/13, the Section 1202 provisions may once again be
beneficial, especially when the 75% exclusion (7% effective tax
on higher-income individuals increasing
Replacement Page 01/2013
rate) or 100% exclusion (no tax) applies. In addition, Section 1045
rollover remains a benefit of meeting the QSBS requirements (see
Rollover of gain from sale of small business stock below).
Alternative minimum tax. The excluded portion of gain on
QSBS is a tax preference item in computing alternative minimum
taxable income (AMTI). Seven percent of the amount of gain
excluded under Section 1202 in 2012 is the preference amount
[IRC §57(a)(7)]. However, for 100% gain exclusion QSBS acquired
9/28/10–12/31/11, none of the excluded gain is added back in
computing AMTI. 12/31/13
 Expired Provision Alert: It’s possible Congress will extend
the 100% gain exclusion for QSBS to 2012, but had not done so
at the time of this publication. Similarly, unless extended, the 7%
AMT preference rules apply to tax years beginning before 1/1/13,
so in tax years beginning after 2012 the percentage of otherwiseexcluded gain that is a tax preference item in computing AMTI will
be 28% (for stock acquired after 2000) or 42% (for stock acquired
before 2001), unless it is 100% gain exclusion QSBS. 12/31/13
Empowerment zone businesses. The exclusion is 60% for
stock acquired after 12/21/00 (75% for stock acquired from
2/18/09–9/27/10; 100% for stock acquired 9/28/10–12/31/11) for
gains attributable to periods before 12/31/16 in corporations that
conduct business within an empowerment zone, as designated
by the Secretaries of Agriculture and HUD [IRC §1202(a)(2)].
The District of Columbia Empowerment Zone is not treated as an
empowerment zone for purposes of the exclusion.
Capital gain from the sale of qualified empowerment zone assets
held for more than one year may be rolled over if new property
in the same zone is purchased within 60 days of the sale. (IRC
§1397B)
through 12/31/18
Rollover of gain from sale of small business stock (IRC §1045).
An election is available for tax-deferred rollover of gain from the
sale of qualified small business stock (QSBS) held more than six
months. The taxpayer must purchase new QSBS within 60 days to
qualify for the election. The entire gain is deferred if the new stock
costs at least as much as the amount realized from the sale of the
old stock. If the new stock costs less than the amount realized, the
difference is taxable up to the amount of gain. Basis of new stock
is reduced by the amount of gain deferred.
Holding period: The new stock must continue to meet the active
business requirement for at least six months after purchase to
qualify for Section 1045 rollover. (See Active business requirement
on Page C-8.) For determining capital gain rates on a subsequent
sale, the holding period of the new stock generally includes the
holding period of the old stock. However, the holding period of the
old stock does not count for meeting the six-month test.
Regulations: For guidance on sales by partnerships (and partner
distributees) of QSBS, see Regulation Section 1.1045-1.
Qualified Small Business Stock (QSBS)
C corporation. The stock must be issued by a C corporation with
total gross assets of $50 million or less at all times after August 9,
1993, and before it issued the stock, and immediately after it
issued the stock.
The corporation cannot be a:
1) Domestic international sales corporation or
former DISC,
2) Regulated investment company (RIC),
3) Real estate investment trust (REIT),
4) Real estate mortgage investment conduit
(REMIC),
5) Cooperative or
6) Corporation electing the Puerto Rico and possessions tax credit
or having a direct or indirect subsidiary so electing.
2012 Tax Year | Small Business Quickfinder ® Handbook C-7
Original issue stock. The stock must be acquired by the taxpayer
at its original issue in exchange for money, property other than
stock or as compensation for services. Note: The stock will not
qualify if the corporation redeemed stock from the taxpayer or a
related person during a four-year period beginning two years before
the issuing date. Further, the stock will not qualify if the corporation
redeemed more than 5% by value of its stock during a two-year
period beginning one year before the issuing date.
Active business requirement. During the taxpayer’s holding period, the corporation must use at least 80% of its assets by value in
the active conduct of one or more qualified trades or businesses.
A qualified trade or business is any business other than
those listed in Section 1202(e)(3). Businesses
that do not qualify include professional service
firms, financial businesses, farms, natural
resource producers, hotels and restaurants.
If the corporation owns more than 50% of
another corporation, a pro rata share of that corporation’s assets
are included in the 80% test (a look-through rule). A corporation
will not meet the active business requirement if more than 10% of
(1) its assets’ total value consists of real estate that is not used in
the active conduct of a qualified trade or business or (2) its assets’
total value (in excess of liabilities) consists of stock or securities
in corporations, other than subsidiaries.
Specialized small business investment companies (SSBICs).
The active business requirement is waived for SSBICs. An SSBIC
is any corporation licensed by the Small Business Administration
under Section 301(d) of the Small Business Investment Act of 1958
as in effect on May 13, 1993.
Distributions
Corporations are separate entities from their owners. Corporate
assets are not personal possessions of the shareholders. When
a corporation distributes funds to a shareholder, the method of
distribution determines the tax consequence.
A corporation generally distributes money and property to
a shareholder under one of the following methods:
1)Wages,
2) Fringe benefits,
3) Dividends and return of capital,
4)Loans,
5) Rent payments or
6)Royalties.
 Caution: Withdrawals from a corporation must be carefully
structured to avoid reclassification by the IRS. For example, if
a shareholder charges a corporation rent in excess of FMV for
use of property, the IRS may classify the distribution as a taxable
dividend. See Constructive Dividends on Page C-11.
Dividends and Return of Capital
Distributions made to shareholders out of the earnings and
profits (E&P) of the corporation are generally considered taxable
dividends. If property is distributed, the shareholder’s taxable
portion is the FMV of the property minus any liabilities assumed by
the shareholder in connection with the distribution [IRC §301(b)].
Distributions that are considered a return of capital are not taxable.
See the discussion of Earnings and Profits (E&P) on Page C-11.
A distribution in excess of E&P is generally nontaxable to the
shareholder. The amount of the distribution must first reduce the
adjusted basis of the stock in the hands of the shareholder. Any
amount in excess of the shareholder’s adjusted basis will be treated
as a gain from the sale or exchange of property. [IRC §301(c)]
C-8 2012 Tax Year | Small Business Quickfinder ® Handbook
Tax Effects of Distributions
A corporation does not recognize gain or loss when cash is
distributed to a shareholder.
When a corporation distributes appreciated property to its shareholders (other than its own stock or securities), the corporation
recognizes gain as if it sold the property at FMV [IRC §311(b)]. For
this purpose, FMV is the greater of the actual FMV or the amount
of liabilities assumed by the shareholder in connection with the
transaction. These rules also apply to distribution of property in
satisfaction of a declared dollar dividend.
A corporation will not recognize a loss on the distribution of property
to a shareholder unless the transaction is part of a complete
liquidation. See Corporate Liquidations on Page N-6.
Distributions of cash or property will reduce a corporation’s E&P
but not its taxable income. E&P is generally reduced by the amount
of the basis of the distributed property [IRC §312(a)]. Exception:
On distributions of appreciated property, E&P increases by the
amount of appreciation and decreases by the amount of FMV. See
Earnings and Profits (E&P) on Page C-11 for more information.
Nondividend Distributions
Form 5452, Corporate Report of Nondividend Distributions, must
be filed when nondividend distributions are made to shareholders.
These include distributions that are fully or partially nontaxable
because the corporation’s E&P is less than the distributions. The
form does not need to be filed for distributions of tax-free stock
dividends or distributions exchanged for stock in liquidations or
redemptions.
A distribution of stock or right to acquire stock in a corporation is not a taxable distribution to the stockholder unless
it is one of the following: [IRC §305(b)]
1) Distribution in lieu of money or other property,
2) Disproportionate distribution,
3) Distribution with respect to preferred stock,
4) Distribution of certain convertible preferred stock (there are
exceptions) or
5) Distribution of common and preferred stock resulting in the
receipt of preferred stock by some common shareholders and
receipt of common stock by other common shareholders.
Even if a distribution of stock or stock right falls into one of the
above five categories, it will not be considered a taxable dividend
unless there is sufficient E&P.
Form 1099-DIV
A corporation must report distributions made to its stockholders on
Form 1099-DIV. Distributions reported on Form 1099-DIV include
taxable dividends, capital gain distributions, nontaxable distributions and distributions in liquidation.
 Note: See Guide to Information Returns on Page A-2.
Wages for Shareholders
Shareholders who perform services for a corporation are treated
as employees, and are paid wages subject to employment tax and
other withholding. Corporate officers are specifically identified as
employees under Sections 3401(c) and 3121(d)(1). Since wages
are deductible by a corporation, the incentive exists to pay the
highest wage possible to C corporation shareholders in order to
avoid the double taxation that occurs with dividend distributions.
 Note: This is in contrast to an S corporation, where the incen-
tive exists for a shareholder to take as low a wage as possible to
avoid employment taxes.
Fringe Benefits
Fringe benefits such as health insurance, medical reimbursement,
travel, education, group term-life insurance, etc., can be tax-saving
tools for corporate owners. Costs that would otherwise be nondeductible personal expenses can be converted into tax deductions.
See Fringe Benefits (Fringes) on Page K-1 for more information
about employee benefit plans.
Employer-Provided Meals and Lodging
As long as the provisions of Section 119 are met, a corporation
can provide tax-free living accommodations to an employee even
if the employee is the sole shareholder. This allows a business
deduction for housing costs while the shareholder receives the
accommodations tax free. The IRS may argue that the housing
costs are a disguised benefit rather than a business necessity, but
court decisions have favored the taxpayer.
Court Case: In J. Grant Farms (TC Memo 1985-174), the Tax Court ruled a
corporation was entitled to deduct living expenses for a shareholder because
his duties required him to live on-site. The court in Maschmeyer’s Nursery,
Inc. (TC Memo 1996-78) came to a similar conclusion.
For more information see Fringe Benefits (Fringes) on Page K-1.
Constructive Dividends
If a corporation with E&P makes a distribution to a shareholder
and does not report the payment as a taxable dividend, the IRS
will often reclassify the distribution as a constructive dividend. The
distribution is taxed as a regular dividend up to the E&P of the
corporation. See Dividends and Return of Capital on Page C-8.
The problem of constructive dividends most commonly affects
closely held corporations. Recordkeeping is often inadequate
and leaves the corporation vulnerable in a dispute with the IRS.
Indirect benefit. Constructive dividends may occur not only as the
result of a direct payment, but also as a result of a transaction that
gives an indirect economic benefit to the shareholder.
Transactions that may result in constructive dividends include:
•Unreasonable compensation is paid for a shareholder’s services.
The owner-employee should be compensated based on what
the corporation would expect to pay a nonowner employee for
similar services. See Wages for Shareholders on Page C-8.
•If a corporation pays rent to a shareholder in excess of FMV for
the use of property, the excess could be treated as a constructive
dividend. If the corporation makes excessive improvements to
the rented or leased property, especially on a short-term lease,
constructive dividends may result.
•Personal use of corporation property (auto, airplane, entertainment
facilities, etc.) may result in constructive dividends.
•Closely held corporations often have incentive to obtain working
capital in the form of long-term debt rather than in stockholders’
equity, because interest paid on debt is tax deductible. However,
purported interest payments to shareholders may be reclassified
as nondeductible dividends if the loans are (1) not bona fide
or (2) excessive in relation to equity. Similarly, a loan from the
corporation to the shareholder may be considered a constructive
dividend if it is not a bona fide loan.
•A sale of property to a corporation may result in constructive
dividends if the sale price is more than the property’s FMV.
•Personal expenses, such as auto, travel or entertainment, paid
by a corporation to or for an owner-employee may result in
constructive dividends.
•A constructive dividend may be imposed when a stockholder
purchases property below FMV from a corporation.
Expense reimbursements. In Revenue Ruling 2012-25, the
IRS clarifies that arrangements recharacterizing taxable wages
as nontaxable reimbursements do not satisfy the business con
nection requirement to be excluded from wages under an accountable plan. Employers are considered to be recharacterizing
wages if they (1) temporarily reduce taxable wages and substitute
nontaxable reimbursements until total expenses are reimbursed,
then increase wages to the prior level, (2) pay higher wages to
employees when they don’t receive nontaxable reimbursements
and lower wages when they do or (3) routinely pay nontaxable
reimbursements to employees who haven’t incurred bona fide
business expenses. Amounts paid under such arrangements are
included in employees’ income.
Earnings and Profits (E&P)
See Net Income per Books vs. Taxable Income on Page O-11
Corporate E&P is not the same as taxable income. The amount of
E&P determines taxation of corporate distributions to shareholders.
Taxable distributions of a C corporation come first from current E&P
and then from accumulated prior-year E&P. [IRC §316(a)]
Distributions in excess of E&P are nontaxable to the shareholder
to the extent of stock basis; those in excess of the shareholder’s
stock basis are taxable as a capital gain. [IRC §301(c)]
A corporation must file Form 5452, Corporate Report of
Nondividend Distributions, whenever nontaxable distributions are
made to shareholders.
Section 312 lists several transactions that affect E&P, but does
not give a complete definition. In general, E&P may be described
as the amount available to the corporation to pay a dividend
without depleting its capital. The effect on the E&P account can
be determined by considering whether the transaction increases
or decreases the corporation’s ability to pay a dividend. E&P is
initially increased by the taxable income of a corporation.
⊕ The following transactions add to amount of current E&P:
•Tax-exempt income. [Reg. §1.312-6(b)]
•Life insurance proceeds in excess of premiums paid.
•Deduction of excess charitable contribution in succeeding tax
year.
•Percentage depletion over cost. [Reg. §1.312-6(c)]
•Accelerated depreciation in excess of straight line (SL), units-ofproduction or machine-hours depreciation. [IRC §312(k)]
•Deferred gain on installment sale. [IRC §312(n)(5)]
•Long-term contract reported on completed contract method. [IRC
§312(n)(6)]
•Intangible drilling costs deducted currently. [IRC §312(n)(2)]
•Mine exploration and development costs deducted currently. [IRC
§312(n)(2)]
•Dividend-received deduction.
 The following transactions reduce amount of current E&P:
•Federal income taxes.
•Loss on sale between related parties.
•Life insurance premiums in excess of cash surrender value.
•Excess charitable contribution (over 10% limit).
•Amortized intangible drilling costs deducted over 60 months. [IRC
§312(n)(2)]
•Amortized mine exploration and development costs deducted
over 120 months. [IRC §312(n)(2)]
•Expenses relating to tax-exempt income.
•Excess of capital losses over capital gains.
Corporations can set up their books to show net income based
on E&P rather than tax return net income. This allows the
accumulation of E&P (for purposes of determining how much is
2012 Tax Year | Small Business Quickfinder ® Handbook C-11
available for dividend distributions) to be recorded in the retained
earnings account on the corporation balance sheet.
The difference between book net income (E&P) and tax return net
income is reconciled on Schedule M-1 or M-3, Form 1120. See
Corporation Example on Page C-17.
E&P Example
Beginning balance sheet of WSP Corporation:
Assets:
Cash............................................................ $ 6,000
Inventory......................................................
8,000
Total assets................................................................................... $ 14,000
Liabilities and Equity:
Total liabilities............................................................................... $
0
Common stock............................................. $ 1,000
Retained earnings (E&P)............................. 13,000
Total equity...................................................................................
14,000
Total liabilities + equity.................................................................. $ 14,000
Corporation transactions during the tax year:
Gross sales receipts...................................................................... $
Taxable interest income.................................................................
Tax-exempt interest income...........................................................
Merchandise purchases................................................................
Advertising expenses....................................................................
Wages...........................................................................................
Office expenses.............................................................................
Purchase of equipment..................................................................
Estimated federal tax payments....................................................
Ending inventory............................................................................
90,000
500
250
30,000
5,000
20,000
13,500
25,000
2,700
8,600
Corporation tax return:
Gross sales.................................................................................... $ 90,000
Beginning inventory..................................... $ 8,000
Merchandise purchases.............................. 30,000
Minus ending inventory................................ < 8,600>
Cost of goods sold......................................................................... $ 29,400
Gross profit.................................................................................... $ 60,600
Interest income..............................................................................
500
Total income.................................................................................. $ 61,100
Advertising................................................... $ 5,000
Wages......................................................... 20,000
Office expenses........................................... 13,500
Depreciation ($25,000 × 14.29%)................
3,573
Total operating expenses............................................................... $ 42,073
Net taxable income........................................................................ $ 19,027
Federal income tax ($19,027 × 15%)............................................
2,854
Minus estimated tax....................................................................... < 2,700>
Balance due................................................................................... $
154
Book income for purposes of E&P:
Gross sales.................................................................................... $ 90,000
Beginning inventory..................................... $ 8,000
Merchandise purchases.............................. 30,000
Minus ending inventory................................ < 8,600 >
Cost of goods sold......................................................................... $ 29,400
Gross profit.................................................................................... $ 60,600
Interest income..............................................................................
750
Total income.................................................................................. $ 61,350
Advertising................................................... $ 5,000
Wages......................................................... 20,000
Office expenses........................................... 13,500
Depreciation ($25,000 × 5.00%)..................
1,250
Total operating expenses............................................................... $ 39,750
Net income before tax................................................................... $ 21,600
Minus federal income tax per tax return........................................ < 2,854>
Net income after tax (E&P)............................................................ $ 18,746
Example continued in the next column
C-12 2012 Tax Year | Small Business Quickfinder ® Handbook
Ending balance sheet:
Assets:
Cash............................................................ $ 550
Inventory......................................................
8,600
Equipment................................................... 25,000
Minus accumulated depreciation................. < 1,250 >
Total assets
Liabilities and Equity:
Federal tax payable (total liabilities).............................................
Equity
Common stock............................................. $ 1,000
Retained earnings (E&P) (13,000 + 18,746) 31,746
Total equity...................................................................................
Total liabilities + equity...................................................................
Ending E&P calculation:
Beginning E&P balance............................... $ 13,000
Plus taxable income.................................... 19,027
Plus tax-exempt interest..............................
250
Plus accelerated depreciation
in excess of SL ($3,573 - $1,250).............
2,323
Minus federal income taxes......................... < 2,854 >
Minus dividend distributions........................ <
0>
Equals ending E&P........................................................................
$ 32,900
$
154
$ 32,746
$ 32,900
$ 31,746
Tax Effect of Tax-Exempt Income
Although a C corporation does not pay tax on earnings from taxexempt income such as municipal bond interest, the income will
increase E&P. Thus, the amount of taxable dividends available to
shareholders is increased by tax-exempt income.
Nondeductible expenses such as penalties, fines, capital losses in
excess of capital gains, etc. reduce E&P and the amount of taxable
dividends available for distribution to shareholders.
Accumulated Earnings Tax
A C corporation that accumulates earnings beyond reasonable
business needs is assumed to be accumulating earnings for the
purpose of tax avoidance, unless the taxpayer can
prove otherwise [IRC §533(a)]. The accumulated
earnings tax (AET) is not reported on the tax
return; it is a penalty imposed after an IRS
audit. The tax applies regardless of the
number of shareholders.
The AET is currently 15% of accumulated taxable income (IRC
§531). The 15% rate is scheduled to expire for tax years beginning
after December 31, 2012, at which time the AET will be imposed
at the highest individual tax rate.
Accumulated taxable income is the corporation’s taxable income
for the year reduced by items such as federal tax, excess charitable
contributions, dividends paid deduction and the accumulated
earnings credit. [IRC §535(a)]
The accumulated earnings credit represents the amount
accumulated for reasonable business needs. If audited, the burden
of proof is on the corporation to demonstrate that an accumulation
is reasonable [IRC §533(a)]. Note: Businesses that function as
mere holding or investment companies are assumed to operate
with a tax avoidance motive [IRC §533(b)]. Such businesses
are allowed a minimum credit, but are not allowed additional
accumulation for reasonable business needs.
Minimum credit. Retained earnings of $250,000 or less [$150,000
for personal service corporations (PSCs)] are considered to be
within reasonable business needs. [IRC §535(c)(2)]
Reasonable business needs are analyzed in Regulation
Sections 1.537-1 and 1.537-2. Items identified include:
•Expansion. Includes purchase of assets, acquisition of another
business enterprise or plant replacement.
•Paying off business debts.
For tax years beginning after
December 31, 2012, the AET rate is 20%. Replacement Page 01/2013
•Section 303 redemptions. A corporation can accumulate earnings in anticipation of a need to redeem stock from a deceased
shareholder’s estate.
•Supplier or customer needs. A corporation can accumulate earnings to provide for investments or
loans to suppliers or customers if necessary
to maintain the business of the corporation.
•Working capital. A corporation may need
an amount of working capital to conduct business. For example, a supermarket needs $4 million of inventory
on hand to operate. The corporation can accumulate earnings
to obtain inventory.
•Providing for contingencies such as the payment of reasonably
anticipated product liability losses, actual or potential lawsuits,
loss of a major customer, or self insurance.
Appropriated retained earnings account. If a corporation
needs to accumulate earnings, the board of directors should
discuss the need and the discussion should be reflected in the
corporation’s minutes. This will help the taxpayer demonstrate that
the accumulation is for reasonable business needs in the event of
IRS audit. The financial statements should also reflect the need
to accumulate earnings so shareholders will know the appropriate
amount of earnings available for dividends. Corporations commonly
reflect such business needs by establishing an appropriated
retained earnings account.
Not reasonable business needs. The following purposes are not
considered reasonable business needs:
•Accumulating income to avoid dividend distributions.
•Providing loans to shareholders.
•Paying expenses for the personal benefit of shareholders.
•Providing loans that have no reasonable relation to the conduct
of the business.
•Providing loans to related corporations or shareholders.
•Investments unrelated to business activities.
•Providing for unrealistic hazards.
Court Case: A corporation subject to the accumulated earnings tax argued
that it should be able to reduce accumulated taxable income by the amount
of tax accrued on an installment sale of real estate. The taxpayer also argued
that it should be able to deduct a contested tax liability it had paid.
The Tax Court ruled against the taxpayer on both counts. The court did not
allow a reduction for tax accrued against installment sale income that had not
yet been reported. With regard to the adjustment for the contested tax liability,
the taxpayer relied on Regulation Section 1.535-2(a)(1), which states, “In computing the amount of taxes accrued, an unpaid tax which is being contested
is not considered accrued until the contest is resolved.” The court found that
in this case, the fact that the taxpayer had paid the contested liability did not
mean the contested liability could be accrued. [Metro Leasing and Development
Corporation, 119 TC 8 (2002). On appeal, the 9th Circuit agreed with the Tax
Court. (94 AFTR 2d 2004-5251)]
Bardahl Formula
A method commonly used to substantiate reasonable accumulation
of earnings by a business is called the Bardahl Formula.
The IRS assessed accumulated earnings tax on Bardahl Manufacturing Corporation. The Tax Court held that accumulation of
earnings by Bardahl was not unreasonable and accepted the company’s stated method of computing necessary operating capital.
The formula calculates the amount needed to
fund inventory by analyzing the average
number of days in an operating cycle,
average inventory, average accounts receivable and average accounts payable,
and then comparing the current working capital needs with actual
accumulations of earnings. (Bardahl Manufacturing Corp.,TC
Memo 1965-200)
Corporate Income and Expenses
See also Organizational and Start-Up Costs on Page M-6
Computation of gross income for a corporation is similar to the
computation of gross income for an individual taxpayer. In general,
business income, gains from property transactions, interest, rents,
royalties and dividends are included in corporate income [IRC
§61(a)]. Certain exclusions, such as municipal bond interest, are
allowed for both individuals and corporations.
Gains and losses from property transactions are handled in the same
manner. Section 1221 makes no distinction between corporate and
noncorporate taxpayers in defining a capital asset.
Corporations and individuals are similar in the areas of like-kind
exchanges (IRC §1031) and involuntary conversions (IRC §1033).
Corporation business deductions also parallel those of an individual.
Ordinary and necessary rules of Section 162(a) apply for both. Many
tax credits are also available to both individuals and corporations.
See Business Tax Deductions on Page O-1 and Tax Credits on Page
O-7, which generally apply to both individuals and corporations.
This section covers some of the basic rules for income and expenses of corporations that differ from those for individuals.
Dividends-Received Deduction
Qualified dividends received from domestic corporations are
partially deductible by C corporations. This deduction is meant
to reduce the negative effects of the double tax on C corporation
profits distributed to shareholders as dividends. Dividend income
is reported, and the dividends-received deduction is computed, on
Schedule C of Form 1120.
A corporation may, subject to limitations, deduct 70% of the
dividends received from a domestic corporation if the receiving
corporation owns less than 20% of the distributing. (IRC §243)
If a corporation owns 20% or more of the corporation distributing
dividends, the receiving corporation may, subject to certain limits,
deduct 80% of the dividends received.
Exceptions. The dividends received deduction does not apply to
dividends received from certain banks and savings institutions,
real estate investment trusts, public utilities, regulated investment
companies, tax-exempt corporations, cooperatives and DISCs.
[IRC §243(d) and 246]
Taxable income limit. The otherwise allowable 70% and 80%
deductions are generally limited to a percentage of the recipient’s
taxable income [IRC §246(b)]. The taxable income percentage
limitation is the same as the dividends received deduction percentage (70% or 80%). For example, if the recipient corporation
owns 30% (by vote and value) of the payor corporation’s stock, the
basic deduction amount is 80% of any dividend received, limited to
an amount not exceeding 80% of the recipient’s taxable income.
The preceding limits are figured without regard to NOL, domestic
producers or dividends-received deductions; nontaxable portion
of an extraordinary dividend or capital loss carrybacks.
When a corporation sustains an NOL, the above 80% or 70%
limitation of taxable income does not apply.
Example #1: BNG Corporation sustains a $30,000 loss from operations. It received $90,000 in dividends from a 20%-owned corporation. Its taxable income
is $60,000 ($90,000 – $30,000) before the deduction for dividends received.
By claiming the full dividends-received deduction of $72,000 ($90,000 × 80%),
BNG Corporation calculates its NOL as follows:
Operating losses................................................ < $ 30,000>
Dividend income................................................
90,000
Dividends-received deduction........................... < 72,000>
NOL................................................................... < $ 12,000>
Since BNG has an NOL, the 80% of taxable income limitation does not apply
and it is entitled to a full dividends-received deduction of $72,000.
2012 Tax Year | Small Business Quickfinder ® Handbook C-13
Example #2: Assume the same facts as Example #1, except BNG loses
$10,000 from operations instead of $30,000. Taxable income before the
dividends-received deduction is $80,000 ($90,000 – $10,000). After claiming
a dividends-received deduction of $72,000 ($90,000 × 80%), the corporation
has net income of $8,000 ($80,000 – $72,000).
Since in this example there is no NOL after a full dividends-received deduction,
the allowable dividends-received deduction is limited to 80% of taxable income,
or $64,000 ($80,000 × 80%). BNG calculates income as follows:
Operating losses................................................ < $ 10,000>
Dividend income................................................
90,000
Dividends-received deduction
(limited to 80% of taxable income).................... < 64,000>
Taxable income.................................................. $ 16,000
Charitable Contributions
C corporations are allowed to deduct charitable contributions as
a business expense. No deduction is allowed if any of the net
earnings of the receiving organization are used for the benefit of
any private shareholder or individual. The deduction is limited to
10% of the corporation’s taxable income. [IRC §170(b)(2) and (c)]
Taxable income for limitation purposes is calculated
without taking into account the deductions for:
•Charitable contributions.
•Dividends received.
•Premium on repurchase of convertible debt.
•Domestic production activities deduction.
•Dividends paid on certain public utility preferred stock.
•Net operating loss carrybacks.
•Capital loss carrybacks.
Unused contributions from this limitation can be carried forward for
five years. No carryback is allowed. [IRC §170(d)(2)]
Enhanced charitable deduction for qualified book and qualified computer donations. These enhanced deductions expired
December 31, 2011. [IRC §170(e)(3)(D)(iv) and (e)(6)(G)]
 Expired Provision Alert: It’s possible Congress will extend
them to 2012, but had not done so at the time of this publication.
See Expired Tax Provisions on Page Q-1 for more information.
Research property. An exception to the contribution limits applies
to contributions of scientific equipment for use in experimentation
or for certain research training. This exception is only available
for C corporations other than PHCs or service organizations as
described in Section 414(m)(3) [IRC §170(e)(4)]. These contributions are subject to the special computation rules discussed at
Charitable Contributions of Inventory in the next column.
Intellectual property. In addition to the initial deduction, a taxpayer who has donated qualified intellectual property may claim
a subsequent charitable contribution based on a percentage of
the net income received by the charity (other than certain private
foundations) from the property. [IRC §170(m)]
Substantiation requirements. Strict rules exist for substantiating
charitable contributions. For all monetary contributions, the corporation must maintain a bank record or a receipt, letter or other
written communication from the donee organization indicating the
organization’s name, the date of the contribution and the amount
[IRC §170(f)(17)]. There is no de minimis exception. For contributions of $250 or more of either cash or property, the taxpayer must
have a contemporaneous written acknowledgement from the donee
(a canceled check will not suffice). [Reg. §1.170A-13(f)]
Charitable contributions of property over $5,000. C corporations are required to obtain a qualified appraisal for donated
C-14 2012 Tax Year | Small Business Quickfinder ® Handbook
property if the claimed deduction exceeds $5,000. If the claimed
deduction of property other than cash, inventory or publicly traded
securities exceeds $500,000, a qualified appraisal must be attached to the donor’s tax return.
Conservation easements. A deduction is available for qualified
donations. See Conservation easements on Page N-14.
Charitable Contributions of Inventory
The deduction for a charitable contribution of inventory or other
ordinary income producing property is generally limited to the
adjusted basis of the property.
A provision in the Code allows a C corporation (not an S corporation) to donate inventory to charity and deduct up to one-half of
FMV above cost as a charitable contribution [IRC §170(e)(3) and
Reg. §1.170A-4A]. For purposes of this provision, depreciable
property under Section 1221(a)(2) also qualifies for the deduction.
The following rules must be met: [IRC §170(e)(3)]
1) The charity must be a Section 501(c)(3) organization,
2) The charity must use the donated property solely for the care
of the ill, the needy or infants,
3) The charity cannot exchange the donated property for money,
other property or services,
4) The corporation must be given a written statement from the
charity that says it will follow rules (2) and (3) above,
5) If the property is subject to the Federal Food, Drug and Cosmetic Act regulations, all such regulations must be satisfied and
6) Use of the donated property must be related to the purpose or
function that gives the charity its exempt status.
The charitable deduction is computed by taking the FMV of the
donated property at the time of contribution and subtracting onehalf the gain that would not have been long-term capital gain if the
property had been sold at its FMV. The deduction is further limited
to twice the basis of the donated property.
If the donated property has any potential recapture of ordinary
income under Section 617, 1245, 1250 or 1252 (depreciation
recapture), then the FMV for the above computation purposes
must first be reduced by the recapture amount before making
the above charitable deduction computation. [IRC §170(e)(3)(E)]
 Note: If the inventory’s cost is incurred in the same year as the
contribution, the amount is included in cost of goods sold (COGS).
The contribution is not subject to the 10% of taxable income
limitation. If the contribution is made from beginning inventory,
the item is removed from inventory and shown as a charitable
contribution subject to the 10% limitation. [Reg. §1.170A-1(c)(4)]
Example: GIJ Corporation donates inventory to Toys for Tots. The FMV of
the inventory equals $1,000, and GIJ’s basis in the inventory equals $200. If
GIJ had sold the inventory for its FMV, the amount of gain that would not be
long-term capital gain is $800 ($1,000 – $200). One-half of $800 is $400. The
charitable deduction would be $600 ($1,000 – $400) except for the fact that
the deduction is limited to twice its basis ($200 × 2 = $400). GIJ can take a
charitable contribution deduction of $400 and must reduce its COGS by $200.
 Expired
Provision Alert: The Section 170(e)(3)(C) special
rules for contributions of food inventory expired at the end of 2011.
It’s possible Congress will extend them to 2012, but had not done
so at the time of this publication. See Expired Tax Provisions on
Page Q-1 for more information.
N Observation: Some corporations making donations that
qualify for the enhanced deduction for inventory may, because of
the 10% of taxable income limitation, prefer to limit their deduction
and the required cost of goods sold adjustment to the inventory’s
basis. While it studies this issue, the IRS will not challenge either
method. (Notice 2008-90) have been extended through 2013.
Replacement Page 01/2013
S Corporations

Tab D Topics
Basics of S Corporations.........................................Page D-1
S Corporation Taxes................................................Page D-6
Reasonable Wages..................................................Page D-8
Shareholder’s Basis.................................................Page D-9
Distributions...........................................................Page D-10
S Corporation Example..........................................Page D-11
S Corporation Shareholder Codes for
Schedule K-1, Form 1120S.................................Page D-21
Related Information
•Shareholder’s Adjusted Basis Worksheet–Tab A
•Depreciation and Amortization–Tab J
•Employee Benefit Plans–Tab K
•Accounting Methods–Tab L
•Corporate Liquidations–Tab N
•Disposition of Assets–Tab N
•Business Tax Deductions–Tab O
•Tax Credits–Tab O
•Net Income per Books vs. Taxable Income–Tab O
•S Corporation Year-End Planning Checklist–Tab P
•What’s New–Tab Q
Basics of S Corporations
Form 1120S
For guidance on tax planning for S corporations, see the S Corporation Year-End Planning Checklist on Page P-13. See also Tab
13 of the Tax Planning for Businesses Quickfinder® Handbook.
Filing requirements. Every S corporation must file, regardless of
the amount of income or loss. It must file even if it stops conducting
business. Filing ends when totally dissolved.
Filing deadline. By the 15th day of the third month following the
close of its tax year or date of dissolution.
Electronic filing of Form 1120S is mandatory for S corporations
that have $10 million or more in assets and annually file 250 or
more returns of any type (including information returns such as
Forms W-2 and 1099). (Reg. §301.6037-2)
Extension deadline and form number. A six-month extension
may be obtained by filing Form 7004, Application for Automatic
6‑Month Extension of Time To File Certain Business Income Tax,
Information, and Other Returns.
Penalties. The penalty for failure to file a return is $195 per month
per shareholder up to 12 months (IRC §6699). The penalty is assessed against the corporation.
If S corporation taxes are due, a late filing penalty may be imposed
equal to 5% of tax owed per month, up to 25%. If the return is
more than 60 days late (including extensions) a minimum penalty
of the lesser of $135 or the amount of unpaid tax applies. A late
payment of tax penalty may also be imposed equal to one-half of
one percent per month, up to 25%. (IRC §6651)
Penalty Sections 6662 and 6664 (accuracy related penalties on
understatements), and Section 6676 (erroneous refund claim
penalties) now include the economic substance doctrine—see
Economic Substance on Page B-1. Additional information regarding penalties is found at Preparer Penalties on Page P-17 and
Penalties on Page C-1.
Schedule K-1 deadline. S corporations are required to furnish
a Schedule K-1 to each shareholder by the due date, including
extensions, of the corporation tax return (Form 1120S). A $100
penalty, imposed with respect to each Schedule K-1 for which a
failure occurs, applies for failure to furnish Schedule K-1 when due,
failure to include all required information or for including incorrect
information. The $100 penalty may be reduced to $30 or $60 per
failure, depending on when and whether the failure is corrected.
(IRC §6722)
The maximum penalty ranges from $250,000­– $1,500,000
($75,000–$500,000 for small businesses). Higher penalties apply if the failure is due to intentional disregard of the law, and the
penalties will be adjusted for inflation. See Section 6722 for details.
Reasonable cause exception. The penalties discussed at Penalties and Schedule K-1 deadline, both in the previous column, will
not be imposed if the failure was due to reasonable cause. (IRC
§6651, 6699 and 6724)
Estimated tax requirements. Shareholders pay estimated tax
for their individual returns. The S corporation pays estimated tax
if corporate-level taxes apply. [IRC §6655(g)(4)]
C Corporation vs. S Corporation
An eligible domestic corporation can elect to be taxed as an S corporation. An S corporation generally does not pay federal income
tax—its profits and losses pass through directly to shareholders.
This avoids the C corporation double tax, and allows shareholders
to deduct corporate losses on their individual returns.
C Corporation
Taxation Double taxation of profits.
Income is taxed at the corporate
level; profits distributed as
dividends are taxed at the
individual level.
Dividends Dividends paid by a C
corporation are generally taxed
to the individual at the same
rate as long-term capital gains
(0% or 15%) in 2012.
Ordinary C corporation losses are not
Losses passed through to shareholders.
Losses can be deducted only
at the corporate level as NOL
carrybacks and carryforwards.
Capital
Gains
Capital
Losses
S Corporation
Profits are passed through
directly to shareholders, escaping
corporate-level tax.
S corporation earnings passed
through to a shareholder are taxed
as ordinary income.
Losses are passed through
directly to shareholders. Currentyear losses are deductible up
to the shareholder’s basis in S
corporation stock and loans to the
S corporation.
Taxed at the same rate as
Pass through to shareholders and
ordinary income.
are eligible for favorable capital
gain tax rates for individuals.
Allowed only to the extent of
Pass through to shareholders.
capital gains. Net capital losses Capital losses are deductible
are carried back three years and subject to limitations on the
forward five years.
shareholder’s return.
For tax purposes, S corporations are treated similar to partnerships.
Many rules governing S corporations are intended to subject S
corporation shareholders to the same tax treatment as partners.
An S election can be useful in a corporation’s early years, since
losses pass through to shareholders.
S Corporation Considerations
Under the 2003 Tax Act, the tax rate for individuals on most dividends was lowered to the same rate as long-term capital gains.
This significantly reduced the negative effects of double taxation
at the C corporation level. Considering that S corporation profit
passed through to shareholders is taxed as ordinary income, in
certain situations it was advantageous for an S corporation to
terminate its S status and convert to a C corporation.
2012 Tax Year | Small Business Quickfinder ® Handbook D-1
on higher-income taxpayers
has been extended to 2013 and later, but with an increased tax rate of 20% on higher-income taxpayers.
U Caution: The
taxation of dividends paid
to individuals at long-term capital gain rates is
scheduled to expire after 2012. In addition, individual long-term capital gain and ordinary income tax
rates are scheduled to increase after 2012. Regardless of whether these provisions are extended, the
marginal tax rates (current and projected) of specific
shareholders and corporations should be used in
determining the most tax-favorable form of business organization
the tax
(such as a C corporation versus an S corporation).
years
involved,
Factors to consider:
rate
•The accumulated earnings tax for C corporations has been lowered
from the top individual rate to 15% (through 2012). (IRC §531)
•An S corporation that elects to revoke its S status must generally
wait five years before it can again elect S corporation status.
[IRC §1362(g)]
is
•Previously taxed S corporation profits not distributed within one
year from the date of S corporation termination are converted
to taxable earnings and profits (E&P). See Post-Termination
Transition Period on Page D-11.
•C corporations may be subject to personal holding company
(PHC) or personal service corporation (PSC) taxes. See Tab F.
•C corporations with accumulated E&P may be subject to additional taxes upon conversion to an S corporation. See S
Corporation Taxes on Page D-6.
•S corporation losses flow through to shareholders. C corporations
do not pass losses through.
in 2012 (20% for tax
years beginning after
S Corporation Requirements December 31, 2012).
•All shareholders must consent to S corporation status.
•Limited to 100 shareholders.
•The corporation can have only one class of stock. See One Class
of Stock on Page D-3.
•Must be a domestic corporation. Individual shareholders must be
U.S. citizens or residents. A resident alien [one who (1) has been
lawfully admitted for permanent residence in the U.S., (2) meets
a substantial presence test as outlined in Section 7701(b)(3) or
(3) elects to be treated as a U.S. resident, but is not a citizen]
can be a shareholder, but a nonresident alien (someone who is
neither a citizen of the U.S. nor meets any of the tests for resident
alien status) cannot. [Reg. §1.1361-1(g)(1)]
•The corporation must use a permitted tax year, or elect to use a
tax year other than a permitted tax year. See Required Tax Year
on Page L-6.
•Only individuals, estates, certain trusts and certain charities may
be shareholders. (IRC §1361)
Ineligible shareholders. Corporations, partnerships
(unless the stock is held as a nominee for an individual
treated as the shareholder), LLCs, LLPs, nonresident
aliens and IRAs are ineligible. Exception: Certain
single-member LLCs can be S corporation shareholders. (Letter Ruls. 200008015 and 9745017)
U Caution: Actions by one shareholder can
terminate S status.
IRS Ruling: A minority shareholder in an S corporation sold one share of stock
to an ineligible shareholder in a dispute over dividends. The corporation’s S
status was terminated. The IRS did allow the corporation to reelect S status
without the normal five-year waiting period, but the corporation needed to
obtain a private letter ruling to do so. (Letter Rul. 9616022)
Strategy: An S corporation should keep control of stock transfers with a shareholder transfer agreement, right of first refusal,
call option or other buy/sell agreement terms.
D-2 2012 Tax Year | Small Business Quickfinder ® Handbook
Stock Ownership Requirements
A C corporation is not eligible to hold stock in an S corporation;
however, an S corporation can own up to 100% of the stock of a
C corporation. An S corporation cannot file a consolidated return
with an affiliated C corporation. The C corporation may, however,
still file a consolidated return with its affiliated C corporations.
Qualified Subchapter S subsidiary (QSub). An S corporation
can elect to treat a wholly owned subsidiary as part of the S
corporation for tax purposes—the subsidiary is disregarded. The
subsidiary does not need to be an S corporation, but it must be a
corporation that would qualify for S status if its stock was held by
the shareholders of the parent S corporation. [IRC §1361(b)(3)]
U Caution: A QSub is treated as a separate corporation for purposes of employment taxes (including FICA and FUTA, Railroad
Retirement and FIT withholding) and certain excise taxes (such as
the retail excise taxes of Chapter 31 of the Code and the facilities
and services taxes of Chapter 33). [Reg. §1.1361-4(a)(7) and (8)]
A QSub-eligible subsidiary is a domestic corporation that is owned
100% by an S corporation and is not one of the following:
•A financial institution that uses the reserve method of accounting
for bad debts under Section 585,
•An insurance company subject to tax under the rules of Subchapter L of the Code,
•A corporation that has elected to be treated as a possessions
corporation under Section 936 or
•A domestic international sales corporation (DISC) or former DISC.
Form 8869, Qualified Subchapter S Subsidiary Election, may be
filed at any time during the tax year, but the effective date of election cannot be more than:
•Two months and 15 days prior to date of filing the election, or
•Twelve months after the date of filing the election.
Late filed election. The IRS has the authority to waive inadvertently invalid QSub elections or terminations of these elections.
To obtain relief, the QSub and the S corporation parent must: (1)
take steps to qualify the corporation as a QSub within a reasonable period of time after discovering the circumstances causing the
invalid election or termination, and (2) agree to any adjustments
proposed by the IRS to treat the corporation as a QSub during the
relevant period. [IRC §1362(f)]
Tax effects of election:
•Existing Corporation. If an election is made to treat an existing
corporation as a QSub, the transaction is treated as a deemed
liquidation of the subsidiary under Sections 332 and 337. See
Parent-Subsidiary Liquidations on Page N-8.
•New Corporation. If a QSub election is in effect when the subsidiary is formed, liquidation is not considered to have occurred.
The QSub is disregarded for tax purposes.
Eligible Trusts [IRC §1361(c)(2), (d) and (e)]
1) Grantor trusts owned by a U.S. citizen or resident. The trust can
continue as an eligible shareholder for two years beginning on
the grantor’s date of death.
2) Testamentary trusts to which stock is transferred under the
terms of a will. The trust is an eligible shareholder for two
years after the stock is transferred to it. The decedent’s estate
is considered the shareholder for the 100-shareholder limit.
3) Trusts created to exercise voting power of stock transferred to
them. Each beneficiary of the trust is treated as a shareholder
for the 100-shareholder limit.
4) Qualified Subchapter S trusts (QSSTs). May have only one income beneficiary and must distribute or be required to distribute
all accounting income each year. Principal distributed during
the beneficiary’s life must be distributed to the beneficiary.
Replacement Page 01/2013
Example #1: A C corporation with accumulated E&P elects to
be an S corporation. In 2012, its gross receipts total $100,000.
Included in the gross receipts is $40,000 of passive investment
income. Expenditures directly connected to the production of the
passive investment income total $10,000. The net passive
income equals $30,000 ($40,000 – $10,000).
25% of gross receipts equals $25,000 ($100,000 × 25%). The amount by
which passive investment income in 2012 exceeds 25% of gross receipts
equals $15,000 ($40,000 passive investment income – $25,000).
ENPI calculation: $15,000 ÷ $40,000 × $30,000 = $11,250
Passive investment income tax for 2012: $3,938 ($11,250 × 35%)
Example #2: Assume that in Example #1, the $40,000 of passive investment
income consisted of $12,000 from interest and $28,000 from rents. The amount
of the $3,938 passive income tax allocated to interest is $1,181 ($3,938 ×
$12,000 ÷ $40,000). The amount allocated to rents is $2,757 ($3,938 ×
$28,000 ÷ $40,000). The amount reported on Schedule K for interest and
rental income is reduced by the tax allocated above.
The tax is reported on Form 1120S, line 22a; it is computed using
a worksheet provided in the 1120S instructions.
Combined Basis
=
of Assets
Net Unrealized
Built-In Gain
Built-in gains are triggered by property disposition. At the time
a C corporation elects S status, if the combined FMV of its assets
exceeds basis, the difference is net unrealized built-in gains. If
the assets with built-in gains are later sold, a special tax applies.
These rules apply only to corporations that elected S status after
1986, and affect dispositions of property for 10 years after the date
of S election (the recognition period).
 Note: If FMV is less than basis as of the date of S election,
the built-in gains rules do not apply.
When determining whether a corporation is subject to
the BIG tax, the corporation’s most recent S election
applies, not an earlier election that was revoked or
terminated (Regs. §1.1374-8 and §1.1374-10). Builtin gains and losses are computed for each asset at
the beginning of the first tax year of the S corporation.
Unrealized gain or loss then carries with each asset
and is recognized when the property is disposed of.
Net unrealized built-in gains are listed in the available
space on line 6 of Schedule B (Form 1120S). When
the built-in gain assets are sold, the number shown
on line 6 is reduced by the amount of gain recognized
in prior years.
Example: Welcome, Inc., a C corporation, elects S corporation status. On the
first day of the S election, Welcome’s assets have FMV and basis as follows:
FMV
Machine........................... $ 9,000
Basis
$ 4,000
Difference
$ 5,000
Truck................................
7,000
9,000
Building............................
55,000
52,000
3,000
Totals............................... $ 71,000
$ 65,000
$ 6,000
< 2,000>
Welcome, Inc., has net unrealized built-in gains of $6,000 at the date of S
election. The machine and building are built-in gain assets; the truck is a
built-in loss asset.
 Caution: Fair market value is a frequent IRS target with regard
to BIG tax. It may be wise to obtain a professional appraisal of a
corporation’s assets to avoid IRS adjustment.
Replacement Page 01/2013
Calculating BIG tax. Net recognized built-in gain is subject to
the top corporate tax rate of 35%. BIG tax is reported on Schedule D, Part III of Form 1120S. Net recognized built-in gain is the
smallest of:
1) The overall limit—net unrealized built-in gain,
2) The current recognition limit—the amount that would be taxable
income if only recognized built-in gains and losses were taken
into account or
3) The taxable income limit—the corporation’s taxable income for
the year, computed as if it were a C corporation.
Carryovers. If net recognized built-in gain for the year is reduced
by the taxable income limit (item 3 above), the remainder is carried
forward and subject to BIG tax in the following year. However, if
a sale of built-in gain property results in a net loss, the loss is not
carried forward.
 Strategy: If sale of an asset triggers built-in loss, offset the loss
Built-In Gains (BIG) Tax (IRC §1374)
Combined FMV
–
of Assets
BIG tax generally will not apply for assets acquired while the corporation is an S corporation, or if the corporation elected S status
for all years. Exception: If an S corporation acquires an asset from
a C corporation (or another S corporation that is subject to the BIG
tax) and the asset’s basis is the transferred basis from the other
corporation, BIG tax may apply.
by selling an asset with built-in gain. This will take the asset with
built-in gain off the table without triggering BIG tax.
Loss carryovers/accrued expenses. Capital losses or NOLs that
carry over from a C to an S corporation reduce the S corporation’s
net recognized built-in gain; carried over minimum tax credits and
business tax credits reduce the BIG tax. Also, for cash basis taxpayers, expenses paid after the S election that would have been
deducted by an accrual method taxpayer before the S election are
deductible against recognized built-in gains.
Example #1: Liner, Inc., an S corporation sells a machine with basis of $4,000
for $10,000. The machine carried a built-in gain of $5,000. The corporation
pays built-in gains tax of $1,750 ($5,000 × 35%) on the $5,000 built-in gain
and passes $4,250 of gain ($6,000 – $1,750) through to its shareholders.
Example #2: TUGG, Inc., a cash basis S corporation collects $5,000 in accounts receivable for sales that occurred before the corporation elected S
status. In the same tax year, TUGG pays $2,000 in expenses that would have
been deductible prior to the S election if the taxpayer had been on the accrual
basis. The net built-in gain from these items for the year is $3,000 ($5,000
built-in gain – $2,000 built-in loss).
Exceptions: Built-in gains tax does not apply to gain from the sale
of standing timber or subsequently produced coal or domestic
iron ore (Rev. Rul. 2001-50). Similarly, the sale of oil and gas
subsequently produced from a working interest held on the date
of the corporation’s S election is not subject to the built-in gains
tax. [Reg. §1.1374-4(a)]
2011–2013
Temporary suspension. The BIG tax was suspended for certain
tax years for qualifying S corporations. BIG tax was not imposed
during 2009 and/or 2010 if the seventh tax year of the corporation’s 10-year recognition period ended before that tax year. For
tax years beginning in 2011, the BIG tax was not imposed if the
fifth year of the recognition period ended before that tax year. [IRC
§1374(d)(7)(B)]
,
s
is
Unless the S corporation’s 10-year recognition period expired in
2009, 2010 or 2011, the S corporation is again subject to the BIG
tax for the tax year beginning in 2012.
2014.
Example: XL, Inc., a calendar year C corporation, elected S status on March
1, 2002, effective January 1, 2002. The seventh tax year of XL’s 10-year
recognition period ended on December 31, 2008. Thus, XL’s net recognized
BIG during 2009―2011 was not subject to the BIG tax. XL’s 10-year recognition period ends on December 31, 2011, therefore XL is not subject to the
BIG tax for 2012.
2012 or 2013,
2012 Tax Year | Small Business Quickfinder ® Handbook D-7
Investment Credit Recapture Tax
The general business credit is composed of many different credits
(see Tax Credits on Page O-7 and Form 3800, General Business
Credit). Business credit recapture is the responsibility of the party
that claims the credit. Therefore, if a C corporation claims the credit,
the succeeding S corporation is responsible for the recapture. If
the company is an S corporation when the credit originates, the
credit passes through to the shareholders and they must report the
recapture; they remain responsible for the recapture if the S election terminates and the recapture occurs when the corporation is
in C status. See Form 4255, Recapture of Investment Credit, for
tax computation details.
LIFO Recapture Tax (IRC §1363)
A C corporation that accounts for inventory under the last-in first-out
(LIFO) method may be liable for LIFO recapture tax upon conversion to an S corporation. If the inventory amount using the first-in
first-out (FIFO) method is greater than the inventory amount using
LIFO at the time of conversion, the difference is subject to LIFO
recapture tax. See Form 1120S, line 22a instructions.
Estimated Tax Payments (IRC §6655)
If an S corporation is liable for any corporate-level taxes, estimated
payments may be required. The corporation is not required to make
estimated payments if the year’s tax liability is less than $500.
Total required estimated tax payments equal the lesser of:
1) 100% of current-year tax liability or
2) The sum of the following:
•100% of the current year tax if the only taxes taken into account were the taxes on built-in gains and recapture of business credits; and
•100% of the tax on excess net passive income that was shown
on the preceding year’s return.
Estimated tax payments for the tax on excess net passive income
can be based on the prior year’s tax, but not those for the built-in
gains tax and business credit recapture. [IRC §6655(g)(4)(C)]
Underpayment penalty is computed on Form 2220, Underpayment
of Estimated Tax by Corporations. If the corporation’s income varied during the year, the required estimated tax may be reduced by
using the annualized income installment method or the adjusted
seasonal installment method on Form 2220.
 Note: If the prior tax year was less than 12 months or there
was no tax, the amount of the required annual estimated tax must
be determined under method (1) above. Estimated payments are
due under the same payment schedule as with C corporations. See
Estimated Tax (IRC §6655) on Page C-2 for other rules.
Items that are subject to special exceptions or generally incurred
once or infrequently during a tax year should not be annualized.
In addition, the regulations allow taxpayers to make a reasonably
accurate allocation of certain income and expense items, and cover
other issues such as the adjusted seasonal installment method
and short tax years. [Reg. §1.6655-2, -3 and -5]
Reasonable Wages
An incentive exists for an S corporation to pay little or no wages
to shareholder employees. This is because wages are subject to
employment taxes (FICA and FUTA), while ordinary income passing
through to S corporation shareholders is not subject to employment
taxes, either at the corporate or the individual level. However, the
issue of reasonable wages frequently ends up in court, and several decisions have held for the IRS. When the IRS is successful
in recharacterizing distributions as wages, the S corporation and
employee are subject to employment taxes, as well as penalties and
interest for underpayment and failing to file employment tax returns.
D-8 2012 Tax Year | Small Business Quickfinder ® Handbook
Section 3121(a) defines wages as “all remuneration for employment.” For federal employment tax purposes, Section 3121(d)
defines an employee in part as any officer of a corporation. However, there is an exception to employee status for an officer who
performs no (or only minor) services [Reg. §31.3121(d)-1(b)]. For
additional information, see Reasonable Compensation in Tab 12
of the Tax Planning for Businesses Quickfinder® Handbook.
Establishing that Compensation is Reasonable
For compensation to be deductible, it must be reasonable for the
services actually rendered. The Code specifically empowers the
IRS to reallocate an S corporation’s income in family incomesplitting situations. Section 1366(e) provides that a member of
an S corporation shareholder’s family must receive reasonable
compensation for services rendered or capital furnished to the
corporation. This provision applies to family members whether or
not they own shares in the corporation. Under these rules, the IRS
can adjust income to reflect reasonable compensation for services
rendered or capital furnished to the corporation. Inadequate salary,
rent, or interest could result in reallocations by the IRS.
There is no rigid set of rules for measuring the reasonableness
of compensation. Each situation must be resolved based on its
unique facts and circumstances.
Several Tax Court decisions have focused on these factors:
•The character and financial condition of the corporation;
•The role the shareholder-employee plays in the corporation,
including position, hours worked and duties;
•The corporation’s compensation policy for all employees and the
shareholder’s salary history, including the internal consistency in
establishing the shareholder’s salary;
•How the compensation compares with similarly situated employees of other companies;
•Conflicts of interest in setting compensation levels and
•Whether a hypothetical, independent investor would conclude
that there is an adequate return on investment after considering
the shareholder’s compensation.
The courts have also considered additional factors in deciding
whether compensation is reasonable, including:
•The employee’s qualifications;
•The size and complexity of the business;
•A comparison of salaries paid to sales and net income;
•General economic conditions;
•Salaries versus distributions and retained earnings;
•The corporation’s dividend history;
•Whether employee and employer dealt at arm’s length;
•Corporate intent and
•Whether the employee guaranteed the employer’s debt.
No single factor controls, but rather a combination of the factors
must be considered. Furthermore, these factors are not all-inclusive
(and may not be given equal weight).
Wages should be justifiable. Anticipating an IRS attack and being
ready for it is the best assurance the wages paid will be deemed
reasonable. Wages should be set to accomplish the desired result
(for example, splitting income among family members by paying
higher wages or minimizing wages to an employee-shareholder to
reduce payroll taxes). However, the amount so determined should
consider the preceding factors, and the practitioner should decide
how to counter an IRS argument. Documentation of why the compensation is reasonable can be placed in the corporate minutes.
See Partnership vs. S Corporation—SE Tax on Page P-5 for
examples showing the difference in taxation of compensation
between partnerships and S corporations.
Income and Expense Chart for a Decedent (Continued)
Category
Medical Expenses
Where to Report
Final Form 1040, Schedule A
Form 706, Schedule K
Miscellaneous
Itemized Deductions
Partnership Income
(Loss)
Passive Losses
Form 1041
Final Form 1040
Real Estate,
State and Local
Income Taxes
Explanation
Medical expenses paid before death. Can elect to deduct medical expenses incurred before death but paid from the
estate within one year of the day following death [Reg. §1.213-1(d)]. Election does not apply to medical expenses
for dependents of the decedent. To elect, attach a statement to Form 1040 stating the estate has waived the right
to claim medical expense for estate tax. With the election, deduction is taken on Form 1040, Schedule A in year
costs were incurred (a Form 1040X may be needed).
Unpaid medical expenses at death are reported on Form 706 as a claim against the estate, unless an election is made
to report on decedent’s final Form 1040. Amounts deducted on Form 706 are not subject to the 7.5% AGI limitation.
If deduction taken on Form 1040, amount not allowed due to 7.5% AGI limitation cannot be claimed on Form 706.
Any insurance reimbursements after death of amounts previously deducted on Form 1040. Report as IRD.
Miscellaneous itemized deductions paid before death.
Form 706, Schedule J or Form Unpaid miscellaneous itemized deductions at date of death are reported on Form 706. When paid, deduct on
1041
Form 1041 as DRD.
Form 1041
Incurred and paid after death: may be subject to 2% AGI limit. See Deductions on Page G-5.
Final Form 1040, Schedule E
Form 1041 (or beneficiary’s
return)
Final Form 1040
Form 1041
Personal Residence
—Cash Method of Accounting—
Form 1041
Final Form 1040, Schedule A
Form 706, Schedule K and
Form 1041 (or beneficiary’s
return)
Form 1041 (or beneficiary’s return)
Final Form 1040, Schedule E
Rental Income
Form 706 and Form 1041 (or
and Expenses
beneficiary’s return)
Form 1041 (use Schedule E of
Form 1040)
S Corporation Income Final Form 1040, Schedule E
(Loss)
Income (or loss) up to date of death using any reasonable method of allocating income (loss). Allocation is often
based on pro rata amount for year or interim closing of books.
Income (or loss) after death not included on final Form 1040.
Losses are allowed to extent of passive income, plus accumulated unused losses to extent they exceed any
increase in basis allocated to the activity. For example, if a passive activity’s basis is increased $6,000 upon
taxpayer’s death, and unused passive activity losses as of date of death are $8,000, decedent’s deduction is
$2,000 ($8,000 – $6,000).
Estates are subject to the same passive loss limitation rules as individuals. The fiduciary’s level of participation
determines the classification. If decedent actively participated in a rental real estate activity before death, the
estate will be allowed the special $25,000 rental real estate exemption for up to two years after decedent’s death.
The Section 121 exclusion of gain from sale of personal residence does not apply to estates. If personal residence
is a capital asset to the estate (either held for investment or rental purposes), estate can deduct loss on sale. If
property is used by estate beneficiaries for personal purposes, loss on sale is not deductible. If home was not
subject to probate and passed directly to heirs, sale of home is reported on beneficiaries’ Form 1040.
Paid before death. General sales taxes deductible if state and local income taxes not deducted. [IRC §164(b)(5)]
Expired Provision Alert: The election to deduct state and local sales tax expired at the end of 2011. It’s possible
Congress will extend it to 2012, but had not done so at the time of this publication. See Expired Tax Provisions
on Page Q-1 for more information.
has been extended
Real estate taxes accrued before death but paid after death.
through 2013.
Accrued and paid after death.
Income and expenses received or paid before death.
Income and expenses accrued before death but not actually received or paid until after death (IRD and DRD).
Passive activity loss rules apply to estates (for Form 1041 reporting).
Income and expenses accrued and received or paid after death. Passive loss rules apply to estates.
Pro rata share of income (or loss) up to death. Generally, amount of income (or loss) is computed as follows:
S corporation income or loss for the year, divided by number of days in S corporation’s year, multiplied by number
of days shareholder was alive. Can elect under Section 1377(a)(2) to close S corporation books on day of death.
Form 1041 (or beneficiary’s return) Income (or loss) after date of death and not included on final Form 1040.
U.S. Savings Bond Final Form 1040 or Form 1041 Two options: (Rev. Rul. 68-145)
1) Executor elects to report interest accrued before death on final Form 1040. Interest accrued after death is
Interest (Decedent did
reported on Form 1041 (or beneficiary’s return) in year bond is redeemed or matures.
not elect to report
2) All interest (both before and after death) is reported on Form 1041 (or beneficiary’s return) in year bond
interest annually)
is redeemed, matures or an election is made to report income. Interest accrued before death is IRD.
Alternatively, recipient of an inherited bond can elect to report interest annually. (Rev. Rul. 64-104)
Form 706, Schedule B
FMV of bonds, including interest accrued up to date of death, which may be IRD.
Interest accrued up to date of death.
U.S. Savings Bond Final Form 1040
Form 1041 (or beneficiary’s
Interest accrued after death. Note that the last Series E bonds matured in 2010 and the last Series H bonds
Interest (Decedent
return)
matured in 2009. These bonds stopped paying interest at that time and any deferred interest should have been
elected to report
recognized on the 1040 in the year the bond matured.
interest annually)
Form 706, Schedule B
FMV of bonds as of date of death. No IRD.
Final Form 1040
Payments cease at death; therefore, subject to reporting on final Form 1040.
Social Security
Standard Deduction
Wages
Final Form 1040
Full amount allowed. No proration required.
Final Form 1040
Wages received before death.
Form 706, Schedule F and Form Wages earned before death but received after death (IRD).
1041 (or beneficiary’s return)
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2012 Tax Year | Small Business Quickfinder ® Handbook H-3
Death of a Taxpayer
Personal Representative Duties
The primary duties of a personal representative are to collect the
decedent’s assets, pay the decedent’s creditors and distribute
the remaining assets to the heirs and beneficiaries. The personal
representative is either the executor, a court-appointed estate representative or, if no probate proceeding is required, any person in
actual or constructive possession of the decedent’s property. The
personal representative is also responsible for filing tax returns
and paying tax on behalf of the decedent and estate. The IRS can
place a lien on all property included in the gross estate (including
property not subject to probate) and can collect tax up to 10 years
after death (IRC §6324). Thus, beneficiaries of estate assets are
ultimately responsible for the tax liabilities of the decedent and
estate to the extent of assets received. A personal representative
can be held personally liable for tax if estate assets are distributed
to beneficiaries or to creditors while taxes remain unpaid. See also
Who Files Return on Page H-6.
Estate Administration Step-By-Step
1) Locate will and codicils.
2) Make a preliminary inventory of the decedent’s assets and
liabilities. Determine which assets are probate assets (see
Probate Assets table on Page H-5). If the probate assets’
value is high enough to require probate under state law, apply
for probate.
3) Verify deadlines for probate and tax filings: (a) estate tax return
(if required), (b) gift tax return for decedent’s final year, (c)
fiduciary income tax return, (d) decedent’s final Form 1040, (e)
Forms 1040 and 709 for preceding years unfiled by decedent
and (f) GST tax return if taxable distribution or termination
occurred at death.
4) Obtain an employer identification number (EIN) and a state
identification number for the decedent’s estate if required.
See Employer Identification Numbers (EINs) on the inside
front cover for how to obtain an EIN.
5) Choose estate’s year end (Form 1041). Although the closing
month of the accounting year must be listed on Form SS-4,
the personal representative elects the year by filing the first
return, and is not bound by the month listed on Form SS-4.
6) Notify the IRS of fiduciary relationship (Form 56 can be used).
The IRS will send notices concerning the decedent’s tax liability to the decedent’s last known address until the notification
is filed. (Reg. §301.6903-1)
7) Locate and arrange to collect probate property. Open an estate
checking account and transfer assets to cover expenses.
8) Notify all payers who issued Form 1099 to the decedent
in the previous year of the decedent’s death. For probate
assets, provide the estate EIN and request that after-death
income be reported to the estate. For nonprobate assets,
provide the recipient’s Social Security number and request
that after-death income be reported to the recipient.
9) Notify all partnerships and S corporations in which the decedent held an interest.
10) Prepare a detailed inventory and valuation (see the Estate
Inventory Worksheet on Page A-11). Arrange for appraisals
of property if required for Form 706 or probate proceeding.
Nonprobate assets may also require valuation.
11) Request Form 712 for any life insurance policy on decedent’s
life. Notify life insurance company of death.
12) Obtain names, addresses and SSNs of all beneficiaries.
13) If the decedent was receiving Social Security benefits before
H-4 2012 Tax Year | Small Business Quickfinder ® Handbook
death, return any benefits received after death to the Social Security Administration.
14) Hold and manage property during probate and collect income.
15) If the estate is solvent and distributions are authorized by state
law, pay administration expenses as incurred, pay claims as
they are settled and make partial distributions to beneficiaries
if appropriate.
16) Sell property if assets are needed to pay expenses or claims
or if distribution in kind is not practical (check state law to
determine authority to sell).
17) File tax returns as they become due [Final Form 1040, Form
1041, Form 706 (if required) and Form 709 (if gifts made in
year of death)]. Make estimated tax payments if required for
any tax year ending two or more years after death.
18) Optional—Request prompt assessment under Section 6501(d)
to shorten the statute of limitations on income tax returns to
18 months (or the remainder of the original three years, if
less). File Form 4810 separately after the returns are filed.
Prompt assessment is available for Forms 1041, 1040 and
709 including returns filed by the decedent before death.
19) Optional—Request discharge from personal liability for estate
tax (under Section 2204) and for the decedent’s income and
gift taxes under Section 6905 by filing Form 5495. (Regs.
§20.2204-1 and §301.6905-1)
20) After final determination of estate tax liability and the expiration of the probate creditor claims period, prepare to close the
estate. Plan for payment of final expenses and taxes.
21) Pay any remaining claims against the estate.
22) Pay any specific gifts made by will.
23) Account to the heirs entitled to share the residual estate, and
distribute the estate assets according to the terms of the will
or state intestacy law.
24) Close probate. Estate administration generally ends either
by court order or after the personal representative submits
a closing document to the court. An estate can terminate for
federal income tax purposes before the administration ends
under state law [Reg. §1.641(b)-3]. An estate terminates for
income tax purposes when all assets have been distributed
except for a reasonable amount set aside in good faith for
payment of unascertained or contingent expenses. A personal
representative can file a final Form 1041 return even though a
set-aside amount is held in an estate account. After the estate
terminates for tax purposes, the beneficiaries report any gross
income, deductions and credits of the estate.
25) Notify the IRS that the fiduciary relationship has ended, with
a letter to the IRS stating that, “Pursuant to IRC §6903(a), the
fiduciary capacity has terminated.”
Taxable Income in the
Year of Death
If the decedent was a cash method taxpayer, income received
(actually or constructively) by the decedent through the date of
death is reported on the decedent’s final Form 1040. If the decedent
was an accrual method taxpayer, income accrued prior to death
is reported on the final Form 1040. After-death income is reported
on the return of the recipient of the income.
Estate. Income earned on decedent’s assets during the time they
are held by the probate estate is reported on the estate income
tax return (Form 1041). This period begins the day after death
and ends when the assets are distributed to the beneficiaries.
Income in respect of the decedent paid to the decedent’s estate
and capital gains and losses on assets sold by the estate are also
reported on Form 1041.
Section 179 Deduction
See Tab 10 in the 1040 Quickfinder® Handbook for Section 179
rules concerning:
•Qualifying and non-qualifying property.
•Limitations for using the Section 179 deduction.
•Maximizing benefits of Section 179—planning.
•Section 179 recapture.
See Tab 11 in the 1040 Quickfinder® Handbook for limits on Section 179 deductions for certain heavy vehicles, including SUVs.
Qualifying property threshold. Only 50% of the cost of qualified
zone property placed in service is counted when determining
whether the qualifying property threshold ($2,000,000 for 2011)
has been exceeded.
Increased limits also apply to certain qualified Section 179 disaster
assistance property. See Disaster Assistance Property in Tab 5 of
the Depreciation Quickfinder® Handbook.
Business Income Limitation
The Section 179 deduction cannot cause a business
loss [IRC §179(b)(3)]. The expense deduction is lim2010–2013
Section 179 Expense Limits
ited to taxable income computed as follows.
Overall expense limit. For tax years beginning in 2012, the anPartnerships. The income limitation is the aggregate
nual deduction limit is $139,000 ($500,000 for tax years beginning
of the partnership’s items of income and expense
in 2010 and 2011). A special $25,000 per vehicle limit applies to
from any trade or business the partnership actively
500,000
certain heavy vehicles (including SUVs).
conducted without regard to credits, tax-exempt
Exception: The Section 179 expensing limit was increased for
income, the Section 179 deduction and guaranteed
property placed in service in certain locations or businesses. See
payments.
Increased limits below. is
can
2010–2013
S corporations. The income limitation is the aggregate of the
Qualified real property limit. For purposes of the $500,000 limit
corporation’s items of income and expense from any trade or busifor tax years beginning in 2010 and 2011, qualified real property
ness the corporation actively conducted without regard to credits,
up to but not exceeding $250,000, could be treated as Section 179
is tax-exempt income, the Section 179 deduction and the deduction
2012 and 2013
property if the taxpayer elected.
 Expired Provision Alert: For 2011, qualified real property was for shareholder-employee compensation.
assigned a 15-year recovery period (SL depreciation required) and
C corporations. The income limitation is the corporation’s taxwas eligible for Section 179 expensing. It’s possible Congress
able income before the Section 179 deduction, net operating loss
will extend these rules to 2012, but had not done so at the time
deduction and special deductions, excluding items not derived
of this publication. See Expired Tax Provisions on Page Q-1 for
from a trade or business actively conducted by the corporation.
more information.
so elects
Qualified real property is limited to qualified:
Election
1) Leasehold improvement property,
The Section 179 election is made on an item-by-item basis for
2) Restaurant property and
qualifying property. The election is made by completing Part I of
3) Retail improvement property.
Form 4562. Section 179 elections made in any tax year beginning
In addition, the property must be depreciable, acquired for use in an
after 2002 and before 2013 can be revoked without the consent
active trade or business and not ineligible. Ineligible real property
of the IRS, including the election to treat real property as Section
includes property that is:
2014
179 property. [IRC §179(c)(2)]
1) Used predominantly to furnish lodging or in connection with
A taxpayer is allowed to make or revoke the expensing election
furnishing lodging.
on an amended return (Rev. Proc. 2008-54). Once the election is
2) Used outside of the U.S.
2013
revoked, however, it cannot be reinstated.
3) Used by certain tax-exempt organizations.
4) Used by certain governmental units, foreign persons or entities.
5) An air-conditioning or heating unit.
Partnerships and S Corporations
No unused amounts of the $250,000 real property limit may be
Partnerships and S corporations must apply the
carried over to tax years after 2011. Amounts that cannot be carried
annual deduction limit, qualifying property limit
over beyond that year will be treated as placed in service in 2011.
and business taxable income limit before passing
2012 and 2013 through any Section 179 expense. The limits then
Qualifying Property Limitation
apply separately to each individual partner or
The Section 179 deduction limit is reduced dollar-for-dollar to the
shareholder [Reg. §1.179-2(b) and (c)]. However,
extent the amount of qualifying Section 179 property placed in
an owner does not include his allocable share of
service during the year exceeds $560,000 (for 2012). Thus, the
the pass-through entity’s cost of qualifying property in determining
Section 179 deduction is completely phased out when the amount
whether his qualifying property additions exceed the threshold
of Section 179 property placed in service during the year exceeds
($560,000 for 2012). The cost of property that is not deductible
$699,000.
2,000,000
2,500,000
under Section 179 because of the business taxable income
Increased limits for qualified zone property. An enterprise
limitation may be carried over to the next tax year and added to
zone business that places qualified zone property in service in an
the cost of qualifying property placed in service in that tax year.
empowerment zone [IRC §1391(b)(2)] before 2012 can increase
Amounts carried over must be applied on a first-in first-out (FIFO)
its Section 179 deduction and qualified property limits. (See IRS
basis. If costs from more than one year are carried forward to a
Pub. 946.)
2014
subsequent year in which only part of the total carryover can be
 Expired Provision Alert: The increased limit for qualified zone
deducted, the costs being carried forward from the earliest year
property expired at the end of 2011. It’s possible Congress will exmust be deducted first.
$2,000,000
tend it to 2012, but had not done so at the time of this publication.
However, a partner or S shareholder who is passed through more
See Expired Tax Provisions on Page Q-1 for more information.
Section 179 deduction in a single tax year than what is allowed
Annual deduction limit. The annual Section 179 deduction limit is
on his return (after considering all his sources of the Section 179
increased by the smaller of:
deduction) cannot carry over the excess deduction. Instead, it
has been extended to 2013
•$35,000 or
is lost even though the partner or S shareholder must reduce
•the cost of Section 179 property that is also qualified zone prophis basis in the pass-through entity by the lost deduction. (Rev.
erty placed in service during the year). [IRC §1397A(a)]
Rul. 89-7)
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2012 Tax Year | Small Business Quickfinder ® Handbook J-3
Example: Martha is a 50% partner in Better Living Partnership. The partnership
netted $100,000 in profits in 2012 without regard to any Section 179 deduction.
The partnership elects to expense $139,000 under Section 179. The partnership is only permitted to pass through $100,000 to its partners because of the
income limit. The $39,000 excess Section 179 deduction is carried over to 2013
to be added to the 2013 partnership Section 179 deduction. Martha receives
a 2012 Schedule K-1 from the partnership reporting a $50,000 Section 179
deduction (50% of $100,000).
Martha is also a 100% shareholder of Insider Magazine, an S corporation. The
S corporation passes through $96,000 of Section 179 expense on her 2012
Schedule K-1. The $7,000 of excess Section 179 deductions passed through
to Martha ($250,000 + $296,000 – $139,000) is not deductible on her Form
1040, nor can it be carried over to her 2013 Form 1040. In addition, Martha
must reduce her basis in her partnership interest and S corporation stock by
the $7,000 unused Section 179 expense.
500,000
50,000
UNICAP Rules
457,000
457,000
Amounts allowed as a Section 179 deduction are not subject to
Section 263A uniform capitalization. [Reg. §1.179-1(j)]
Advantages of Electing Section 179
•May reduce business owner’s adjusted gross income (AGI), which
could increase deductions subject to limitations and phase-outs
based on AGI.
500,000
•May claim a full $139,000 Section 179 deduction even if the
qualifying property is placed in service on last day of tax year.
•May avoid the short-year depreciation rules.
•May avoid the mid-quarter convention depreciation rule.
•May avoid UNICAP rules.
•May avoid an AMT depreciation adjustment.
Recapture—Section 179 and
Listed Property
Section 179 Recapture
The Section 179 deduction must be recaptured as ordinary income
if business use of the property falls to 50% or less during its regular
MACRS recovery period. [Reg. §1.179-1(e)]
The amount originally deducted as Section 179 expense is reduced
by the depreciation on the same amount that would have been
allowed under regular MACRS, using the same property class and
recovery period as the underlying property. The excess is recaptured as ordinary income. The basis of the underlying property is
then increased by the recaptured amount.
Recapture Rule for Listed Property
If listed property (for example, autos, computers and entertainment
property) business use falls to 50% or less for any year during its
alternate MACRS recovery period, the excess depreciation must be
recaptured. (The recapture rule applies to listed property regardless
of whether a Section 179 deduction was claimed.) [IRC §280F(b)]
Excess depreciation is (1) the amount of depreciation (including
any Section 179 deduction) actually claimed in prior years, minus
(2) the amount of depreciation that would have been allowed using
straight-line depreciation under ADS.
Where to Report
When the qualified business use of an asset decreases to 50% or
less, the recapture amount is first entered on Part IV, Form 4797.
This amount is then reported as income on the form where the
deductions were originally claimed.
J-4 2012 Tax Year | Small Business Quickfinder ® Handbook
•If the form is Schedule C or F, the recaptured amount is subject
to self-employment (SE) tax.
•Recapture on Part IV of Form 4797 that is subject to SE tax for
a sole proprietor or a partner only applies when business use
drops to 50% or less. Section 179 property disposed of before
the end of its MACRS recovery period is not subject to Section
179 recapture if Section 1245(a) applies [Reg. §1.179-1(e)(3)].
Although Section 1245 recapture produces ordinary income, it
is not subject to SE tax. [Reg. §1.1402(a)-6]
Example #1: Apple Partnership bought office equipment on January 1, 2011,
for $10,000. The full $10,000 was deducted under Section 179 (which was
passed through to each partner on the partnership tax return). Each partner
was able to reduce his or her SE income by the amount of his or her distributive share of the Section 179 deduction. On January 2, 2012, the partnership
sold the office equipment for $10,000.
Total gain from the sale is determined by Section 1245(a) [see IRC §1245(a)(2)(C)].
It is therefore not considered Section 179 recapture, but it is subject to Section 1245
ordinary income recapture.
Example #2: Assume the same facts as Example #1, except that instead of
selling the office equipment, it was distributed to the partners, who in turn used
the equipment for personal purposes.
The partnership must now recapture the portion of the Section 179 deduction
that exceeds SL depreciation as income subject to SE tax.
Note: In the examples above, the income related to the sale or reduction in
business use is not included in the partnership’s ordinary income but instead
passes through to the partners as a separately stated income item, the tax
consequences of which depend on how much of the original Section 179
deduction the partner actually claimed on his or her return.
 Note: See Depreciation Recapture on Page J-6 for a discussion of the general depreciation recapture rules.
Short Tax Year—MACRS
A short tax year is any tax year with less than 12 full months. How a
short tax year affects MACRS computations depends on the nature
of the property and the applicable convention. The half-year, midquarter and mid-month conventions establish the date property is
treated as placed in service. Since a property’s recovery period
begins on the placed-in-service date, depreciation is allowed only
for that part of the tax year the property is treated as in service.
(Rev. Proc. 89-15)
A taxpayer may have a short tax year in these situations:
•The first or last year that a partnership, corporation or an estate
is in existence.
•The first year of a sole proprietorship, employee’s trade or business or individual’s rental activity.
•The final return of an individual.
•A year in which a taxpayer changes from a calendar year to a
fiscal year or vice versa.
 Note: In a short tax year, MACRS percentage tables cannot be
used except for property subject to mid-month convention (see below).
Mid-Month Convention
Property subject to the mid-month convention (271/2-year residential property and 311/2-year or 39-year nonresidential real property)
is treated as placed in service or disposed of on the midpoint of the
month it is placed in service or disposed of, regardless of whether
the tax year is a short one [IRC §168(d)(4)(B)]. (See IRS Pub. 946.)
Half-Year Convention
Under the half-year convention, treat property placed in service or
disposed of in a short tax year as placed in service or disposed of
on the midpoint of that year, which always falls on either the first
day or the midpoint of a month.
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Section 1245 Depreciation Recapture
Section 1245 property is personal property (either tangible or
intangible) that is (or has been) subject to depreciation or amortization. Examples include machinery, furniture, vehicles, livestock,
franchises, covenants not to compete and Section 197 goodwill.
When Section 1245 property is disposed of (whether by sale,
exchange or involuntary conversion) at a gain, the gain is treated
as ordinary income up to the lesser of: [IRC §1245(a)]
•The sum of all depreciation or amortization deductions allowed
or allowable (see Allowed or Allowable Depreciation on Page
J-6) or
•Gain realized on the disposition.
Any gain recognized that is more than the ordinary income from
depreciation recapture is a Section 1231 gain.
Section 1250 Depreciation Recapture
Section 1250 property is any depreciable real property that is not
and never has been Section 1245 property [Reg. §1.1250-1(e)].
Section 1250 property includes a depreciable leasehold of land or
of Section 1250 property. However, a fee simple interest in land is
not included because it is not depreciable.
Gain on the disposition of Section 1250 property is treated as
ordinary income to the extent of additional depreciation allowed
or allowable on the property.
Additional Depreciation
Section 1250 Property
Held one year or less
All the depreciation allowed or
allowable is additional depreciation.
Held longer than one year
Excess of the depreciation allowed or
allowable over the amount that would
have been allowed using the SL method.
Unrecaptured Section 1250 Gain
The term unrecaptured Section 1250 gain generally refers to gain
attributable to SL depreciation on real property. For noncorporate
taxpayers, this gain is treated as a capital gain subject to the maximum 25% rate [IRC §1(h)(1)(D)]. For how to calculate unrecaptured
Section 1250 gain, see Tab 7 in the 1040 Quickfinder® Handbook.
Depreciation Recapture—C Corporations
Section 1245 recapture is computed the same way for corporations
and individuals. However, Section 1250 recapture is different for C
corporations [and S corporations that were C corporations in the
last three years—IRC §1363(b)(4)].
Under Section 291(a)(1) for a sale of depreciable real estate that
is Section 1250 property, 20% of the excess of any amount that
would be treated as ordinary income under Section 1245, over
the amount treated as ordinary income under Section 1250, is
additional ordinary income.
Example: AT Inc., a C corporation, purchased a warehouse in 20X1 and
sold it in 20X5. The original cost was $327,000 and the property was sold for
$500,000. None of the gain is subject to regular Section 1250 recapture since
it was depreciated under MACRS (straight-line). However, a portion of the gain
is subject to ordinary income recapture under Section 291.
Sales price...........................................................................
Cost................................................................. $ 327,000
Accumulated depreciation............................... <   27,949>
Gain.....................................................................................
Ordinary income recapture if property were
Section 1245 property.......................................................
Portion of gain subject to Section 1250 recapture...............
Excess.................................................................................
Multiply by Section 291 percentage.....................................
Additional Section 1250 ordinary income recapture............
$ 500,000
< 299,051>
$ 200,949
$  27,949
0
27,949
×     20%
$   5,590
Note: For simplicity, the example above did not allocate an amount for land.
Replacement Page 01/2013
General Asset Account (GAA)
Depreciation
A group of similar assets may be combined in one account and
depreciated as a single item [IRC §168(i)(4); Temp. Reg. §1.168(i)1T(c)(2), effective January 1, 2012]. Depreciation is based on
the total combined basis of assets in the account. A Section 179
deduction does not prevent including the remaining basis of an
asset in a GAA. Assets can be grouped into one or more GAAs.
Assets that are eligible to be grouped into a single GAA may be
divided into more than one GAA. 2014, but may be applied to
tax years beginning after 2011
Grouping Assets
Assets that are subject to the Section 168(a) general depreciation system or the Section 168(g)
alternative depreciation system can be combined
in GAAs. An asset is included in the GAA only
to the extent of its unadjusted depreciable basis. See Tab 2 in the Depreciation Quickfinder®
Handbook for more information on depreciating
assets in GAAs.
Qualifying assets. To group depreciable assets into one or more
GAAs, they must have the following attributes in common: [Temp.
Reg. §1.168(i)-1T(c)(2)]
1) Depreciation method,
2) Recovery period,
2014 (2012 if the
taxpayer so elects)
3) Convention and
4) Tax year in which they were placed in service.
Prior to 2012, under the former regulations, assets had to be in
the same asset class in order to be grouped into a single GAA.
Election. To elect GAA treatment under Section 168(i)(4), check
the box on line 18 of Form 4562. The election is available each
year that new assets are placed in service.
Recordkeeping. Taxpayers must maintain records that:
1) Identify the assets included in each GAA,
2) Establish the unadjusted depreciable basis and depreciation
reserve of the GAA and
3) Reflect the amount realized on dispositions from each GAA.
Dispositions from a GAA
Under the temporary regulations, a disposition of an asset is deemed to occur when
(1) ownership of the asset is transferred
or (2) when the asset is permanently
withdrawn from use in the taxpayer’s trade
or business or from use in the production of
income. A disposition includes the sale, exchange, retirement,
physical abandonment or destruction of an asset; the transfer of
an asset to a supplies or scrap account; and the retirement of a
structural component of a building. [Temp. Reg. §1.168(i)-1T(e)(1)]
Disposition of a single asset from the account is treated as if the
asset has a zero basis. Thus, all sale proceeds are treated as
ordinary income.
Gain is recognized as ordinary income up to:
The total beginning basis of the account
+ Any expensed amounts subject to recapture as depreciation.
– Amounts previously recognized as ordinary income from
the sale of other property from the account.
Depreciation continues until the final asset in the GAA is disposed.
Any sale proceeds in excess of the original depreciable basis
are generally Section 1231 capital gains.
2012 Tax Year | Small Business Quickfinder ® Handbook J-7
Example: Hitek Corporation purchases 10 computers with a total depreciable
basis of $20,000. Hitek elects to group the computers into one GAA, which will
be depreciated under MACRS using 200% DB over five years.
First Year: GAA depreciation is $4,000.
Second Year: Hitek sells two computers for $5,000. The $5,000 amount realized is reported as ordinary income (on Part II of Form 4797) because it is
not more than the $20,000 total beginning basis of the account. Second-year
GAA depreciation is $6,400.
Third Year: Hitek sells seven computers for $16,000. Hitek reports $15,000
as ordinary income ($20,000 total beginning basis of the account minus
$5,000 previously recognized as ordinary income). The remaining $1,000
amount realized is a capital gain under Section 1231.
Third-year GAA depreciation is $3,840.
Fourth Year: Hitek sells the last computer for $2,000.
Fourth-year GAA depreciation in the year of disposition
is $1,152.
The disposition of the GAA results in a Section 1231 loss of $2,608 [$2,000
amount realized from sale of final asset minus adjusted basis of $4,608
($20,000 original cost less $15,392 depreciation claimed)].
Expensing Policy
In general, depreciation rules apply to assets that have a useful
life of more than one year. There is no minimum dollar amount in
the Code that provides an exception to this rule. A screwdriver,
for example, that costs $10 must be depreciated if its useful life
is more than one year.
Generally, no deduction is allowed for expenditures for (1) new
buildings or permanent improvements or betterments made to increase the value of any property or estate or (2) restoring property
or making good the exhaustion thereof for which an allowance has
been made [IRC §263(a)]. There are exceptions to this general
rule in Section 263 and elsewhere. A widely applicable exception
has long provided that amounts paid or incurred for incidental
repairs and maintenance of property are currently deductible, not
capital expenditures.
The Supreme Court has recognized the highly factual nature of
determining if expenditures are for capital improvements or deductible repairs. Following its lead, other courts have articulated
a number of ways to distinguish between deductible repairs and
capitalizable improvements. Despite the court-developed guidance and IRS regulations and rulings on the capitalization versus
deduction issue, whether a cost is an ordinary repair or should
be capitalized has continued to be a source of much controversy
and uncertainty. In December 2011, the IRS issued a third set
of proposed regulations, along with a matching set of temporary
regulations. The temporary regulations are effective for tax years
beginning in 2012. See Tab 1 in the Depreciation Quickfinder®
Handbook for more detailed coverage of the new temporary
regulations.
2014, but may be applied to
tax years beginning after 2011
Capital Improvements vs. Deductible
Repairs
What can be expensed currently? Taxpayers
generally may deduct amounts paid for repairs
and maintenance to tangible property if the
amounts paid are not otherwise required to
be capitalized under Section 263(a) or any other
provision of the Code or regulations. [Temp. Reg.
§1.162-4T(a)]
Repairs undertaken contemporaneously with improvements that do not directly benefit or are not incurred because
of the improvement do not have to be capitalized. [Temp. Reg.
§1.263(a)-3T(f)(3)]
J-8 2012 Tax Year | Small Business Quickfinder ® Handbook
What must be capitalized? Expenditures that result in any of
the following with respect to a unit of property [as defined in
Temp. Reg. §1.263(a)-3T(e) and discussed in Tab 1 of the Depreciation Quickfinder® Handbook] must be capitalized: [Temp.
Reg. §1.263(a)-3T(d)]
1) A betterment,
2) A restoration or
3) An adaptation to a new or different use.
If used for business or the production of income, these assets
may be depreciated.
Betterment. There is a betterment to a unit of property only if an expenditure results in any of the following: [Temp. Reg. §1.263(a)-3T(h)]
1) Amelioration of a material condition or defect that either existed
before the taxpayer’s acquisition of the unit of property or arose
during the production of the property.
2) A material addition to the unit of property.
3) A material increase in capacity, productivity, efficiency, strength,
quality or output of the unit of property.
Restoration. An amount is paid to restore a unit of property only
when it: [Temp. Reg. §1.263(a)-3T(i)]
1) Is to replace a component of a unit of property and the taxpayer
has properly deducted a loss for that component (other than a
casualty loss under Reg. §1.165-7).
2) Is to replace a component of a unit of property and the taxpayer
has properly taken into account the adjusted basis of the component in realizing gain or loss from the component’s sale or
exchange.
3) Is to repair damage to a unit of property for which the taxpayer
has properly taken a basis adjustment due to a casualty loss
(or relating to a casualty event) described in Section 165.
4) Returns the unit of property to its ordinarily efficient operating
condition if the property has deteriorated to a state of disrepair
and is no longer functional for its intended use.
5) Results in the rebuilding of the unit of property to a like-new
condition after the end of its class life.
6) Is for the replacement of a part or a combination of parts that
comprises a major component or a substantial structural part
of a unit of property.
Adaptation to a new or different use. Amounts paid to adapt
a unit of property to a new or different use must be capitalized.
Adapting a unit of property to a new or different use generally
occurs when an adaptation is not consistent with the property’s
intended ordinary use when it was originally placed in service.
[Temp. Reg. §1.263(a)-3T(j)]
Materials and Supplies
Materials and supplies used to improve tangible property must
generally be capitalized. [Temp. Reg. §1.263(a)-3T(c)(2)]
Other materials and supplies are treated as follows: [Temp. Reg.
§1.162-3T]
•The cost of incidental materials and supplies is deducted in the
year paid (or accrued if accrual-method taxpayer), provided income is clearly reflected. Materials and supplies are incidental if
carried on hand, and no record of consumption is kept or physical
inventory taken.
•The cost of non-incidental materials and supplies is deducted in
the year the item is used or consumed in the taxpayer’s business.
For more information see Materials and Supplies on Page O-3.
De Minimis Rule
Taxpayers are not required to capitalize items that would be
capitalized under the general rules if the de minimis rule applies.
Taxpayers can apply the de minimis rule to any tangible property
regardless of its cost, plus materials and supplies that the taxpayer
Replacement Page 01/2013
elects to include if the following requirements are met: [Temp. Reg.
§1.263(a)-2T(g)]
1) The business has an applicable financial
statement (AFS) as defined in the temporary
regulation and discussed in Tab 1 of the Depreciation Quickfinder® Handbook.
2) The business has a written accounting policy
in effect at the beginning of the tax year requiring it to expense items that cost no more than
a specified dollar amount on its applicable financial statement
and that policy is followed.
3) The total amount expensed under this rule in any tax year is
limited to the greater of (a) 0.1% of the taxpayer’s gross receipts
for federal income tax purposes or (b) 2% of the taxpayer’s
depreciation and amortization expense as determined on its
AFS.
N Observation: The de minimis rule may be of limited use to
many small businesses that do not have an AFS or written accounting policy in place at the beginning of the year.
Accounting method change. To recharacterize previously capitalized expenditures as currently deductible repairs, taxpayers must
request a change in accounting method on Form 3115, Application
for Change in Accounting Method. Temporary Regulation Section
1.162-4T covers the rules on changing accounting methods to
conform to the rules in the temporary regulations.
Amortization
Organizational and Start-Up Costs
Business start-up and organizational costs
are generally capital expenditures. However,
qualifying costs of up to $5,000 are deemed
deducted as a current business expense [IRC
§195(b)(1), 248(a) and 709(b)]. To qualify, costs
must be:
•A business start up cost,
•An organizational cost for a corporation or
•An organizational cost for a partnership.
Amounts in excess of $5,000 are amortized ratably over a
180-month period beginning with the month the business begins
operations. The $5,000 deduction is reduced (but not below
zero) by the amount total start-up or organizational costs exceed
$50,000. See Organizational and Start-Up Costs on Page M-6.
 Note: Syndication costs are capital expenses that cannot be
amortized. [IRC §709(a)]
Example #1: DNK, a calendar-year partnership
incurred start-up costs of $4,200 for the period
between February 5, 2012 and March 15, 2012.
On March 16, 2012, DNK opened its doors to the
public and began operating as a business. DNK
currently deducts its start-up costs in 2012.
Example #2: Assume the same facts as in Example #1, except that DNK’s
start-up costs were $53,000. DNK’s 2012 deduction is $4,833 [$5,000 – $3,000
(start-up costs in excess of $50,000) + $2,833 ($51,000 ÷ 180 × 10 months)].
Reporting Amortization
Amortization is reported in Part VI of Form 4562. For the first year
of amortization, a description of the cost must be included along
with the Code section allowing the deduction.
Code
Section
59(e)
167(h)
169
171
174
178
194
195
197
248
709
—
Description
Optional write off of certain tax preference items
Geological and geophysical costs
Pollution control facilities (limited by Section 291 for corporations)
Certain bond premiums
Research and experimental costs
Cost of acquiring a lease
Qualified forestation and reforestation costs
Business start-up costs
Goodwill and certain other intangible assets
Corporation organizational costs
Partnership organizational costs
Creative property costs (amortized pursuant to Rev. Proc. 2004-36)
Where to report. Report total amortization expenses from Form
4562 on the “Other deductions” line on the business tax return.
Intangible Assets—Section 197
Fifteen-year amortization beginning with the month the asset is acquired applies to the following intangible assets that are purchased
by a taxpayer (not self-created) in connection with acquiring assets
that make up a trade or business or a substantial part of a trade
or business: [IRC §197(a)]
•Goodwill, going-concern value or workforce in place.
•Covenant not to compete.
•Copyright or patent.
•Franchise, trademark or trade name.
•Customer based intangible (for example, composition of market
or market share).
•Supplier based intangible (for example, favorable contracts or
shelf space at retail outlet).
•License, permit or other right granted by a governmental unit.
•Business books and records, operating systems or any other
information base.
•Computer software acquired in connection with the purchase of
a business and not available to the general public.
The 15-year write-off period does not apply to movie or book
rights that are not included in the purchase price of a business.
Purchased mortgage servicing rights can be amortized over 108
months. [IRC §167(f)(3)]
Depletion
See also IRC §611, §612 and §613 and IRS Pub. 535
A depletion deduction is allowed only if a taxpayer has an “economic
interest” (generally as an owner or operator) in mineral property; an
oil, gas or geothermal well; or standing timber. [Reg. §1.611-1(b)]
Cost Depletion
Cost depletion is usually calculated by dividing the adjusted basis
of the mineral property by the total number of recoverable units in
the deposit, and multiplying the resulting rate per unit by:
1) Number of units sold for which payment is received during the
year, if cash method of accounting is used, or
2) Number of units sold, if accrual method of accounting used.
 Note: It is the taxpayer’s responsibility to prove, by using an
acceptable method, the number of recoverable units.
Percentage Depletion
Percentage depletion uses a certain percentage (specified for
each mineral) of gross income from the property each year. The
maximum depletion deduction under this method is 50% (100%
for oil and gas) of the taxable income from the property computed
2012 Tax Year | Small Business Quickfinder ® Handbook J-9
without the depletion deduction and without the manufacturing
deduction under Section 199. [IRC §613(a)]
The selected depletion percentages for the more common minerals
are listed in the table below.
Deposits
Percent
Sulfur and uranium; and, if from deposits in the United States,
22.0%
asbestos, lead, zinc, nickel, mica and certain other ores and minerals
Gold, silver, copper, iron ore and oil shale, if from deposits in the
15.0%
United States
Coal, lignite, sodium chloride and certain asbestos
10.0%
Clay and shale used in making sewer pipe or bricks or used as
7.5%
sintered or burned lightweight aggregates
Clay (used or sold in manufacture of drainage and roofing tile,
5.0%
flower pots and kindred products), gravel, sand and stone
Most other minerals and metallic ores
14.0%
Notes:
• For a complete list of minerals and their depletion rates see Code Section 613.
• Natural resources that do not qualify for percentage depletion include timber,
soil, sod, dirt, turf, water or similar inexhaustible sources.
Depletion allowed or allowable each year is the greater of percentage depletion or cost depletion. Also, depletion, whether cost or
percentage, is figured separately for each property.
Basis Limitation
Cost depletion deduction cannot exceed property’s basis. (IRC §612)
Percentage depletion reduces basis, but continues to be (1) computed (as long as there is gross income from the property) and (2)
deductible (as long as there is taxable income from the property),
even after the basis has been reduced to zero. [IRC §613(a)]
This means that a taxpayer could be entitled to neither percentage
depletion (if barred because of the lack of taxable income) nor
cost depletion (if barred because the mineral property’s adjusted
basis is zero).
Percentage Depletion Reduction—
Corporations
The percentage depletion deduction of a corporation for iron ore
and coal (including lignite) is reduced (that is, cut back) by 20%
of the excess of:
1) Amount of the percentage depletion deduction for the tax year
over
2) Adjusted basis of the property at the close of the tax year
(determined without the depletion deduction for the tax year).
[IRC §291(a)(2)]
 Note: The above cutback applies to an S corporation only if it
was formerly a C corporation and only for the first three tax years
it is an S corporation after a C tax year. [IRC §1363(b)(4)]
Form T (Timber)—Forest Activities Schedule
The cost depletion method must be used for timber depletion [IRC
§611(a)]. The depletion deduction is based on the taxpayer’s cost
or other basis in the timber, not including the cost of land.
Generally, Form T should be filed with the income tax return when
standing timber is sold or cut or when there are other timber
transactions.
Form T must be completed to claim a deduction for depletion of
timber or for depreciation of plant and other improvements that are
timber related, or to elect to treat the cutting of timber as a sale or
exchange under Section 631(a).
Oil and Gas
Percentage Depletion
Percentage depletion with respect to oil and gas properties is
available only to independent producers (generally working interest owners who are not retailers or refiners) and royalty owners.
J-10 2012 Tax Year | Small Business Quickfinder ® Handbook
The percentage depletion rate for oil and gas properties is 15% of
gross income (22% for natural gas sold under a fixed contract in
effect on February 1, 1975 and at all times thereafter). (IRC §613A)
A taxpayer’s depletable oil quantity is limited to average daily
production of 1,000 barrels [IRC §613A(c)]. For natural gas, the
average daily depletable quantity is 6,000 cubic feet times the
depletable oil quantity (1,000 barrels). If depletion is claimed on
both oil and gas production, the depletable oil quantity must be
reduced by the number of barrels (equivalent) used to figure the
depletable natural gas quantity.
See Depletion on Page J-9 for more information on depletion,
including cost depletion.
Marginal production properties. Producers of so-called marginal
production properties are eligible for a higher depletion rate when
the reference price of crude oil for the preceding calendar year is
below $20 a barrel [IRC §613A(c)(6)]. For 2012, however, there
was no adjustment, so the depletion rate on marginal production
was also 15%. (IRS Notice 2012-50)
Limits on depletion deduction. The oil and gas depletion deduction for independent producers and royalty owners is limited
to the lesser of:
•100% of taxable income from the property figured without the
depletion deduction and the Section 199 producer’s deduction
[IRC §613(a)] or
•65% of the taxpayer’s taxable income from all sources, computed
without the depletion deduction, the Section 199 producer’s deduction, any net operating loss carryback and any capital loss
carryback. [IRC §613A(d)(1)]
Any depletion not deductible because of the 65% of taxable income
limit can be carried over to the next tax year.
The 100% of taxable income limit for marginal production properties was temporarily suspended, effective for tax years beginning
in 2009, 2010 or 2011. [IRC §613A(c)(6)(H)]
 Expired Provision Alert: The temporary suspension of the
net income limitation expired at the end of 2011. It’s possible that
Congress will extend it to 2012, but had not done so at the time
of this publication. See Expired Tax Provisions on Page Q-1 for
more information.
Lease Bonuses and Advanced Royalties
Lease bonuses and advanced royalties are payments a lessee
makes, before production begins, to a lessor for the grant of rights
in a lease to extract oil and gas from leased property. A depletion
deduction is not allowed on income from oil and gas lease bonuses
and advanced royalties. [IRC §613A(d)(5)]
Geological and Geophysical (G&G) Costs
Oil and gas G&G costs are amortizable over 24 months using the
SL method and the half-year convention. For major integrated oil
companies, a seven-year amortization period is used. [IRC §167(h)]
Partnership and S Corporation Properties
The depletion allowance for partnership oil and gas property,
whether cost or percentage, must be figured separately by each
partner and not by the partnership. Only the partner will have the
necessary information to determine the 65% of taxable income
limitation. Each partner must also keep track of his proportionate
share of the adjusted basis of the partnership oil or gas property as
determined by the partnership agreement. Therefore, the partner
must reduce the share of adjusted basis of each property by the
depletion deduction each year.
Where to report. The oil and gas partner reports and deducts
depletion on Schedule E (Form 1040). The partner’s share of
the net income or loss from the partnership is also reported on
Schedule E as either passive or nonpassive.
The depletion allowance is figured separately by each S corporation shareholder in the same way as a partner in a partnership.
Replacement Page 01/2013
Employee Benefit Plans
See IRS Pubs. 535 and 15-B

Tab K Topics
Basics of Benefits....................................................Page K-1
2012 Fringe Benefits Comparison Chart.................Page K-2
Nondiscrimination Rules for Employee Benefits......Page K-3
2012 Employer and Self-Employed
Retirement Plan Chart...........................................Page K-4
Exceptions to 10% Withdrawal
Penalty Before Age 591/2.......................................Page K-5
2012 Medical Reimbursement Plan
Comparison Chart.................................................Page K-6
Tax-Free Fringe Benefits.........................................Page K-7
Dependent and Child Care......................................Page K-8
Educational Assistance Program.............................Page K-9
Adoption Assistance Program..................................Page K-9
Employee Achievement Awards...............................Page K-9
Meals and Lodging..................................................Page K-9
Health Insurance Benefits......................................Page K-10
Group Term-Life Insurance....................................Page K-12
Long-Term Care Insurance....................................Page K-12
Cafeteria Plans......................................................Page K-13
Nonqualified Deferred-Compensation Plans.........Page K-13
Employer-Provided Autos......................................Page K-14
Qualified Retirement Plans....................................Page K-16
Form 5500.............................................................Page K-18
Basics of Benefits
Employee Benefit Tax Planning
For guidance on tax planning using fringe benefits, see Tab 5 of
the Tax Planning for Businesses Quickfinder® Handbook. Tab 6 of
that Handbook covers tax planning with retirement plans.
Employer Deductions
Trade or business expenses are allowed as a deduction against
business income only if they meet the ordinary and necessary expense rules of Section 162. Section 162 applies to all businesses.
A necessary and ordinary expense that benefits an employee of
the business will also be deductible by the business, even if the
employee benefit is excluded from the employee’s taxable income.
Fringe Benefits (Fringes)
A fringe benefit is any compensation or other benefit received by
an employee that is not in the form of cash. Some fringe benefits
may be excluded from the employee’s gross income and therefore
are not subject to income tax. Other fringe benefits are taxable to
the employee. Fringe benefits are excludable from income only if
so specified by the Tax Code. The general rule to determine the
taxable portion of a fringe benefit is to subtract from the FMV of the
fringe benefit any amount that the (1) Code specifically excludes
from income and (2) recipient paid for the benefit.
U Caution: The receipt of cash by an employee is always taxable,
even if the employee uses the cash to purchase otherwise de minimis
benefits. For example, cash provided to an employee to buy theatre
tickets is fully taxable even though the value of the theatre tickets might
be excludable as a de minimis fringe benefit if provided in lieu of cash.
Owner/employer. From the perspective of an owner who is also an
employee of a business entity, a fringe benefit will generally provide
two favorable tax benefits. The fringe benefit is tax deductible by the
business that pays the expense, and tax free or tax deferred to the
employee who receives the benefit. For employment tax purposes,
a shareholder performing services for his or her corporation is
considered an employee; a partner or a self-employed individual
is not considered an employee. For fringe benefit purposes, the
same is generally true except for several specific exceptions. See
the 2012 Fringe Benefits Comparison Chart on Page K-2.
S corporation shareholders. For fringe benefit purposes, an S
corporation is treated as a partnership, and a greater-than-2%
shareholder is treated as a partner rather than an employee. The
term greater-than-2% shareholder includes individuals who are
considered to indirectly own stock under the constructive ownership rules of Section 318 (such as spouse, parents, children and
grandchildren of shareholder). (IRC §1372)
Fringe benefits subject to the 2% shareholder rules include:
•An accident and health plan. (IRC §105 and 106)
•Up to $50,000 of group term-life insurance on an employee’s life.
(IRC §79)
•Meals and lodging furnished for employer’s convenience. (IRC §119)
Inclusion in income. An S corporation that pays any of the above
expenses for the benefit of a more-than-2% shareholder must add
the cost to the employee-shareholder’s gross wage (Rev. Rul. 9126). The employee-shareholder must pay income tax on the benefit,
and the S corporation is allowed a tax deduction for wages paid. If the
requirement for exclusion under Section 3121(a)(2)(B) is satisfied,
these payments are not wages for Social Security and Medicare tax
purposes even though included for income tax purposes.
Partnerships have two choices:
1) If the payment of the expense is for the benefit of a partner
performing services for the partnership, the expense is considered a guaranteed payment to the partner, and deductible
by the partnership as such. The payments will not reduce the
partner’s capital account.
2) If the payments are paid based on the profits of the partnership
and not on services rendered by the partner, the expenses are
considered a reduction in distributions to the partner and are
not deductible as an expense by the partnership.
Example #1: S corporation, Chargit, is 100% owned by Charlie Garrit. The
corporation pays premiums on $75,000 of group term-life insurance each
for Charlie and the corporation’s other two employees. Because Charlie is a
more-than-2% shareholder, the corporation must add the cost of the entire
$75,000 insurance to Charlie’s wages. However, only the cost of the $25,000
excess is added to the wages of the non-shareholder employees. See Group
Term-Life Insurance on Page K-12.
Example #2: EJ owns 100% of the stock of EJ Horse Ranch, Inc., which is
a C corporation. The corporation requires that, as the only employee of the
business, EJ must live on the ranch for the convenience of the employer to care
for the horses. The cost of meals and lodging is deductible by the corporation,
and tax free to EJ as an employee of the corporation. (IRC §119)
Example #3: Assume the same facts as in Example #2, except that the
corporation is an S corporation. The S corporation deducts the expenses as
wages paid to EJ. The wage is taxable on EJ’s personal tax return.
Nondiscrimination Rules
The nondiscrimination rules are designed to prevent employers
from discriminating in favor of owner-employees or other key personnel. If an employee benefit plan is offered to every employee,
the plan is generally not considered a discriminatory plan. If the plan
is only offered to certain highly compensated or key employees,
the benefits may be taxable to those employees.
For rules that determine which employee benefits are taxable to
highly compensated or key employees, see the Nondiscrimination
Rules for Employee Benefits chart on Page K-3.
2012 Tax Year | Small Business Quickfinder ® Handbook K-1
2012 Fringe Benefits Comparison Chart
Employee Benefits
Benefit
Accident and
Health Insurance
Adoption
Assistance
Description
Who Is Considered an Employee?
Provision
Non-Owner Self-Employed
2
Employee
Individual 1 Partner
Tax free to the employee, subject to certain
restrictions.


Expenses connected with the legal
adoption of an eligible person.
Employer-paid expenses are tax free to the
employee, within certain dollar limits and an
AGI phase-out range.
Tax free or tax deferred to the employee.




May be tax deferred or taxable to the employee
depending on conditions.

4
Deferred
Compensation
Dependent Care
Assistance
Expenses for the care of a dependent
while the employee is at work.
Employees can pay for day care costs with
pre-tax earnings or employer contributions.


Tax free to the employee.


Employee
Achievement
Awards
EmployerProvided Vehicle
Minimal benefits, such as occasional
personal use of office equipment by
employee.
Educational costs, such as tuition, fees,
books, supplies, etc. Education does not
have to be job related.
Tangible personal property, such as a
watch, given to an employee for length of
service or safety achievement.
Cost of vehicle used by the employee for
business or personal purposes.
May be taxable or tax free to the employee
depending on conditions.

Group Term-Life
Insurance
Cost of term life insurance provided to the
employee.
Up to $50,000 of coverage tax free to the
employee.

Job Placement
Assistance
(Work. Cond.)
Cost of providing counseling on
interviewing skills, resume preparation,
secretarial services, etc.
Tax free to the employee unless the benefit is
conditional or received in lieu of some other
taxable benefit.

Meals and
Lodging
Meals and lodging provided to the
employee on the employer’s business
premises.

No-AdditionalCost Service
Hotel accommodations, telephone
services, and transportation by aircraft,
train, bus, subway and cruise liner.
On-Premises
Athletic
Facilities
Athletic facilities on the employer’s
business premises.
Tax free to the employee if furnished on
the business premises, furnished for the
employer’s convenience and—for lodging
only—as a condition of employment.
Value excluded from the employee’s gross
income if service is offered to public and
employer incurs no additional cost by offering
the service to the employee.
Tax free to the employee if the facility is
generally only used by employees, their
spouses, children, etc.
De Minimis
Fringe
Educational
Assistance
C Corporation
Shareholder 3
Cost of accident and health insurance
provided to employee.
Two or more benefits consisting of cash
and qualified benefits that the employee
can select.
Employee agrees to work now and defer
receipt of salary until a future date.
Cafeteria Plans
>2% S Corp.
Shareholder 3
Employer assistance payments of up to $5,250
are excluded from the employee’s gross
income.
Tax free to the employee up to a specified
dollar limit.
5
4, 6













5
4
5
4
5
4
5
4


7





8











The value of discounted price offered to the
employee is tax free to the employee when
certain conditions are met.




Amount received as payment or
Tax free to the employee.
reimbursement for expenses that would be
deductible under Section 217 if paid by the
240
individual employee.
Employer and/or employee contributions to Tax deferred to the employee until funds are
Qualified
withdrawn.
Retirement Plans an employer-sponsored retirement plan.

Qualified
Employee
Discounts
Goods and services the employer
generally offers to the public.
Qualified
Moving Expense
Reimbursement
Qualified
Transportation
Fringe
Retirement
Planning
Services
Working
Condition Fringe
Employer-provided commuter vehicle
transportation between the employee’s
residence and place of employment, transit
passes and qualified parking.
Retirement planning advice to the
employee and/or spouse.
Exclude $125 per month for 2012 for the
combined value of transit passes and
employer-provided transportation; $240 per
month in 2012 for qualified parking. (Rev. Proc
2011-52)
Tax free to the employee.
9, 10
11
9
11
9

11


12






13
13
13






; IRC §132
Property and services the employer provides Tax free to employee if it would have been
to employees to perform their jobs.
deductible as a business expense had the
employee paid for the goods or services.
8
5
5
5
5
3
4
An independent contractor who performs services for another company.
8 Includes currently employed employee, and any director of the employer.
A partner who provides services for the partnership.
9 Includes any individual currently employed by the employer, the spouse and dependent
children of the employee, any individual who was formerly employed by the employer and
Assumes S and C corporation shareholders are providing services as employees.
separated due to retirement or disability, and the surviving spouse of an employee who died
Not more than 5% of amounts paid by the employer during the year may be provided to
while employed or after separation due to retirement or disability.
more-than-5% owners (including their spouses and children).
10 Special rule for parents in the case of air transportation.
5
See Reg. §1.132-1(b)(2) and (4).
11 Includes the spouse and children of the partner.
6 Includes any currently employed person, retired, disabled or laid-off employee and any
12 An independent contractor can participate in his or her own plan, but cannot participate in
employee presently on leave (for example, armed forces).
another company’s plan as an independent contractor of that company.
7 Safety achievement awards cannot go to managerial, administrative, clerical or other
13 The IRS has not comprehensively defined “employee” under Section 132(m) for this benefit.
professional employees.
Note: The cost of employee fringe benefits is generally tax deductible to the employer, and tax free or tax deferred to the employee when certain requirements are met.
1
2
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Tax-Free Fringe Benefits
IRC §132
No-Additional-Cost Services
An employer may exclude the value of a no-additional-cost service
from an employee’s gross income if: [IRC §132(b)]
1) The service is offered for sale to customers in the ordinary
course of the line of business in which the employee is performing services and
2) The employer does not incur any substantial additional cost
(including foregone income and labor costs) in providing the
service to an employee.
Examples of no-additional-cost services: Excess capacity
services such as hotel accommodations, telephone services and
transportation by aircraft, train, bus, subway and cruise line.
Qualified Employee Discounts
Employees may exclude from gross income certain discounts on
the purchase of their employer’s goods or services if: [IRC §132(c)]
1) The discount received on property is not greater than the gross
profit percentage of the price at which the property is offered
for sale to the public.
2) The discount received on services is not greater than 20% of
the price at which the services are offered to the public.
To qualify for the tax-free benefit, the goods or services must be offered for sale to customers in the ordinary course of the employer’s
business. Furthermore, the discounts must be made available to
all employees, not just to officers, owners or highly compensated
employees [Reg. §1.132-8(a)]. However, the tax-free discount rule
does not extend to real property of any kind or personal property
held for investment (such as stocks or bonds).
Little value and frequency. The question of whether or not a
de minimis fringe benefit is of little value was addressed in Chief
Counsel Advice 200108042. A nonmonetary recognition award
having a fair market value (FMV) of $100 did not qualify as a de
minimis fringe benefit. (Informally, the IRS has indicated that this
does not mean that noncash awards with a FMV of less than $100
are de minimis.) Other examples of de minimis fringe benefits in
Regulation Section 1.132-6(e)(1) include theater and sporting
event tickets, which often exceed $100 in value. In Field Service
Advice 200219005, where meals and sporting event tickets were
determined to not qualify as de minimis fringe benefits, the FSA
stated in part: “The smaller in value and less frequently a particular
benefit is provided, the more likely that such a benefit is properly
characterized as a de minimis fringe benefit.”
Meal furnished for the convenience of the employer. Meals
provided under the convenience of the employer rules are a de
minimis fringe benefit excludable by the employee and fully deductible by the employer. See Meals and Lodging on Page K-9.
On-Premises Athletic Facilities
The value of athletic facilities provided by an employer to its employees is excluded from an employee’s income [IRC §132(j)(4)].
The facility must be located on premises owned or leased by the
employer, and substantially all of its use must be by employees,
their spouses and dependent children. The facility can be a tennis
court, gym, pool or golf course. This exclusion does not apply if
the facility is made accessible to the general public. The exclusion
does not apply to any residential use facility. For example, a resort
with athletic facilities does not qualify. [Reg. §1.132-1(e)]
Qualified Transportation Benefits
240
Employer-provided qualified transportation fringe benefits are
excludable from the employee’s income, up to certain limits.
Public transportation. Employers can provide up to $125 per
month in 2012 (Rev. Proc. 2011-52) to help employees defray the
Working Condition Fringe Benefits
costs of commuting. Employers can:
; IRC §132
An employer-provided service or property is tax free to an employee if it would have been deductible as a business expense by
1) Give tokens or transit passes each month to an employee for
the employee if paid out of his or her own pocket. [IRC §132(d)]
the monthly limit,
2)
Sell
tokens or transit passes to employees at a discount for the
Job placement assistance (Rev. Rul. 92-69). Job placement
monthly
limit or
services offered by employers are treated as a working condition
fringe as long as the services are geared to assisting employees
3) Reimburse employees up to the monthly limit for public comobtaining employment in the same line of work. The employer must
muting expenses.
also have a business purpose for providing the assistance, such as
 Caution: A cash reimbursement arrangement for transit passes
maintaining employee morale, promoting a positive public image,
is allowed as a qualified transportation fringe only if no vouchers
avoiding wrongful termination suits or fostering a positive work
or transit passes are readily available for direct distribution by the
atmosphere. The tax-free benefits include the value of counseling
employer to employees. [Reg. §1.132-9(b), Q/A-16(b)(1)]
on interviewing skills, resume preparation, and providing office
Commuter transportation. An employer may provide a commuter
space and secretarial services.
highway vehicle (van pool) for transportation of employees to and
from work. The combined value of employer-provided commuter
De Minimis Fringe Benefits
transportation and transit passes excludable from income is limited
These minimal benefits are so small that it would be unreasonable
to $125 per month for 2012. (Rev. Proc. 2011-52)
; IRC §132
or administratively impractical for an employer to account for the
To qualify, these requirements must be met: [IRC §132(f)(5)]
benefits. [IRC §132(e); Reg. §1.132-6(a)]
240 1) Vehicle must seat at least seven adults, including driver,
Examples:
2) 80% of van use must be for transporting employees to and from
•Occasional typing of personal letters by a secretary.
work and
•Occasional personal use of office equipment.
3) At least half of the seating capacity must be used by employees
•Holiday gifts of low-value noncash property, such as a turkey.
(excluding the driver).
•Occasional sports or theater tickets, employee parties, picnics.
Under the commuting valuation rule, each one-way trip is valued
•Coffee and donuts.
at a flat rate of $1.50 ($3.00 per round trip) (Notice 94-3). Workers
do not have to include either type of assistance in gross income,
•Flowers, fruit or similar items given on account of an illness.
as long as the statutory monthly limit is not exceeded. Amounts
•Group term-life insurance payable on the death of an employee’s
over the monthly limit are included in income and subject to federal
spouse or dependent if $2,000 or less. (IRS Notice 89-110)
income tax, federal withholding, FICA and FUTA.
Discounts may also be extended to retired or disabled former employees, surviving spouses and dependent children of employees.
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Qualified parking. In addition to transportation benefits, an employer may provide $240 per month in 2012 for qualified parking
expenses (Rev. Proc. 2011-52). This includes reimbursed costs
incurred at park and ride lots.
Employers can offer a choice between qualified parking as a taxfree fringe benefit or a taxable cash equivalent benefit.
Parking on or near the business premises of the employer or on
or near a location from which the employee commutes to work by
mass transit or by carpool qualifies. This provision means parking
costs at non-temporary work locations, which normally are not
deductible under Section 162(a), are excluded from employee
income when provided as a qualified transportation fringe benefit.
(Chief Counsel Advice 200105007)
Qualified bicycle commuting. Defined
as the purchase, repair, improvement
and storage of a bicycle regularly used for
travel between the employee’s home and
place of employment, qualified bicycle
commuting reimbursement is considered
a qualified transportation fringe benefit [IRC §132(f)]. The annual
limit per employee is $20 per month (maximum $240 during the
year); this amount is not indexed for inflation. The excess must
be included in income.
Unlike other qualified transportation fringe benefits that can be
provided to an employee simultaneously, qualified bicycle commuting cannot be used in conjunction with any other qualified
transportation fringe benefit.
The reimbursement period is the 15-month period beginning with
the first day of the calendar year. This means the employer has
until March 31st of the following year to reimburse its employees.
Use of electronic media. Revenue Ruling 2006-57 and INFO
2010-0146 provide guidance on use of smartcards, debit or credit
cards, or other electronic media to provide qualified transportation
fringes. The guidance is effective January 1, 2012, but may be
relied on by employers and employees for transactions occurring
before 2012. (Notice 2010-94)
Generally, if the cards can be used only to pay transit expenses,
the value of the card is excluded from the employee’s income and
substantiation of their use by the employee is not required.
Frequent Flyer Miles
The IRS has considered the issue of taxability of frequent flyer
miles that are received as the result of business travel and used
for personal purposes. The current position of the IRS is that frequent flyer miles are nontaxable. However, this does not apply to
frequent flyer mileage that is converted to cash (through employer
reimbursement) or awarded as an incentive award. If the IRS
reverses its position in the future and holds that the benefits are
taxable, it will not apply to prior years. (Announcement 2002-18)
Qualified Moving Expense Reimbursements
An employee may exclude from income any qualified moving
expense reimbursement. [IRC §3401(a)(19), 132(a)(6) and (g)]
Qualified moving expense reimbursements are amounts received
(directly or indirectly) from the employer as payment for expenses
that would be deductible moving expenses if paid by the employee.
These include:
1) Moving household goods and personal effects from the former
home to the new home and
2) Travel (including lodging) from the former home to the new home
[but not including meals—IRC §217(b)(1)].
Only reimbursements made under an accountable plan may be
excluded from income. Note: Nonqualified reimbursements must
be included in an employee’s wages.
K-8 2012 Tax Year | Small Business Quickfinder ® Handbook
Qualified Retirement Planning Services
Qualified retirement planning services are excludable from employees’ gross wages [IRC §132(a)(7) and (m)]. Qualified retirement
planning services is defined as “any retirement planning advice
or information provided to an employee and his spouse by an employer maintaining a qualified employer plan.” Qualified employer
plans include annuity plans, governmental plans, 403(b) annuity
contracts, simplified employee pensions (SEPs) and savings incentive match plans for employees (SIMPLEs).
 Note: The provision is not meant to include related services
such as tax preparation, accounting, legal or brokerage services.
Employer Provided Cell Phones
When an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the IRS will treat
the employee’s use of the cell phone for reasons related to the
employer’s trade or business as a working condition fringe benefit,
the value of which is excludable from the employee’s income.
The IRS will not require recordkeeping of business use in order
to receive this tax-free treatment. Rather, the key is to document
the substantial noncompensatory business reason for providing
the phone. In addition to the working condition fringe exclusion
for an employee’s business use of a cell phone, the IRS will treat
the value of any personal use of a cell phone provided by the
employer primarily for noncompensatory business purposes as
excludable from the employee’s income as a de minimis fringe
benefit. Again, recordkeeping of business use will not be required.
(Notice 2011-72)
 Note: IRS guidance does not address an employer provided
cell phone allowance for a stated dollar amount (such as $100 per
month). Without adequate substantiation, a stated dollar amount
cell phone allowance would most likely be taxable income to the
employee. Thus, employers who pay employees an allowance
should instead consider providing employees with cell phones
or reimbursing employees for reasonable cell phone expenses.
Additionally, although not addressed in the guidance, the IRS has
indicated informally that iPads and other tablets will be treated
like cell phones.
Dependent and Child Care
IRC §129 and 45F
Under a Section 129 dependent care plan, employees can exclude
from gross income up to $5,000 ($2,500 MFS) of employer-provided dependent care assistance as a tax-free fringe benefit. The
excludable amount is not subject to FICA, FUTA or federal income
tax withholding. The cost of the benefit may be paid through employer contributions to the plan, salary reductions under a cafeteria
plan or a combination of the two methods.
The exclusion may not exceed the earned income of the employee
or, if less, the earned income of his or her spouse. The plan must
only cover the same type of expenses that qualify for the dependent care tax credit, which is computed on Form 2441, Child and
Dependent Care Expenses.
General requirements:
1) Plan must be in writing and for exclusive benefit of employees.
2) Plan must provide reasonable notification of the availability and
terms of the program to eligible employees.
3) Employer must provide each employee, by the following January 31, with written statement of amounts spent for dependent
care assistance under the plan. Employer may report this
amount (or the amount deferred by the employee if the plan
was amended to include a grace period), on the employee’s
Form W-2 in box 10.
4) Plan may not discriminate in favor of highly compensated.
Special rules for qualified conservation contributions:
Costs of abandoned business restructuring. Generally, costs
incurred in investigating and pursuing mutually exclusive business
 Expired Provision Alert: Certain provisions of the qualified
restructurings (recapitalization, divestiture of business divisions,
conservation contribution deduction expired at the end of 2011.
etc.) must be capitalized as part of the cost of the completed
It’s possible Congress will extend them to 2012, but had not done
transaction. However, if such costs relate to a transaction that is
so at the time of this publication. See Expired Tax Provisions on
not completed, they can be deducted under Section 165 at the
Page Q-1 for more information.
2014
are
time the transaction is abandoned.
Before 2012, qualified conservation contributions that were not
have
deductible in the year made because of the applicable percentagesset cquisitions
of-income limitation on total contribution deductions had a 15-year
carryover period (rather than the usual five-year carryover period). is
Form 8594; see also IRC §1060
For individual taxpayers, a conservation contribution was taken into
Form 8594, Asset Acquisition Statement Under Section 1060, is filed
account for purposes of the 50%-of-AGI-limitation base (100% in the
by both the seller and the buyer of a group of assets that constitutes
case of farmers and ranchers) only after taking into account all other
an applicable asset acquisition. An applicable asset acquisition is any
contributions (which are subject to the five-year carryover period),
direct or indirect transfer of a group of assets that constitutes a trade
saving this contribution for deduction in later years (Notice 2007-50).
or business in the hands of either the seller or the buyer, and the purThe special 100% limit also applied to corporate farmers and ranchchaser’s basis in the assets is determined wholly by the amount paid
ers for whom it is especially beneficial, as deductibility of donations
for the assets. The purpose is to identify goodwill or going-concern
by corporations is generally limited to 10% of taxable income. [IRC
value that could be attached to the sale price of the business.
§170(b)(1)(E) and (b)(2)(B)]
applies
Differences in the buyer and seller amounts on Form 8594 can
give the IRS incentive to examine the transaction and make its
Abandonment or Worthlessness of
own allocations. To avoid drawing attention to the transaction, the
Investment Property—Ordinary vs. Capital Loss
buyer and the seller can agree in writing to specific allocations and
Sale of investment property at a loss is generally subject to capiprepare the Forms 8594 according to those allocations.
tal loss limits. However, if nondepreciable investment property is
The allocation is generally done under the rules of Section 338 and
abandoned or becomes worthless, the transaction may be eligible
Regulation Section 1.338-6 and is referred to as the residual method
for deduction as an ordinary loss. (Reg. §1.165-2)
(discussed below). Further guidance on the Section 338 rules is
Under the Regulations, ordinary loss treatment for worthless or
provided in Tab 9 of the Tax Planning for Businesses Quickfinder®
abandoned property applies to transactions that do not constitute
Handbook. If a written agreement is entered into and that agreement
a sale or exchange, even if the property is a capital asset.
differs from the residual method figures reported on Form 8594, the
Establishing abandonment. A taxpayer must show intent to abanwritten purchase agreement will take precedence (Peco Foods, Inc.,
don an asset and must overtly act to abandon it. Under Regulation
TC Memo 2012-18). As a practical matter, any taxpayer involved in
Section 1.165-1(b), the loss must be “evidenced by closed and
an asset acquisition who has a cost segregation study done on cost
completed transactions, fixed by identifiable events, and, ... actuallocation should do it before entering into a written agreement. The
ally sustained during the taxable year.” For example, a taxpayer
written agreement should match that cost segregation, and those
who deeded property to the taxing authorities was found to have
figures should be used for Form 8594 reporting to avoid unwanted
abandoned the property. [Jamison, 8 TC 173 (1947)]
IRS questions.
Dispositions must be carefully structured to achieve the desired tax
The taxpayer should be very careful in assigning allocations, as
effects. For example, a loss on investment property that is properly
the amounts agreed to become the tax bases of assets; changing
abandoned is treated as an ordinary loss. However, if the same
allocations (for example, to assign more to a depreciable asset
property is sold for $1, the loss is subject to capital loss limits.
and less to land) could result in an accounting method change.
Accounting method changes are discussed in Tab L.
Where to report. An individual’s deduction for abandonment or
Form 8594 is not required to be filed if:
worthlessness of investment property is taken as a miscellaneous
1) The acquisition is not an applicable asset acquisition (as defined
itemized deduction on Schedule A of Form 1040, subject to the
above),
2%-of-adjusted gross income (AGI) floor. The loss is reported on
2) The group of assets that constitutes a trade or business is exSchedule A rather than another form (such as, Form 4797) because
changed for like-kind property in a transaction to which Section
it is a Section 165(a) deduction. That Code section falls under Part
1031 applies (however, if Section 1031 does not apply to all
VI of Subchapter B of the Code, which covers itemized deductions
the assets transferred, Form 8594 is required for the group of
for individuals and corporations. Such deductions (unless another
assets to which Section 1031 does not apply) or
Code section, regulation or ruling, etc., requires they be reported
3)
A
partnership interest is transferred.
elsewhere on the return) are reported on Schedule A.
The
buyer’s
and seller’s Forms 8594 are filed with their tax returns
Abandoned/worthless securities. While losses under Section 165
for the year of the sale. If the amount allocated to any asset is
generally are ordinary, Section 165(g) provides that a capital loss
increased or decreased after Form 8594 is filed, a new Form 8594
results when a security that is a capital asset becomes worthless
must be filed (by attaching it to the tax return for the year of the
during the tax year. The worthless security is treated as if it was sold
increase or decrease) reporting the adjustment.
on the last day of the tax year. Some taxpayers have claimed ordinary
losses under Section 165(a) for abandoned securities, arguing that
Allocation Using the Residual Method
Section 165(g) applies only when a security becomes worthless,
Allocation of purchase price must be made to determine the buyer’s
not when it is abandoned. However, the IRS position is that, if the
basis in each acquired asset and the seller’s gain or loss on the
abandoned security is a capital asset, the loss is treated as a capital
transfer of each asset. The amount allocated to an asset, other
(not ordinary) loss on the last day of the tax year—the same as a
than intangible assets (goodwill and going-concern), cannot exceed
worthless security. To abandon a security, a taxpayer must permaits FMV on the purchase date.
nently surrender and relinquish all rights in the security and receive
Allocate the sale price in the following order (commonly
no consideration in exchange for the security. [Reg. §1.165-5(i)]
referred to as the residual method):
Class I assets are cash and general deposit accounts (including sav Note: See Revenue Ruling 93-80 for information about worthings and checking accounts) other than certificates of deposit held in
lessness or abandonment of partnership interests with liabilities
banks, savings and loan associations and other depository institutions.
versus without liabilities.
A
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A
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Class II assets are actively traded personal property within the
meaning of Section 1092(d)(1) and Regulation Section 1.1092(d)-1
[determined without regard to Section 1092(d)(3)]. In addition, Class
II assets include certificates of deposit and foreign currency even
if they are not actively traded personal property. Class II assets do
not include stock of target affiliates, whether or not actively traded,
other than actively traded stock described in Section 1504(a)(4).
Examples of Class II assets include U.S. government securities
and publicly traded stock.
Class III assets are assets that the taxpayer marks-to-market at
least annually for federal income tax purposes and debt instruments (including accounts receivable). However, Class III assets
do not include (1) debt instruments issued by persons related at
the beginning of the day following the acquisition date to the target
under Section 267(b) or 707; (2) contingent debt instruments subject to Regulation Sections 1.1275-4 and 1.483-4, or Section 988,
unless the instrument is subject to the noncontingent bond method
of Regulation Section 1.1275-4(b) or is described in Regulation
Section 1.988-2(b)(2)(i)(B)(2); and (3) debt instruments convertible
into the stock of the issuer or other property.
Class IV assets are stock in trade of the taxpayer, other property
of a kind that would properly be included in the inventory of the
taxpayer if on hand at the close of the tax year, or property held by
the taxpayer primarily for sale to customers in the ordinary course
of its trade or business.
Guidelines for determining FMV of inventory. The IRS has
issued a revenue procedure setting forth guidelines in making a
FMV determination for inventory items when a taxpayer acquires
the assets of a business for a lump sum. Three basic methods a
taxpayer may use are replacement cost method, comparative sales
method and income method. (Rev. Proc. 2003-51)
Class V assets are all assets other than Class I, II, III, IV, VI and
VII assets.
Class VI assets are all Section 197 intangibles (as defined in Section 197) except goodwill and going-concern value. See Section
197(e) for further information on exceptions.
Section 197 intangibles include:
•Workforce in place.
•Business books and records, operating systems or any other
information base, process, design, pattern, know-how, formula
or similar item.
•Any customer-based intangible.
•Any supplier-based intangible.
•Any license, permit or right granted by a government unit.
•Any covenant not to compete entered into in connection with the
acquisition of an interest in a trade or a business.
•Any franchise, trademark or trade name.
Class VII assets are goodwill and going-concern value (whether
or not the goodwill or going-concern value qualifies as a Section
197 intangible).
 Note: If an asset can be included in more than one class,
choose the lower numbered class (for example, if an asset could
be included in Class III or IV, choose Class III).
Court Cases: Corporation did not own intangibles. A corporate CPA firm distributed its assets to its shareholders in complete liquidation of the corporation.
The corporation discontinued its business operations, but did not dissolve the
corporation. However, the CPA-shareholders continued to render services to the
clients of the corporation. In determining the gain recognized by the corporation
upon the liquidation of the corporation, the taxpayer maintained that the corporation did not own the intangibles of the corporation—client base, workpapers and
goodwill. Rather, the corporation’s position was that the accountants themselves
owned the intangibles, and therefore the corporation did not realize any gain
attributable to these intangibles. The court agreed with the corporation and held
that when the business of the corporation is dependent upon its key employees,
there is no salable goodwill, unless they enter into a covenant not to compete
with the corporation or an employment contract with the corporation. [Norwalk,
TC Memo 1998-279 (1998); Martin Ice Cream Company, 110 TC 189 (1998)]
Continued in the next column
N-16 2012 Tax Year | Small Business Quickfinder ® Handbook
Proceeds from sale of goodwill were ordinary income. If there is a covenant not
to compete, it is very difficult for a taxpayer to argue successfully that goodwill
is a personal asset, and thus, distribution of sale proceeds for goodwill should
be treated as long-term capital gain. In the Howard case, a covenant not to
compete did exist, and the court upheld the IRS’s position that proceeds of
the sale of goodwill associated with a dental practice were corporate income
taxable as a dividend when distributed to the shareholder. [Howard, 106 AFTR
2d 2010-5533 (DC Wash. 2010, aff’d 108 AFTR 2d 2011-5993 (9th Cir. 2011))]
Example: Elroy sells his business to Ted for $200,000. The business consists
of the following assets:
Asset
FMV
Checkbook balance...................... $ 10,000
5,000
Accounts receivable......................
25,000
Inventory...................................
15,000
Office equipment and furniture.........
80,000
Building.....................................
20,000
Land........................................
Total......................................... $ 155,000
The difference between the FMV of the above assets (Class I through VI) and
the selling price ($200,000 – 155,000 = $45,000) is allocated to Class VII,
goodwill and going-concern.
Allocating sales price amount to specific assets sold. Under
Section 1060, an allocation of the total sales price to the individual
assets sold within Classes I through VII must be made. This is not
done on the buyer’s or seller’s Form 8594, which generally deals
with aggregate amounts allocated to the classes of assets. Instead,
these calculations are performed in the tax workpapers that support
the amount of sales price allocated to each asset. See Worksheet
to Allocate Purchase/Sale Price to Specific Assets on Page N-18.
Valuation
The valuation of each asset is generally the FMV on the date of
sale. Fair market value is defined as the price at which the property
would change hands between a willing buyer and a willing seller,
neither being under any compulsion to buy or to sell and both
having reasonable knowledge of relevant facts.
It is recommended that the buyer and seller obtain a professional
appraisal of each asset. An improper valuation could result in
reclassification by the IRS. The allocation may also affect estate
valuations for estate tax planning purposes. Noncompete covenants in purchase agreements can be treated as a capital asset
to the purchaser and seller, if the covenant is closely related to the
sale of business goodwill. For the seller, the amount assigned to
the noncompete covenant could result in capital gain treatment.
Section 197 Intangible Assets
Amortizable Section 197 intangibles such as goodwill, customer
lists and a covenant not to compete are defined as assets that are
acquired. Amortizable Section 197 intangibles do not include selfcreated intangibles. [IRC §197(c)(2)]
When a buyer purchases Section 197 intangible assets, a subsequent loss on the sale of a Section 197 intangible is not allowed
if one or more of the other Section 197 intangibles are retained
[IRC §197(f)(1)(A)]. The loss is treated as a basis adjustment to
the remaining Section 197 intangible assets.
Stock Redemption
A stock redemption can be construed as an indirect acquisition of a
trade or business, thus requiring covenant not to compete payments
payable over a five-year period to be amortized over 15 years pursuant to Sections 197(a) and 197(d)(1)(E) [Frontier Chevrolet Co.,
91 AFTR 2d 2003-2338 (9th Cir. 2003)]. In other words, covenant not to
compete payments must be amortized over 15 years regardless of the period of the covenant—Section 197 trumps the covenant agreement. See
Covenants not to compete on Page N-10 for additional considerations.
Successor Liability Laws
Successor liability laws transfer responsibility for payment of certain business debts to the new owner when a business is sold.
Anyone considering buying a business should check for possible
liens, back taxes, penalties or fines that may be transferred upon
purchase. Laws vary from state to state.
@ Strategy: A representative for the acquiring company who is fa-
miliar with IRS procedures should obtain a power of attorney from the
company being acquired. Copies of tax records can then be obtained
and examined for back taxes, interest, penalties or possible audit items.
U Caution: Liabilities assumed by a purchaser are not necessarily limited to the amount of liabilities that are known at the time.
@ Strategy: To diminish risks created by the successor liability
laws, the acquiring company should acquire the target company
with an asset purchase rather than a stock purchase, if possible.
Installment Sales (Form 6252)
The installment method allows a taxpayer selling a business in
exchange for a note to defer the recognition of gain until payment
is actually received (IRC §453). The buyer would like the seller to
finance the sale rather than obtain financing through a bank or other
lending institution, which generally means strict loan qualification
procedures and credit checks. The seller may want to spread the
gain out over a number of years to minimize the effect of subjecting
other income to higher ordinary income tax rates, such as Social
Security benefits, investment income and retirement plan distributions. However, the seller takes on all the risk.
Repossession. If the seller has to repossess the business, the
seller will recognize gain to the extent payments received prior to
the repossession exceed gain already reported under the installment method, limited to the initial gain on the sale minus the sum of
(1) repossession costs and (2) gain on the sale reported as income
before the repossession. The seller also could lose a substantial
amount of the value of goodwill due to the buyer’s negligence in
operating the business. Such a risk should influence the negotiations between the buyer and seller in valuing the various assets
in the original sales contract.
The installment method does not apply to assets that produce
ordinary income when sold. Only capital gains may be reported
under the installment method. Any ordinary income as a result of
the sale of a business asset must be reported as income in the
year of sale, regardless of when payment is actually received.
Ordinary income in a sales contract may be produced by:
•Inventory.
•Accounts receivable.
•Depreciation recapture.
@ Strategy: The seller should obtain a sufficient down payment
from the buyer to cover the tax liability on ordinary income in the
year of the sale.
Sale of business. If multiple assets are sold in a single sale
(such as the sale of an entire business), the seller must determine
whether the installment method can be used to report the sale of
each asset. The buyer and seller must use the residual method to
allocate the sale price. See Allocation using the Residual Method
on Page N-15.
Installment method reporting. Income from an installment sale
is reported on Form 6252, Installment Sale Income. Dispositions of
eligible property by an installment sale must be reported using the
installment method unless the taxpayer makes an election not to
use installment method reporting [IRC §453(d)]. Generally, such an
election is irrevocable, but exceptions do exist. The IRS allowed a
taxpayer to revoke the election out when the taxpayer acted as soon
as he became aware that his accountant had mistakenly elected out
of installment method reporting. The request was granted because
the reason for revoking the election was not a desire to avoid tax
but was based on the accountant’s mistake. (Ltr. Rul. 200813019)
Reporting Requirements for Certain
Acquisitions
Certain domestic corporations involved in an acquisition of control
or a substantial change in capital structure must file Form 8806,
Information Return for Acquisition of Control or Substantial Change
in Capital Structure (Reg. §1.6043-4). This reporting requirement
applies to acquisitions involving acquired stock with a FMV of $100
million or more and changes in which the shareholders receive
cash or property (including stock) of $100 million or more.
Tax Treatment of Assets Included in Sale of a Business
Asset
Buildings and
building
components
Buyer’s Tax Treatment
Depreciable over 39 years.
Seller’s Tax Treatment
Long-term gain attributed to depreciation is unrecaptured Section 1250 gain. Maximum
individual capital gain rate on unrecaptured Section 1250 gain is 25% for 2012.
500,000
Long-term gain in excess of depreciation is a capital gain under Section 1231. Maximum
individual capital gain rate on Section 1231 property is 15% for 2012.
Land
Nondeductible—cost is capitalized and recovered when Long-term gain is Section 1231 gain. Maximum individual capital gain rate on Section
sold.
1231 property is 15% for 2012.
Equipment and
Depreciable—generally over five or seven years unless Gain attributed to depreciation is ordinary income under Section 1245. Maximum
vehicles
other class life applies. For 2012, up to $139,000 may
individual ordinary income tax rate is 35% for 2012.
qualify for current expense deduction under Section 179. Long-term gain in excess of depreciation is a capital gain under Section 1231. Maximum
individual capital gain rate on Section 1231 property is 15% for 2012.
Inventory
Added to cost of goods—deductible when sold to customers. Gain is ordinary income. Maximum individual ordinary income tax rate is 35% for 2012.
Intangible assets
Amortizable over 15 years as Section 197 intangibles.
Long-term gains on self-created intangibles are generally considered capital gains. Top
such as goodwill,
individual capital gain rate is 15% (for 2012). Exception: Income from a covenant not to
covenant not to
compete is generally ordinary income, not subject to SE tax, maximum rate of 35%. [Barrett,
compete, copyright,
58 TC 284 (1972), acq. 1974-2 CB 1]. However, if a noncompete agreement cannot be
patent, customer list,
clearly distinguished from a consulting agreement or other agreement entered into at
employee contract,
the same time, payments under the noncompete agreement could be subject to SE tax.
franchise, trademark
Gain on acquired intangibles attributed to amortization is ordinary income under Section
or trade name
1245. Maximum individual ordinary income tax rate is 35% for 2012.
Long-term gain on acquired intangibles in excess of amortization is a capital gain under
Section 1231. Maximum capital gain rate on Section 1231 property is 15% for 2012.
Notes:
• A loss on the sale of any business asset is an ordinary loss under Section 1231. Ordinary losses are deductible against other ordinary income.
• A loss is not allowed on the disposition of a Section 197 intangible asset that was acquired in a transaction with other Section 197 intangibles that the taxpayer retains.
The basis of the retained Section 197 intangibles are increased by the unrecognized loss.
• A short-term gain on the disposition of any business asset is subject to ordinary income tax rates.
• If a building component is portable and removable, it may be considered separate and qualify as equipment rather than as a part of the building. Examples include
window air conditioners, movable partitions, movable shelving, window blinds, etc. Buyer should consider a cost segregation study to identify components.
• If the seller is a C corporation, capital gains and ordinary income are taxed at the same rate. A net capital loss is nondeductible and must be carried back three years
and forward five years. [IRC §1212(a)(1)]
Replacement Page 01/2013
2012 Tax Year | Small Business Quickfinder ® Handbook N-17
Worksheet to Allocate Purchase/Sale Price to Specific Assets
See Allocating sales price amount to specific assets sold on Page N-16.
Taxpayer:
Date:
Explanation: Complete this worksheet to use the Section 1060 residual method to allocate purchase/sale price when assets comprising a trade or business are bought or
sold. The buyer uses this worksheet to allocate purchase price to establish the tax basis of each acquired asset. The seller uses this worksheet to allocate the sale price to
individual assets to compute gains and losses on the sale.
1) Identify total purchase/sale price. This amount is available for allocation to all asset
classes.
2) List aggregate FMV of Class I assets (cash and general deposit accounts).
Purchase Price
Allocated
to Specific
Assets in Class
Aggregate
Purchase
Price Amounts
<
>
3) Allocate line 2 amount to specific Class I assets dollar for dollar. Total should equal
line 2 amount.
4) Remaining purchase/sale price after allocation to Class I assets (line 1 – line 2).
This is the aggregate amount available for allocation to Class II assets.
5) List lesser of line 4 or aggregate FMV of all Class II assets (actively traded personal
property, CDs, U.S. government securities, publicly traded stock, foreign currency).
6) Fill in FMVs of specific assets using third column. Allocate amount from line 5 to
specific Class II assets in proportion to FMV using second column. Allocations cannot exceed FMV. Total for second column should equal line 5 amount.
7) Remaining purchase/sale price (if any) after allocation to Class II assets (line 4 –
line 5). This is the aggregate amount available for allocation to Class III assets.
8) List lesser of line 7 or aggregate FMV of all Class III assets (assets taxpayer marks
to market at least annually for federal income tax purposes and debt instruments,
including accounts receivable).
9) Fill in FMVs of specific assets using third column. Allocate line 8 amount to specific
Class III assets in proportion to FMV using second column. Allocations cannot
exceed FMV. Total for second column should equal line 8 amount.
10) Remaining purchase/sale price (if any) after allocation to Class III assets (line 7 –
line 8). This is the aggregate amount available for allocation to Class IV assets.
11) List lesser of line 10 or aggregate FMV of all Class IV assets (stock in trade, other
property properly includable in inventory if on hand at end of tax year, property
primarily for sale to customers).
12) Fill in FMVs of specific assets using third column. Allocate line 11 amount to specific
Class IV assets in proportion to FMV using second column. Allocations cannot
exceed FMV. Total for second column should equal line 11 amount.
13) Remaining purchase/sale price (if any) after allocation to Class IV assets (line 10 –
line 11). This is the aggregate amount available for allocation to Class V assets.
14) List lesser of line 13 or aggregate FMV of all Class V assets (assets not in any
other asset class). Class V includes land, equipment, other hard assets and
intangibles not included in Classes VI or VII (intangibles that are not Section 197
intangibles).
15) Fill in FMVs of specific assets using third column. Allocate line 14 amount to specific Class V assets in proportion to FMV using second column. Allocations cannot
exceed FMV. Total for second column should equal line 14 amount.
16) Remaining purchase/sale price (if any) after allocation to Class V assets (line 13 – line
14). This is the aggregate amount available for allocation to Class VI assets.
17) List lesser of line 16 or aggregate FMV of all Class VI assets (amortizable Section
197 intangible assets other than goodwill and going concern value).
18) Fill in FMVs of specific assets using third column. Allocate line 17 amount to specific Class VI assets in proportion to FMV using second column. Allocations cannot
exceed FMV. Total for second column should equal line 17 amount.
<
<
<
<
<
19) Remaining purchase/sale price (if any) after allocation to Class VI assets (line
16 – line 17). This is aggregate amount available for allocation to Class VII assets
(goodwill or going concern value). Place this amount in first, second, and third
columns. You should now have allocated entire purchase price.
FMV of
Specific
Assets in Class
>
>
>
>
>
Note: Total of lines 2, 5, 8, 11, 14, 17 and 19 from first column should equal total purchase price. Total of lines 3, 6, 9, 12, 15, 18 and 19 from second column should also
equal total purchase price. Total of third column may differ from total purchase price if less than full FMV was paid.
N-18 —End of Tab N—
2012 Tax Year | Small Business Quickfinder ® Handbook
Deductions, Credits and Books vs. Tax

Tab O Topics
Business Tax Deductions........................................ Page O-1
U.S. Production Deduction..................................... Page O-4
Tax Credits.............................................................. Page O-7
Selected Energy Tax Incentives for Businesses..... Page O-7
Net Income per Books vs. Taxable Income............Page O-11
Business Tax Deductions
Accountable plan. Employer reimbursements for an employee’s
business expenses are deductible by the employer and not included in the employee’s income. The expenses must have a business
purpose and be substantiated by the employee, and the employee
must return any excess reimbursements within a reasonable
period of time. See Tab 9 of the 1040 Quickfinder® Handbook for
more information. If the expenses are not substantiated or excess
expenses are not returned within the required period of time, the
expenses are treated as paid under a nonaccountable plan. See
Nonaccountable plan on Page O-3.
Advertising. Advertising costs that relate to business activities
are deductible as current operating expenses. Advertising is not
capitalized under UNICAP. Advertising to influence legislation is
not deductible. Prepaid advertising costs are deductible in the year
to which they apply.
2014, but may be applied to
tax years beginning after 2011
Amortization. See Tab J.
Attorneys, etc. See Lawyers’ costs incurred on behalf of clients
and Legal and professional fees on Page O-3.
Auto expenses. Passenger automobiles rated at or below an
unloaded gross vehicle weight of 6,000 pounds are listed property
[IRC §280F(d)(5)]. Deduction limits and substantiation requirements apply.
The value of an employer-provided vehicle must generally be
included in the employee’s wages. See Employer-Provided Autos
on Page K-14 for more information.
Self-employed individuals, including partners in a partnership, and
employees who do not use more than four vehicles at a time for
business are allowed to compute their deduction using the standard
mileage rate. The 2012 standard mileage rate is 55.5¢ per mile
(Rev. Proc. 2010-51 and Notice 2012-1). The IRS no longer updates
mileage rates each year in a revenue procedure. Therefore, the
rules in Rev. Proc. 2010-51 remain in effect until superseded, and
the IRS publishes subsequent notifications as needed. Generally,
a corporation can deduct 100% of the costs associated with an
auto. The business portion of the employee’s use is deductible
as a transportation expense while the personal use is deductible
either as additional compensation or as a taxable fringe benefit.
Awards and bonuses. Bonuses paid to employees are deductible
if intended as additional pay for services. Gifts to employees or
customers are limited to $25 per year, per individual [IRC §274(b)].
Cash or gift certificates given to employees must be treated as taxable wages. Also see Employee Achievement Awards on Page K-9.
Bad debts—business. See Business Bad Debts on Page O-12.
Barrier removal for disabled or elderly. Up to $15,000 of the
cost of removing barriers to make a facility more accessible for
disabled or elderly individuals may qualify for a current deduction
(IRC §190). Some barrier removal costs may also qualify for the
Replacement Page 01/2013
disabled access credit (Form 8826). See General Business Tax
Credit Summary on Page O-9.
Bribes or kickbacks. Payments made directly or indirectly to
a government official or employee are not deductible if made
in violation of the law. Payments are not deductible if made to
any person in violation of a federal or state law that provides a
criminal penalty for loss of license or privilege to engage in a
trade or business.
Capital expenses. Capitalizable expenditures typically are permanent improvements or betterments that increase the value of
property, restore its value or use, substantially prolong its useful
life or adapt it to a new or different use [IRC §168 and 263(a)].
Incidental expenses that do not materially add to the value of a
property or appreciably prolong its useful life are deductible as
incurred. Materials and supplies are typically deductible in the
year consumed. See Improvements and repairs on Page O-2 and
Materials and supplies on Page O-3.
The IRS issued temporary regulations (effective January 1, 2012)
to help taxpayers determine whether an expense must be capitalized. Temp. Reg. §1.263(a)-3T(d) dictates that expenditures are
typically capitalized if they result in:
•A betterment,
•A restoration or
•An adaptation to a new or different use.
The temporary regulations state that, for property other than buildings, all functionally interdependent components of a property
comprise a single unit of property if placing one component in
service depends on placing the other component in service. [Temp.
Reg. §1.263(a)-3T(e)(3)]
For buildings, expenditures are capitalized if they result in an improvement to the building (including its structural components) or any
of the following building systems: [Temp. Reg. §1.263(a)-3T(e)(2)]
1) Heating, ventilation and air conditioning (HVAC).
2) Plumbing systems (including pipes, drains, valves, sinks, bathtubs and toilets).
3) Electrical systems (including wiring outlets, junction boxes and
lighting fixtures).
4)Escalators.
5)Elevators.
6) Fire protection and alarm systems.
7) Security systems.
8) Gas distribution systems.
Repairs that are subject to capitalization under the UNICAP rules or
any other provision of the Code or regulations cannot be deducted.
(Temp. Reg. §1.162-4T)
æ Practice Tip: The IRS has indicated that the temporary regulations could be finalized, with some further changes, in early 2013.
See Expensing Policy on Page J-8 for more information.
Cell phones. Cell phones and similar telecommunications equipment are no longer included in the definition of listed property (to
which strict substantiation rules and deduction limits apply). [IRC
§280F(d)(4)(A)]. See Employer Provided Cell Phones on Page
K-8 for guidelines on their proper tax treatment.
Charitable contributions. See Charitable Contributions on Page
O-14. For C corporations, see Charitable Contributions and Charitable Contributions of Inventory on Page C-14. See also Tab 5 of
the 1040 Quickfinder® Handbook and Tab 12 of the Tax Planning
for Businesses Quickfinder® Handbook.
2012 Tax Year | Small Business Quickfinder ® Handbook O-1
Circulation expenses. The cost of increasing circulation of a
newspaper, magazine or other periodical is deductible as a current operating expense, or may be capitalized and amortized as
a deferred expense. (IRC §173)
Club dues are generally nondeductible if the club has a principal
purpose of providing access to or conducting entertainment activities for members or their guests. Out-of-pocket business meals
and entertainment expenses incurred at a club are deductible,
subject to limits. See Tab 9 in the 1040 Quickfinder® Handbook.
Computer software. See Computer Software on Page O-14.
Cost of goods sold. See Cost of Goods Sold (COGS) on Page
O-15.
Demolition expenses. Costs incurred to demolish a structure are
added to basis of the land where the demolished structure was
located. (IRC §280B)
2014 (January 1, 2012 if
Depletion. See Tab J.
the taxpayer so elects)
Depreciation. See Tab J.
Development costs. Costs of developing a mine or other natural
deposit (other than an oil or gas well) may be deducted. The costs
must be paid after the discovery of ores or minerals in commercially
marketable quantities [IRC §616(a)]. An election can be made to
treat the costs as deferred expenses deducted ratably as the ores/
minerals are sold [IRC §616(b) or to amortize the costs over ten
years. [IRC §59(e)]
Disaster losses. A taxpayer that sustains a loss occurring in a
disaster area can elect to deduct the loss in the tax year before
the year the loss occurred. The taxpayer thus has the option of
selecting either the year of the loss or the prior year in which to
claim the deduction (Reg. §1.165-11). See also Qualified disaster
expenses on Page O-4.
Donations of patents, etc. A deduction for a contribution of a
patent or certain other items of intellectual property to charity is
limited to the lesser of (1) the taxpayer’s basis in the property or
(2) the FMV. Taxpayers may deduct certain additional amounts in
later years, based on a specified percentage of qualified income
received by the charitable organization from the contributed property. No deduction is permitted for income received by the charity
after the expiration of the legal life of the patent or other intellectual
property. [IRC §170(e) and (m)]
Education expenses. An employer can deduct the following
employee education expenses:
•Educational Assistance Program. Up to $5,250 of qualified educational assistance can be excluded from an employee’s income
(IRC §127). See Tab K for more information about educational
assistance programs.
•Working Condition Fringe Benefit [IRC §132(d)]. Employerprovided education is excludable from an employee’s income if
the expense would have been deductible as a business expense
if paid out of the employee’s pocket. An individual is generally
not allowed to deduct education expenses if (1) the education is
required to meet minimum requirements of the individual’s employment or trade, or (2) the education will qualify the individual
for a new trade or business. See Work-Related Education Costs
in Tab 5 of the 1040 Quickfinder® Handbook for more information
about deducting education expenses for individuals.
Employee awards. See Awards and bonuses on Page O-1.
Employee benefit programs. See Tab K.
Entertainment. See Meals and entertainment on Page O-3. See
Tab 9 in the 1040 Quickfinder® Handbook and Tab 7 in the Tax Planning for Businesses Quickfinder® Handbook for more information
on travel, meal and entertainment tax issues.
Entertainment expenses included in W-2 wages. When an
employer adds the personal value of a benefit to a “specified individual’s” taxable W-2 wages, the employer’s deduction is limited to
O-2 2012 Tax Year | Small Business Quickfinder ® Handbook
the lesser of the actual cost of the benefit or the amount included
in the employee’s taxable wages. This rule applies to expenses for
activities generally considered to be entertainment, amusement
or recreation and facilities used in connection with such activities,
such as a company airplane. Specified individuals generally include
officers, directors and 10% or greater owners of private and publicly
held companies. [IRC §274(a) and (e)]
Environmental clean-up costs. Revenue Ruling 94-38 held that
costs incurred to construct groundwater treatment facilities were
capital expenses. Other costs incurred to clean up land and to
treat groundwater contaminated with hazardous waste resulting
from business operations were deductible as business expenses.
However, Revenue Ruling 2004-18 issued a clarification of the
prior ruling, stating that otherwise deductible costs incurred by a
manufacturing operation must be included in inventory under the
uniform capitalization rules of Section 263A.
Newly issued temporary regulations require that for tax years
beginning on or after January 1, 2012, taxpayers must capitalize
amounts paid to improve or better a material condition or defect
that existed prior to a taxpayer’s acquisition of property, whether or
not the taxpayer was aware of the defect at the time of acquisition
[Temp. Reg. §1.263(a)-3T(h)]. Therefore, if a taxpayer purchases
land contaminated prior to acquisition, the clean-up cost is capitalized. However, environmental remediation costs paid or incurred to
clean up a state designated qualified contaminated site may qualify
for deduction. The deduction applies for expenditures incurred
through December 31, 2011. (IRC §198)
 Expired
Provision Alert: The expensing of environmental
remediation costs expired at the end of 2011. It’s possible Congress will extend it to 2012, but had not done so at the time of this
publication. See Expired Tax Provisions on Page Q-1 for more
information.
The IRS has privately applied rules similar to those for soil remediation costs to a taxpayer removing mold from a building. A
deduction was allowed for the cost of removing mold from a nursing
home where the facility was not contaminated at acquisition and
the mold removal did not prolong the building’s life or increase its
value. (Letter Rul. 200607003)
Environmental remediation costs incurred to clean up land contaminated with a taxpayer’s hazardous waste during operation of the
taxpayer’s manufacturing activities are allocable to the inventory
produced under Section 263A during the year costs are incurred.
(Rev. Rul. 2005-42)
Fines. See Penalties and Fines on Page O-20.
Franchise. See Intangible Assets on Page O-17.
Fringe benefits. See Tab K.
Gifts. See Awards and bonuses on Page O-1.
Goodwill. See Intangible Assets on Page O-17.
Impact fees on real estate development (Rev. Rul. 2002-9).
Impact fees are one-time charges imposed by a state or local
government for offsite capital improvements necessitated by a new
or expanded development. The Revenue Ruling treats impact fees
as capital expenses that are added to the basis of the buildings.
This allows developers to depreciate impact fees over the life of
constructed buildings, rather than adding the fees to the basis
of nondepreciable land. Impact fees may also be considered for
purposes of computing the low-income housing credit.
Impairment losses. See Impairment Losses on Page O-16.
Improvements and repairs. Taxpayers may deduct amounts
paid for repairs or maintenance of tangible property provided the
amounts are not otherwise required to be capitalized (Temp. Reg.
§1.162-4T). Also see Capital expenses on Page O-1 and Expensing Policy on Page J-8.
Replacement Page 01/2013
In the U.S. Requirement
in tax years
beginning after
• The 50 states, District of Columbia, U.S. territorial waters and the
seabeds and subsoils of any waters adjacent to U.S. territorial
waters that the U.S. has exclusive exploration and exploitation
rights over. [Reg. §1.199-3(h)]
• Taxpayers with foreign activities must allocate gross receipts.
Imports • Some taxpayers import partially manufactured items and then finish
the process in the U.S.
• To the extent that the taxpayer’s actions, given all of the facts and
circumstances, are substantial, the gross receipts from the activity
will qualify as DPGR.
Exports • If the taxpayer manufactures a product in the U.S. and then exports
it, all of the gross receipts will be DPGR, regardless of whether the
is
taxpayer imports the property back into the U.S. for final disposition.
[Reg. §1.199-3(g)(5), Ex. 5]
Note: The DPD was available for certain Puerto Rico activities between December 31, 2005 and January 1, 2012.
before January 1, 2014.
U.S.
Defined
 Expired Provision Alert: The DPD allowable for income attributable to production activities in Puerto Rico expired at the end
of 2011. It’s possible Congress will extend it to 2012, but had not
done so at the time of this publication. See Expired Tax Provisions
on Page Q-1 for more information.
What Is QPAI?
Qualified production activities income (QPAI) is the taxpayer’s
domestic production gross receipts (DPGR) reduced by:
1) The cost of goods sold allocable to those receipts and
2) Other expenses, losses or deductions (other than the DPD
itself) that are properly allocable to those receipts.
Determining DPGR. DPGR is the taxpayer’s gross receipts from
the lease, rental, license, sale, exchange or other disposition of
QPP that was manufactured, produced, grown or extracted in
whole or in significant part within the U.S.
Additional activities producing DPGR include:
•Qualified film production;
•Electricity, natural gas or potable water produced in the U.S.;
•Farming and processing of agricultural products and food;
•Construction performed in the U.S. and
•Engineering or architectural services performed in the U.S. for
U.S. construction projects.
Gross receipts from a related party rental, lease or license are
excluded. [IRC §199(c)(7)]
Computing gross receipts. Gross receipts are computed using the taxpayer’s normal accounting method. Therefore, the
taxpayer could potentially recognize gross receipts (for example,
advance payments) in a different tax year than when the costs
are recognized.
Gross receipts include: [Reg. §1.199-3(c)]
•Total sales, net of returns and allowances;
•Service income;
•Investment income and
•Any other income from incidental or outside sources.
Gross receipts also include interest, gains from the sale of property, dividends, rents, royalties, annuities and tax-exempt income
(although these items will reduce the amount of the deduction
because such income is not DPGR.)
Exclusions from gross receipts computation:
•Sales tax if the tax is imposed on the buyer and the taxpayer
merely collects the tax and pays it over to the taxing authority.
•Cost of sales is not deducted, nor is the basis of property sold if
the property is not a capital asset. Therefore, there is no basis
reduction for property that is inventory, or that is held for sale to
customers in the ordinary course of business.
Gross receipts allocation. Taxpayers with both DPGR and nonDPGR must use a reasonable method to identify gross receipts
that constitute DPGR. [Reg. §1.199-1(d)(2)]
Replacement Page 01/2013
Exceptions for allocating gross receipts between DPGR and
non-DPGR:
•If less than 5% of total gross receipts are non-DPGR (such as
interest income, gains from the sale of property and dividends),
then the taxpayer can classify 100% of its gross receipts as
DPGR. [Reg. §1.199-1(d)(3)]
•Taxpayers with a de minimis amount of gross receipts (less than
5%) from embedded services may include the embedded service
income as DPGR. [Reg. §1.199-3(i)(4)]
Allocating costs to gross receipts. Classifying receipts as DPGR
is only the first step. The next step is to allocate the appropriate
costs against the DPGR to determine the QPAI.
•Taxpayers must subtract from DPGR the cost of goods sold allocable to DPGR, as well as other expenses, losses or deductions
(other than the DPD itself) that are properly allocable to such
receipts. [Reg. §1.199-4(a)]
•Regulation Section 1.199-4(a) provides three methods for allocating
and apportioning deductions (the Section 861 method, the simplified
deduction method and the small business simplified overall method).
Taxpayers can change the allocation method from year to year.
•There are rules for determining cost of goods sold allocable to
DPGR [Reg. §1.199-4(b)] and for determining deductions properly allocable to DPGR. [Reg. §1.199-4(c)]
•Certain taxpayers ($100 million or less average annual gross
receipts or tax year end total assets of $10 million or less) can
apportion deductions to DPGR using the simplified deduction
method. [Reg. §1.199-4(e)]
•Smaller taxpayers ($5 million or less average annual gross
receipts, cash method farmers, or $10 million or less average
annual gross receipts and using the cash method under Revenue
Procedure 2002-28) are allowed to use the small business simplified overall method to apportion cost of goods sold and other
deductions to DPGR. [Reg. §1.199-4(f)]
U Caution: While using the simplified methods significantly
reduces the complexity of the calculations, the allocation may
not be as accurate as one made under the Section 861 rules.
Using one of the simplified methods could cause the taxpayer
to allocate too much cost to DPGR, which would reduce QPAI
and, thus, reduce the DPD.
Calculating the DPD
See Filled-in Sample Form 8903 on Page O-6.
A taxpayer calculates the DPD after determining its QPAI.
•QPAI equals the taxpayer’s DPGR less COGS and other deductions, expenses and losses allocable to DPGR.
•For a taxpayer with only DPGR from qualified production property manufactured in the U.S., QPAI will essentially equal the
taxpayer’s taxable income (AGI for an individual taxpayer) before
the DPD, with exceptions for Section 165 losses and Section 172
net operating losses (see Losses affect the DPD computation as
follows on Page O-6).
Determining W-2 wages. The DPD is driven by the taxpayer’s
DPGR, but is limited to 50% of the W-2 wages properly allocable
to DPGR paid by the taxpayer during the year.
æ Practice Tip: Because of the limitation of W-2 wages to those
allocable to DPGR, taxpayers will have to design and implement
recordkeeping systems to capture the portion of employees’ time,
and thus employees’ pay, devoted to qualifying Section 199 activities (for example, by establishing separate general ledger accounts
for DPGR-related wages and other wages).
@ Strategy: Since payments to independent contractors are not
W-2 wages for the DPD, taxpayers may want to bring qualifying
activities in-house that previously have been sub-contracted out.
However, before doing so they should determine whether the deduction gained from including the workers’ W-2 wages in the DPD
computation outweighs the additional expense and administrative
burden of carrying these workers on the payroll.
2012 Tax Year | Small Business Quickfinder ® Handbook O-5
W-2 wages for the DPD include: [Reg. §1.199-2(e)(1)]
•Wages subject to income tax withholding,
•Wages that are employee elective deferrals,
•Wages that are deferred compensation and
•Wages that are employee designated Roth contributions.
Taxpayers must actually report the wages on Form W-2 and file
the W-2s with the Social Security Administration no later than 60
days after their extended due date.
Note: Partnership income allocated to partners and guaranteed
payments do not appear to meet the definition of wages for Section
199 deduction purposes. [Reg. §1.199-2(e) and Rev. Rul. 69-184]
DPD Computation Steps
Step 1
Step 2
Step 3
Step 4
Unmodified Box W-2 wages are the wages computed by taking the lesser of
Box 1 or Box 5 (Medicare wages).
Method
Modified Box 1 1) Start with the total of Box 1 wages.
2) Subtract any amounts in Box 1 that are not wages for
Method
FITW purposes and amounts included in Box 1 that
are treated as wages under Section 3402(o), such as
supplemental unemployment compensation benefits.
3) Add amounts reported in Box 12 of Form W-2 that are
properly coded D, E, F, G or S.
Tracking Wages This is the most complex method—it requires the taxpayer to track
total wages subject to FITW and make appropriate modifications.
Method
Gross receipts.................................................................................. $ 900,000
Cost of goods sold (including $350,000 of W-2 wages, $150,000
of which are paid to Dee).................................................................. < 600,000>
Other allocable expenses, losses and deductions........................... < 100,000>
Net income....................................................................................... $ 200,000
HeatCo’s QPAI is $200,000, the same as its taxable income, and its tentative
deduction is $18,000 (9% × $200,000). The deduction is limited to 50% of
qualified W-2 wages, which is $175,000 (50% × $350,000). Thus, HeatCo’s
DPD is $18,000, as shown on Form 8903 below.
Allocating W-2 wages. After using one of the options described
in the table above to compute W-2 wages, taxpayers can use any
reasonable method or one of the safe harbors in Regulation Section 1.199-2(e)(2) to allocate these wages to DPGR.
8903
Department of the Treasury
Internal Revenue Service
to your tax return.
▶ See
Attachment
Sequence No. 143
separate instructions.
Identifying number
Name(s) as shown on return
HeatCo
Note. Do not complete column (a), unless you have oil-related
production activities. Enter amounts for all activities in column (b),
including oil-related production activities.
75-0000000
(a)
Oil-related production activities
1 Domestic production gross receipts (DPGR) . . . . . . . .
1
2 Allocable cost of goods sold. If you are using the small business
simplified overall method, skip lines 2 and 3 . . . . . . . .
2
3 Enter deductions and losses allocable to DPGR (see instructions) .
3
4 If you are using the small business simplified overall method, enter the
amount of cost of goods sold and other deductions or losses you
ratably apportion to DPGR. All others, skip line 4 . . . . . . .
4
5 Add lines 2 through 4 . . . . . . . . . . . . . . .
5
6 Subtract line 5 from line 1 . . . . . . . . . . . . . .
6
7 Qualified production activities income from estates, trusts, and
7
certain partnerships and S corporations (see instructions) . . .
8 Add lines 6 and 7. Estates and trusts, go to line 9, all others, skip line
9 and go to line 10 . . . . . . . . . . . . . . . .
8
9 Amount allocated to beneficiaries of the estate or trust (see
9
instructions) . . . . . . . . . . . . . . . . . .
10a Oil-related qualified production activities income. Estates and
trusts, subtract line 9, column (a), from line 8, column (a), all others,
enter amount from line 8, column (a). If zero or less, enter -0- here .
10a
−0−
b Qualified production activities income. Estates and trusts, subtract
line 9, column (b), from line 8, column (b), all others, enter amount
from line 8, column (b). If zero or less, enter -0- here, skip lines 11
through 21, and enter -0- on line 22 . . . . . . . . . . .
10b
11 Income limitation (see instructions):
• Individuals, estates, and trusts. Enter your adjusted gross income figured without the
domestic production activities deduction . . . . . . . . . . . . . . . .
• All others. Enter your taxable income figured without the domestic production activities
deduction (tax-exempt organizations, see instructions) . . . . . . . . . . .
12 Enter the smaller of line 10b or line 11. If zero or less, enter -0- here, skip lines 13 through 21,
and enter -0- on line 22 . . . . . . . . . . . . . . . . . . . . . . . .
13 Enter 9% of line 12 . . . . . . . . . . . . . . . . . . . . . . . . .
14a Enter the smaller of line 10a or line 12 . . . . . . . . . .
14a −0−
b Reduction for oil-related qualified production activities income. Multiply line 14a by 3%
. .
15 Subtract line 14b from line 13 . . . . . . . . . . . . . . . . . . . . . .
16 Form W-2 wages (see instructions) . . . . . . . . . . . . . . . . . . . .
17 Form W-2 wages from estates, trusts, and certain partnerships and S corporations
(see instructions) . . . . . . . . . . . . . . . . . . . . . . . . . .
18 Add lines 16 and 17. Estates and trusts, go to line 19, all others, skip line 19 and go to line 20
19 Amount allocated to beneficiaries of the estate or trust (see instructions)
. . . . . . .
20 Estates and trusts, subtract line 19 from line 18, all others, enter amount from line 18 . . .
21 Form W-2 wage limitation. Enter 50% of line 20 . . . . . . . . . . . . . . . .
22 Enter the smaller of line 15 or line 21. . . . . . . . . . . . . . . . . . . .
23 Domestic production activities deduction from cooperatives. Enter deduction from Form
1099-PATR, box 6 . . . . . . . . . . . . . . . . . . . . . . . . .
24 Expanded affiliated group allocation (see instructions) . . . . . . . . . . . . . .
25 Domestic production activities deduction. Combine lines 22 through 24 and enter the result
here and on Form 1040, line 35; Form 1120, line 25; or the applicable line of your return . .
}
For Paperwork Reduction Act Notice, see separate instructions.
O-6 OMB No. 1545-1984
Domestic Production Activities Deduction
▶ Attach
Compare the results from Steps 2 and 3, and deduct the lesser
amount.
Example: Dee Wade owns all the shares of HeatCo, a calendar-year C
corporation that makes electric blankets in the U.S. The corporation conducts
no other activities; therefore, all of its income is qualified production activities
income. HeatCo uses the small business simplified overall method to allocate
costs to DPGR. During 2012, HeatCo had the following income and expenses:
Options for Computing W-2 Wages
[Rev. Proc. 2006-47 and Reg. §1.199-2(e)(3)]
Form
(Rev. December 2010)
Compare QPAI to taxable income (AGI for an individual) and select
the lower amount.
Compute the tentative deduction by multiplying the result from Step
1 by 9% (6% for oil-related QPAI).
Compute the wages limitation using the rules discussed above.
Cat. No. 37712F
2012 Tax Year | Small Business Quickfinder ® Handbook
(b)
All activities
900,000
200,000
•Taxpayers do not deduct net operating
losses (NOLs) from DPGR to arrive at QPAI,
even if the taxpayer’s manufacturing activities generated the losses.
–Because taxpayers must base the DPD
on the lesser of QPAI or taxable income
(AGI for individuals), NOL carryovers
(carrybacks and carryforwards) to a tax
year may reduce or eliminate the DPD.
–If the NOL deduction reduces taxable
income to zero, the DPD is zero.
–The taxpayer cannot use the DPD to
create (or increase) an NOL carryover.
200,000
Pass-Through Entities
700,000
700,000
200,000
200,000
11
12
13
200,000
14b
15
16
−0−
18,000
350,000
17
18
19
20
21
22
350,000
350,000
175,000
18,000
23
24
25
Losses affect the DPD computation as
follows:
•Taxpayers with losses under Section 165
must deduct those losses from DPGR if
the proceeds from the sale of the property
are, or would have been, included in DPGR
(such proceeds are included in DPGR if the
underlying property is QPP.)
18,000
Form 8903 (Rev. 12-2010)
The DPD is available to partnerships, S corporations and other pass-through entities, but
the deduction is claimed at the shareholder,
partner or beneficiary level [IRC §199(d)(1)].
Each partner, shareholder or beneficiary is
allocated a share of each component item
of QPAI and wages and must compute their
deduction separately, aggregating their share
of items from all pass-through entities and
individually owned businesses. However,
Revenue Procedure 2007-34 specifies conditions when partnerships and S corporations
can calculate their QPAI and W-2 wages at
the entity level, as well as the manner of allocating and reporting QPAI and W-2 wages to
many types of fuels and uses listed on Form 4136, including the credits previously scheduled to expire for biodiesel mixtures,
renewable diesel mixtures, alternative fuels and alternative fuel mixtures. Credits also continue to be available for
the partners or shareholders. If a partnership or S corporation does
Other Tax Credits for Business Taxpayers Summary
so, each partner or shareholder combines its QPAI and W-2 wages
from the entity with its QPAI and W-2 wages from other sources.
Tax
Tax Credit
Tax Credits
Unlike deductions—which reduce a taxpayer’s tax liability by the
marginal tax rate times the deduction amount (cents on the dollar)—tax credits reduce the tax liability on a dollar for dollar basis.
See the General Business Tax Credit Summary table on Page
O-9 for more information on the component credits of the general
business credit.
Personal Tax Credits
See Tab 12 in the 1040 Quickfinder® Handbook for information on
personal tax credits claimed by individuals on Form 1040.
General Business Credit
A taxpayer must file Form 3800 to claim any of the general business credits.
U Caution: The IRS has not released a draft or final 2012 Form
3800 as of the date of this publication. Therefore, this publication
references information found in the 2011 form. Readers should remain alert for possible changes in the 2012 Form 3800.
Compute each component credit separately on its applicable
form. After each component credit is separately computed on its
applicable form, it is then carried to Form 3800, where the component credits are separately listed and then combined into one
general business credit (GBC). The combined credit is subject to a
limitation based on tax liability. Follow the line-by-line steps of Part
II of Form 3800 to figure the limitation. Attach to the return Form
3800 and the separate forms for each credit claimed.
Exception: Taxpayers whose only source of credits listed on Form
3800, Part III, is from pass-through entities may not be required
to complete and file separate credit forms to claim the general
business credit—see the Form 3800 instructions. If a credit is
being reported from a pass-through entity, that entity’s employer
identification number must be entered in Part III.
Form 3800, Part III includes eight different check boxes for the
specific categories of GBC being reported. A taxpayer must complete a separate Part III for each box checked, and an additional
consolidated Part III if certain conditions are met. See the Form
3800 instructions for details.
Carryback/carryforward of unused credits. The passive activity limit and carryover amounts for all GBCs are also reported on
Form 3800. The general business credit is limited to net income
tax reduced by the greater of: [IRC §38(c)(1)]
•Tentative minimum tax or
•25% of the amount by which the net regular tax liability exceeds
$25,000.
If the full general business credit may not be claimed because of
the limitation, unused credits are carried back one year and forward
20 years (IRC §39). However, no part of any unused current year
business credit attributable to a component credit may be carried
back to tax years before the first tax year that the component
credit was allowable.
Unused credits. Credits as defined in Section 196(c) that remain
unused after the 20-year carryforward period may be taken as a
deduction in the first tax year following the expiration of the 20year period. Unused credits may also be taken as a deduction if
a taxpayer dies or goes out of business. See the instructions for
Form 3800 for more information about deducting carryovers.
Other Tax Credits for Businesses
In addition to the various components of the general business
credit, several other tax credits are available to business taxpayers, including those shown in the following table.
Replacement Page 01/2013
Federal Fuels Tax
IRC §
Foreign and U.S. Possessions Tax
901
Prior-Year Minimum Tax
53
Qualified Tax Credit Bonds, Clean Renewable
Energy Bonds and Gulf Tax Credit Bonds2
Undistributed Capital Gains of REITs and RICs
1
2
Forms
Various
1
54A, 54 and
1400N(l)
852(b)(3)(D)
857(b)(3)(D)
4136
1116
1118
8801
8827
8912
2439
See following discussion.
Gulf tax credit bonds must be issued during 2006, but the tax credit for
bondholders continues to be available in later years.
credit
Federal fuels tax. Taxpayers may be eligible to claim a refund
or credit for federal and state excise taxes paid for motor fuels
for vehicles and equipment. These excise taxes are collected for
highway and road construction and maintenance. Therefore, if
the equipment or vehicle is used off-road, typically in a trade or
business, the excise taxes are refundable. The federal refund can
be claimed on Form 4136, Credit for Federal Tax Paid on Fuels.
 Expired Provision Alert: The credits expired for alcohol fuel
mixtures, biodiesel mixtures, renewable diesel mixtures, alternative
fuels and alternative fuel mixtures (except liquefied hydrogen), at
the end of 2011. It’s possible Congress will extend them to 2012,
but had not done so at the time of this publication. See Expired
Tax Provisions on Page Q-1 for more information.
Note: For 2012, credits are available for liquefied hydrogen.
Selected Energy Tax
Incentives for Businesses
There are many incentives (deductions or credits) for both energy
production and conservation by businesses and individuals. Here’s
a list of recent significant provisions for businesses:
•Alternative Motor Vehicle Credit below.
•Appliance Manufacturer’s Credit on Page O-10.
•Commercial Buildings Deduction on Page O-10.
•Energy Efficient Home Builders Credit on Page O-10.
•Low-speed and 2- and 3- Wheeled Vehicles on Page O-10.
•Plug-in Electric Drive Motor Vehicle Credit on Page O-8.
•Vehicle Refueling Property Credit on Page O-8.
Alternative Motor Vehicle Credit
Form 8910; see also IRC §30B
The alternative motor vehicle credit is determined under a complicated set of rules. For vehicles purchased after 2010, only the
following components of the credit are allowed for the following
types of vehicles.
Alternative Motor Vehicle Credit
Type of Vehicle
Qualified fuel cell
Plug-in conversion1
1 New or Used
New
New or Used
Expired at the end of 2011. See Plug-in conversion credit on Page O-8.
The credit is allowed for both personal and business vehicles.
If claimed for a business vehicle, the credit becomes part of the
taxpayer’s general business credits so any credit not used in the
2012 Tax Year | Small Business Quickfinder ® Handbook O-7
current year is available for carryback (but not to years before
2006) and carryover under the rules for general business credits.
(See Carryback/carryforward of unused credits on Page O-7.)
Qualified fuel cell vehicle credit. A qualified fuel cell vehicle is
a motor vehicle that is propelled by power derived from one or
more cells that convert chemical energy directly into electricity
by combining oxygen with hydrogen fuel that is stored on board
the vehicle and may or may not require reformation prior to use.
[IRC §30B(b)]
The fuel cell credit has two parts: (1) a flat amount based on the
vehicle’s weight and (2) an additional amount based on fuel efficiency improvements compared to 2002 models. To be eligible
for this credit, fuel cell vehicles must also meet certain federal
emission standards.
Qualified Fuel Cell Vehicle Credit—Base Credit Amounts
1
Credit Amount
Gross Vehicle Weight Rating (GVWR) in Pounds
$ 8,0001
Vehicle ≤ 8,500
10,000
8,500 < vehicle ≤ 14,000
20,000
14,000 < vehicle ≤ 26,000
40,000
26,000 < vehicle
2) Recharges vehicles propelled by electricity, but only if the property is located at the point where the vehicles are recharged.
$4,000 for vehicles placed in service after 2009.
Clean-burning fuels include:
Qualified fuel cell motor vehicles include, for example, vehicles
that run on hydrogen power cells. Only new vehicles purchased
after 2005 and before 2015 qualify for the credit.
The IRS will certify the credit amount for qualifying vehicles. Taxpayers can rely on this certification. (Notice 2006-9)
Certified Fuel Cell Motor Vehicles
Make
Year
Model
Honda
2010–2012
FCX Clarity Fuel Cell
$ 8,000
Honda
2008–2009
FCX Clarity Fuel Cell
12,000 Credit Amount
Note: Current as of publication date. To check for updates, search www.irs.gov
for “Qualified Fuel Cell Vehicles.”
Plug-in conversion credit. A tax credit is allowed for plug-in
electric drive conversion kits. The credit equals 10% of the cost
of converting a vehicle to a Section 30D qualified plug-in electric
drive motor vehicle that is placed in service after February 17, 2009
and before 2012. The maximum amount of the credit is $4,000.
Taxpayers may claim this credit even if they claimed a hybrid
vehicle credit for the same vehicle in an earlier year.
 Expired Provision Alert: The plug-in conversion credit expired
at the end of 2011. It’s possible Congress will extend it to 2012,
but had not done so at the time of this publication. See Expired
Tax Provisions on Page Q-1 for more information.
Reporting. Form 8910, Alternative Motor Vehicle Credit, is used
to claim the alternative motor vehicle credits. The business/
investment-use percentage of the credit is then transferred to Form
3800, General Business Credit.
The personal-use portion of the credit is transferred to the “Other
Credits” line of Form 1040 (check box c and write “8910” in the
space next to that box). Any part of the personal-use portion of
the credit that can’t be used in the current year is lost. It cannot
be carried over to other years.
has been
extended
Vehicle Refueling Property Credit
through
2013
Form 8911; see also IRC §30C
 Expired Provision Alert: The alternative fuel refueling property (non-hydrogen refueling property) credit expired at the end
O-8 of 2011. It’s possible Congress will extend it to 2012, but had not
done so at the time of this publication. See Expired Tax Provisions
on Page Q-1 for more information.
Note: For 2012, the credit for hydrogen-related property has
not expired. It applies through 2014.
Taxpayers may claim a 30% credit for the cost of installing cleanfuel vehicle refueling property to be used in a trade or business or
installed at the taxpayer’s principal residence. The credit generally
applies to property placed in service after 2005 and before 2012
(before 2015 for hydrogen-related property).
The maximum allowable credit is:
2014
•$30,000 for business property.
•$1,000 for property installed at a principal residence.
Qualified alternative fuel vehicle refueling (QAFVR) property is any
property, not including a building and its structural components,
whose original use begins with the taxpayer, that is depreciable
(not required for the $1,000 credit) and that:
1) Stores or dispenses a clean-burning fuel into the fuel tank of a
vehicle propelled by that fuel, but only if the storage or dispensing of the fuel is at the point where the fuel is delivered into the
fuel tank of the vehicle or
2012 Tax Year | Small Business Quickfinder ® Handbook
•Any fuel at least 85% of which consists of one or a mixture of
ethanol, natural gas, compressed natural gas, liquefied natural
gas, liquefied petroleum gas or hydrogen.
•Any fuel that is a mixture of diesel fuel and biodiesel determined
without regard to any use of kerosene and containing at least
20% biodiesel.
•Electricity.
The tax basis of QAFVR property is reduced by the portion of the
property’s cost allowed as a credit. Notice 2007-43 provides interim
guidance on the credit pending issuance of regulations.
Plug-In Electric Drive Motor Vehicle Credit
Form 8936, IRC §30D
Taxpayers can claim a credit for each new qualifying vehicle
purchased for use or for lease, but not for resale. The credit
amount ranges from $2,500 to $7,500. The portion of the credit
attributable to the vehicle’s business-use percentage is treated
as part of the taxpayer’s general business credit. The remainder
is a nonrefundable personal credit that can offset both regular tax
and AMT. (IRC §30D)
Qualifying vehicles. These are new four-wheeled plug-in electric
vehicles manufactured primarily for use on public streets, roads
and highways that meet certain technical requirements.
However, the following do not qualify:
1) Vehicles manufactured primarily for off-road use (such as golf carts).
2) Vehicles weighing 14,000 pounds or more.
3) Low-speed vehicles (but see Low-Speed and 2- and 3-Wheeled
Vehicles on Page O-10).
Manufacturer’s certification. The IRS will acknowledge a
manufacturer’s (or in the case of a foreign vehicle manufacturer,
its domestic distributor’s) certifications that a vehicle meets the
standards to qualify for the credit. Taxpayers may rely on such a
certification. (Notice 2009-89)
The credit begins to phase out for a manufacturer’s vehicles when
at least 200,000 qualifying vehicles manufactured by that manufacturer have been sold for use in the U.S. (determined cumulatively
for sales after 2009). As of publication date, no manufacturers had
reached that threshold.
Continued on Page O-10
Replacement Page 01/2013
General Business Tax Credit Summary1
Credit Name
IRC §
Differential Wage Payment
45P
Disabled Access
Employer-Paid FICA on Tips
Employer-Provided Child Care
44
45B
45F
Empowerment Zone Employment
Indian Employment
1396
45A
Pension Plan Start-Up Costs
45E
Small Employer Health
Insurance Premiums
45R
Work Opportunity
51
Agricultural Chemicals Security
45O
Alcohol Fuels
Biodiesel and Renewable Diesel
Fuels
40(e)
40A
Carbon Dioxide Sequestration
45Q
Cellulosic Biofuel Producer
Distilled Spirits
Energy Credits
Investment Credit:
• Rehabilitation Property
• Energy Credit
40(b)(6)
5011
Var.
For
Rate
Employment Credits
Small business employers paying differential wage payments to 2012 = 0%.2 2011 = 20% of eligible differential wage
qualified employees that are active duty uniformed service members. payments; $20,000 maximum wage payments per
year per employee.
Expenses to make business accessible to or usable by disabled. 50%; $5,000 maximum credit.
Amount paid on tips above minimum wage.
100% of eligible amounts.
Employers who provide child care and related services to
25% of qualified child care facility plus 10% of
employees.
resource and referral costs.
Wages paid to employees working in selected geographic areas. Empowerment zone: 20% of wages up to $15,000.
Wages and health insurance costs paid to members of an Indian tribe 2012 = 0%.2 2011 = 20% of increase over amount
or spouse for services performed on a reservation.
paid in 1993.
Credit for start-up costs of new employer retirement plans.
50% of eligible costs up to a maximum credit of $500,
Employer cannot have more than 100 employees
for first 3 years of plan.
Qualified small employers that pay at least 50% of a qualified
Up to 35% (25% for tax-exempt organizations) of the
health arrangement for their employees.
lesser of: (1) the amount contributed or (2) the small
business benchmark premium.
Effective for work begun by certain qualified veterans before 1/1/13. Rates vary for certain targeted groups. Maximum
credit per qualified veteran is $9,600 if employed by a
targeted groups
for-profit entity and $6,240 if employed by a qualified
before 1/1/14.
tax-exempt organization.
Other Credits
Retailers, distributors, formulators, aerial applicators and
30% of qualified expenditures subject to facility and
manufacturers of specified agricultural chemicals.
annual limitations.
Sale of straight alcohol or mixture as fuel at retail or use in business. 2012 = 0%.2 2011 = Rate varies depending on mixture.
Use in the production of biodiesel mixture; use of biodiesel in a trade 2012 = 0%.2 2011 = Biodiesel mixture: $1 per gallon
or business or sale at retail; production of qualified agri-biodiesel. For used. Biodiesel: $1 per gallon used or sold at retail.
biodiesel mixture and biodiesel components, $1 rate applies if agri- Agri-biodiesel: 10¢ for each gallon produced.
biodiesel or renewable diesel (may include certain aviation fuel) is used.
The capture of carbon dioxide from an industrial source that would 2012 = $20.88 per metric ton of qualified carbon dioxide
otherwise be released into the atmosphere as greenhouse gas. from a qualified facility ($10.44 per metric ton for tertiary
injectant in oil/gas recovery).
Producers of cellulosic biofuel.
Generally, $1.01 for each gallon produced.
Wholesalers and warehousers of distilled spirits.
2012 = 10.575¢ per case of distilled spirits purchased
or stored.
See Selected Energy Tax Incentives for Businesses on Page O-7. Varies
or 30%
Tax
Forms
8932
8826
8846
8882
8844
8845
8881
8941
990-T
5884
8850
8931
6478
8864
8933
6478
8906
Var.
• 10% for pre-1936 buildings; 20% for historic
3468
structures.
• 10%; 30% for qualified fuel cell and certain
equipment that uses solar energy property to
produce electricity.
• Qualifying Advanced Coal
• 15% or 20% of qualified investment (QI).
• Qualifying Gasification
• 20% of QI.
or 30%
• Qualified Advanced Energy
• 2012 = 0%.2 2011 = Up to 30% of QI.
• Therapeutic Discovery
• 2012 = 0%.2 2011 = Up to 50% of QI from pass-throughs.
Low-Income Housing
70% (or 30%) of qualified building basis over 10 years. 8586
8609A
Low-Sulfur Diesel Fuel
45H Production of low-sulfur diesel fuel by a small business refiner.
5¢ for each gallon produced.
8896
Mine Rescue Team Training
45N Training program costs for qualified employees.
2012 = 0%.2 2011 = 20% of up to $50,000/employee. 8923
New Markets
45D Investment in community development entities.
2012 = 0%.2 2011 = 5% – 6% per year over seven years. 8874
Nonconventional Source Fuel
45K Production of fuel from a nonconventional source.
$3 per barrel-of-oil equivalent sold, subject to inflation 8907
adjustment and phase out.3
Nuclear Power Facility
45J Production of electricity at an advanced nuclear power facility.
1.8¢ per kwh of electricity sold.
NA
Orphan Drug
45C Expenses in testing certain drugs for rare diseases or conditions. 50% of qualified clinical testing costs.
8820
Railroad Track Maintenance
45G Costs to maintain certain railroad track, roadbed, bridges, etc.
2012 = 0%.2 2011 = 50%; not over $3,500 × track miles. 8900
Renewable Electricity, Refined
45 • Electricity sold that was produced using wind, closed-loop biomass, • 2.2¢ per kwh of electricity sold (wind, etc.) or 1.1¢ per 8835
Coal and Indian Coal Production
geothermal, and solar sources or marine and hydrokinetic kwh (marine, etc.).
renewables.
• $6.475 (refined) or $2.267 (Indian) per ton of coal sold.4
(including steel
•
Steel
industry
fuel
produced
at
a
qualified
refined
coal
facility.
• $2.96 per barrel-of-oil equivalent produced and sold.4
industry fuel)
• Refined coal or Indian coal produced at qualified facilities.
• Refined coal 2012 = 0%.2 2011 = Phaseout rules apply
to electricity and refined coal.
Research Activities
41 Business research and experimental expenditures.
2012 = 0%.2 2011 = 20% of expenses over base amount. 6765
1
At the time of publication, the 2012 Form 3800 was not yet available. See the final version of Form 3800, the other referenced forms and their instructions for details of
these credits and others that may be required 2012 Form 3800 entries.
(steel industry fuel)
2
See Expired Tax Provisions on Page Q-1.
3
Notice 2012-30 contains the 2011 amounts—$95.73 reference price; $3.51 credit amount for coke or coke gas only. The IRS will publish the 2012 amounts by April 2013 in a Notice.
4
Notice 2012-35 contains the 2012 amounts.
See Tab 12 in the 1040 Quickfinder® Handbook for information on personal tax credits.
Replacement Page 01/2013
47
48
• Pre-1936 nonresidential buildings/certified historic structures.
• Equipment that uses solar energy to generate electricity, to heat
or cool or provide hot water for use in a structure, or to provide
solar process heat. Also, equipment used to produce or use ,
energy derived from a geothermal deposit.
48A • Investment in qualifying advanced coal project.
48B • Investment in qualifying gasification project.
48C(d) • Investment in qualifying advanced energy project.
48D • Investment in qualifying therapeutic discovery project.
42 Owners of residential rental buildings providing qualified lowincome housing.
2012 Tax Year | Small Business Quickfinder ® Handbook O-9
For 2012 and 2013, a credit equal to the lesser of 10% of the vehicle’s cost or $2,500 is available for purchasing certain 2- and
3-wheeled plug-in electric vehicles that (1) are manufactured primarily for on-road use, (2) are capable of a speed of at least 45
miles per hour and (3) meet several other requirements of Section 30D. [IRC §30D(g)]
U Caution: Certain
low-speed vehicles acquired before 2010 could qualify
for the Section 30D plug-in electric drive
motor vehicle credit (Notice 2009-54). After
2009, such vehicles can only qualify for the
credit for low-speed and 2- and 3-wheeled
vehicles under Section 30.
 Note: A vehicle is considered acquired on the date when title
to that vehicle passes under state law. (Notice 2009-89)
For more information on plug-in electric drive motor vehicles, see
Tab 6 of the Depreciation Quickfinder® Handbook.
Section 30
Low-Speed and 2- and 3-Wheeled Vehicles
Form 8834; IRC §30 and §30D(g)
 Expired Provision Alert: The low-speed and 2- and 3-wheeled
vehicle credit expired at the end of 2011. It’s possible Congress will
extend it to 2012, but had not done so at the time of this publication.
See Expired Tax Provisions on Page Q-1 for more information.
For vehicles bought after February 17, 2009 and before 2012, a
nonrefundable credit is available to purchasers of the following
plug-in electric vehicles, if they meet certain technical requirements: (IRC §30)
was
met
1) Low-speed vehicles [four-wheeled vehicles that can obtain a
speed of 20 (but not more than 25) miles per hour and a gross
vehicle weight rating of 3,000 pounds or less].
was
2)Motorcycles. pre-2012
had to
3) Three-wheeled vehicles.
The credit is 10% of the cost (less any Section 179 deduction, if
used in business), capped at $2,500. The vehicles must be new
(not used). Taxpayers can rely on a manufacturer’s certification
that the vehicle qualifies for the credit. (Notice 2009-58)
could
The IRS has certified several manufacturer’s vehicles as qualifying for the credit. Go to the IRS website and search for “Plug-In
Electric Vehicle Credit” for the most recent list. d
Reporting. The credit for plug-in electric drive motor vehicles
is claimed on Form 8936. The credit for low-speed and 2- and
3-wheeled vehicles is claimed on Form 8834. For both credits, the
portion of the credit attributable to business/investment use of the
vehicle is part of the general business credit and the remainder is a
personal nonrefundable credit that can offset regular tax and AMT.
pre-2012
Commercial Buildings Deduction
Section 179D allows businesses to deduct, rather than capitalize
and depreciate, all or part of the cost of energy efficient commercial building property. The deduction is allowed only for qualifying
property placed in service in 2006 through 2013. IRS guidance
in Notices 2006-52, 2008-40 and 2012-26 is summarized below.
Qualifying property. Energy efficient commercial building property
is depreciable property that is:
•Installed on or in a building located in the U.S. that is not a singlefamily house, a multi-family structure of three stories or fewer
above grade, a mobile home or a manufactured house.
•Part of the (1) interior lighting system, (2) heating, cooling, ventilation and hot water systems or (3) the building envelope.
•Certified that it will reduce or is part of a plan to reduce the overall
energy costs of these systems by 50% or more.
Deduction limits. There are several deduction limits to consider:
•Qualifying property. For any one building, the total deduction for
property meeting the 50% or more energy reduction requirement
is limited to $1.80 times the building square footage.
•Partially qualifying property. A summary of energy savings
percentages necessary to qualify for a partial deduction under
Section 179D is available in Notice 2012-26.
Energy Savings Required to Qualify
for Reduced Deduction1
Notice 2006-52
Notice 2008-40
Notice 2012-26
Interior Lighting
20%
25%
162/3%
Systems
Heating, Cooling,
Ventilation
20%
15%
162/3%
and Hot Water
Systems
Building Envelope
10%
10%
162/3%
Property Placed
1/1/06–12/31/08
1/1/06–12/31/13 3/28/12–12/31/13
in Service
1
Property described in the Notices above is eligible for a reduced deduction limited
to 60¢ times the building’s square footage.
Certification. Before claiming the deduction, the property must
be certified as meeting the requirements by an unrelated qualified
and licensed engineer or contractor. Taxpayers must retain these
certifications in their tax records.
Energy Efficient Home Builders Credit
Form 8908; see also IRC §45L has been extended through 2013 Software programs. The Department of Energy maintains
a public list of software that may be used to calculate energy
 Expired Provision Alert: The energy efficient home builders
and power consumption and costs as part of the certification
credit expired at the end of 2011. It’s possible Congress will extend
process. The list appears at www1.eere.energy.gov/buildings/
it to 2012, but had not done so at the time of this publication. See
qualified_software.html.
has been extended, with
Expired Tax Provisions on Page Q-1 for more information.
2014
modifications, through 2013
Contractors that build new energy efficient
Appliance Manufacturers Credit
homes in the U.S. may claim a tax credit of
Form 8909; see also IRC §45M
$2,000 per dwelling unit for homes sold after
 Expired Provision Alert: The appliance manufacturers credit
2005 and before 2012. To qualify, the unit
expired at the end of 2011. It’s possible Congress will extend it
must be certified to have annual energy conto 2012, but had not done so at the time of this publication. See
sumption for heating and cooling that is at least
Expired Tax Provisions on Page Q-1 for more information.
50% less than comparable units and meet certain
other requirements. The credit can also apply to a substantial reA business tax credit is available for the manufacture of qualifying
construction and rehabilitation of an existing dwelling unit because
energy efficient dishwashers, clothes washers and refrigerators
that counts as new construction for this purpose. A manufactured
in the U.S.
home that meets a 30% reduced energy consumption standard
The per-appliance credit amount depends on the type of appliance.
can generate a $1,000 credit. These credits only apply to homes
For 2011, the maximum overall credit for all qualified appliances
sold by contractors for use as personal residences. The contracis the smaller of 4% of the manufacturer’s average annual gross
tor’s tax basis in the home is reduced by the amount of the credit.
receipts for the three prior tax years or $25 million. The $25 million
The credit applies through 2011.
2013
limit does not apply to certain types of clothes washers and refrigerators—see the Form 8909 instructions for more information. This
The IRS has guidance on the certification process that builders must
credit will benefit consumers to the extent appliance manufacturers
complete to qualify for the credit. See Notice 2008-35 for standard
pass along their tax savings.
homes rules. Notice 2008-36 covers manufactured homes.
The
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O-10 2012 Tax Year | Small Business Quickfinder ® Handbook
Accounting for Bookkeeping
Accounting for Income Tax
Cost of
Goods Sold
(COGS)
Revenue is recognized at the point of sale. The cost of a
product is not deductible until it is sold. GAAP requires the accrual
accounting method so that revenues and related expenses are reported
in the same accounting period.
In determining the cost of goods sold (COGS), an inventory account is
maintained to keep track of the tangible personal property on hand that
may be classified as raw materials, work in process and finished goods.
Long-term assets subject to depreciation and selling expenses are not
included in inventory. GAAP requires certain overhead expenses to be
included in inventory.
Under the periodic system, a physical count of inventory on hand
is taken as of a specific date. The net change between the beginning
and ending inventories determines the COGS amount. Various COGS
expense accounts are used to record daily transactions such as
purchases, purchase returns and allowances, purchase discounts and
freight-in. At the end of the period, inventory is debited or credited to
its actual balance, the expense accounts are debited or credited to
eliminate existing balances, and a COGS account is debited to balance
the entry.
Under the perpetual system, inventory records are maintained and
updated continuously as items are purchased and sold. The inventory
account is debited when an item is purchased. The COGS account is
debited and inventory is credited when the item is sold. At the end of the
accounting period, inventory is adjusted to the actual physical count.
The cost of an item that is produced or purchased for sale to
customers is deductible. An inventory account must be kept when the
production, purchase or sale of merchandise is an income-producing
factor. The accrual accounting method must generally be used for
inventory transactions, even though the cash method may be used for
service-related transactions. (Reg. §1.446-1)
Example: An auto repair shop reports the purchase and sale of parts on
the accrual basis while using the cash method to report labor charges
and general operating expenses. See Inventory Methods on Page L-7.
UNICAP. Under Section 263A, an allocable portion of most indirect costs
must be included in inventory and expensed under the cost of goods sold
rules. See Uniform Capitalization Rules on Page L-8 for more information.
Exception [Rev. Procs. 2001-10 and 2008-52 (as modified by Rev.
Procs. 2011-14 and 2011-43)]: An exception to the accrual requirement
for inventory applies for taxpayers with average annual gross receipts of
$1 million or less. Under this exception, the taxpayer can use the cash
method of accounting even though the production, purchase or sale of
merchandise is an income-producing factor. However, the taxpayer must
still account for the purchase of inventory in the same manner as nonincidental materials and supplies. Non-incidental materials and supplies
cannot be deducted until they are used. (Temp. Reg. §1.162-3T)
Another exception to the accrual requirement applies when gross
receipts are $10 million or less. However, this exception generally
excludes manufacturers, wholesalers, retailers, miners, certain publishers
and certain information industries unless they are principally a service
business or perform certain kinds of custom manufacturing. [Rev. Proc.
2002-28 (as modified by Rev. Procs. 2011-14 and 2011-43)]
See Accounting Methods on Page L-1, for more details.
Demolition
Expenses or
Losses
Although there is no direct guidance in the current FASB
Codification, a practical method of accounting for demolition is to add
costs less salvage value to the basis of the land. Costs added would
include the adjusted basis of any demolished structure and the cost of
demolition. This treatment is supported by a former AICPA Statement
of Position, Accounting for Certain Costs Related to Property, Plant,
and Equipment, which was discontinued in 2004. GAAP for the types of
assets that might be susceptible to demolition is now provided in FASB
ASC 360, Property, Plant, and Equipment.
Costs incurred to demolish a structure must be added to the
basis of the land where the demolished structure was located. [IRC
§280B(2)]
Depletion
Cost depletion is the basic method of computing a depletion
deduction. An estimate is made of the amount of natural resources to be
extracted in units, tons, barrels or any other measurement. The estimate
of total recoverable units is divided into the total cost of the depletable
asset to arrive at a depletion rate per unit. The annual depletion
expense is the rate per unit times the number of units extracted during
the year.
If there is a revision of the estimated number of units that are expected
to be extracted, a new unit rate is computed. The cost of the natural
resource property is reduced each year by the amount of the depletion
expense for the year.
A depletion deduction is allowed only if a taxpayer has an
economic interest (generally an owner or operator) in mineral property,
an oil, gas or geothermal well, or standing timber. See Depletion on
Page J-9 for more information.
The cost of an asset minus its salvage value (if any) is
depreciated over the estimated useful life of the asset. The useful life
is the period for which services are expected to be rendered by the
asset, and it can vary from company to company. GAAP allows several
depreciation methods including straight-line (SL), units-of-production,
sum-of-the-years’-digits and DB.
All normal expenditures to put an asset in service for use by the
business are added to the basis of the asset. Expenditures that do not
improve the asset or prolong the asset’s useful life should be deducted
as a current expense.
Example: A repair to a piece of equipment damaged during shipment
should be expensed rather than added to basis.
Assets are depreciated under the modified accelerated
cost recovery system (MACRS). Three-year, five-year, seven-year
and 10-year properties are depreciated using the 200% DB method.
Fifteen-year and 20-year properties are depreciated using the 150% DB
method. Real property is depreciated using the SL method. Elections
are available to use less accelerated methods of depreciation.
In 2012, up to $125,000 ($139,000 inflation-adjusted) of the cost of
tangible property may be expensed under Section 179.
See Tab J for more information on tax depreciation, including the special
(bonus) depreciation allowance for qualified new property acquired in 2012.
Depreciation
Assets are depreciated using SL depreciation over the
alternative depreciation system (ADS) life listed in Tab J. If the Section
179 deduction was used for tax purposes, the life is five years for E&P
purposes. [IRC §312(k)(3)]
With respect to each property, the excess of the depletion
deduction for regular tax purposes over the adjusted basis in the
property (determined without regard to the depletion deduction for the
tax year) is added back into income for AMT purposes.
Exception: Depletion taken by independent oil and gas producers and
royalty owners. [IRC §57(a)(1)]
500,000
If the 200% DB method was used for tax purposes, the 150%
DB method must be used for AMT purposes. The MACRS recovery
periods are used for both regular tax and AMT purposes [IRC §56(a)(1)].
No AMT adjustment is made on property expensed under Section 179.
Also, no AMT adjustment results from bonus depreciation.
Table continued on the next page
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2012 Tax Year | Small Business Quickfinder ® Handbook O-15
Dividend
Distributions
Accounting for Bookkeeping
Accounting for Income Tax
Cash dividends:
• To record a dividend declaration:
Debit: Retained Earnings
Credit: Dividends Payable
• To record the payment to stockholders:
Debit: Dividends Payable
Credit: Cash
Stock dividends:
• To record a dividend declaration:
Debit: Retained Earnings
Credit: Stock Dividend to be Distributed
• To record the stock distribution to stockholders:
Debit: Stock Dividend to be Distributed
Credit: Common Stock
Credit: Additional Paid-in Capital
Distributions to shareholders have no effect on taxable income
of the corporation, except when a corporation distributes appreciated
property (other than its own securities or stock). Taxable gain equals
the FMV of the distributed property minus the adjusted basis of the
property. [IRC §311(b)]
The FMV of the property is the greater of: (1) the actual FMV or (2) the
amount of any liabilities the shareholder assumed in connection with
the distribution of the property. If the property was depreciable, any
depreciation recapture will be subject to treatment as ordinary income.
A corporation can accumulate its earnings for a possible expansion
or other bona fide business reasons. If a corporation accumulates
its earnings beyond the reasonable needs of the business, it may be
subject to an accumulated earnings tax at a 15% rate in 2012, but
scheduled to increase to the highest individual tax rate for tax years
beginning after 12/31/12 (IRC §531). See Accumulated Earnings Tax on
Page C-12 for more details.
)
(20%
Distributions to shareholders from C corporations first reduce
current E&P and then reduce any accumulated E&P.
The amount by which E&P is reduced depends on what is distributed
to the shareholder(s):
• Cash distributions decrease E&P by the amount distributed, but not
below zero.
• Property distributions decrease E&P by the adjusted basis of that
property, but not below zero.
• Appreciated property distributions increase E&P by the excess of the
FMV over the adjusted basis of the property, and then reduce E&P by
the FMV of the property distributed, but not below zero.
See Tab C for more information on distributions from E&P.
DividendsReceived
Deduction
Not a deduction for GAAP reporting purposes.
Deduction is not allowed for E&P purposes.
C corporations may deduct 70% of the dividends received
from a less-than-20%-owned distributing corporation, or 80% of the
dividends received from a 20%-or-more-owned distributing corporation.
Certain limitations and exceptions apply. See Dividends-Received
Deduction on Page C-13.
Impairment
Losses
An asset is impaired when the FMV of the asset is lower than
the amount at which the asset is carried on the balance sheet (cost of
the asset minus accumulated depreciation). This occurs when the value
of an asset unexpectedly declines a significant amount. If the carrying
amount of the asset is greater than the sum of expected undiscounted
cash flow from the asset’s use and disposition, the value should be
written down for book purposes. The resulting impairment loss is
expensed.
Rules governing accounting for impaired assets do not affect
tax treatment of the item. Cost recovery for tax purposes is determined
by the basis of the item. Any increase or decrease in value of the asset
is not recognized for tax purposes until the asset is sold or exchanged.
Installment
Sales
The installment sales method of accounting is generally not
allowed except under unusual circumstances where receivables are
collectible over an extended period of time and collectibility cannot be
reasonably estimated.
Capital gain on the sale of property is reported under the
installment method of accounting if any principal payment is received
after the tax year in which the sale occurred. The taxpayer may make an
election to report the entire gain in the year of sale. (IRC §453)
Deferral of gain is not allowed for E&P purposes. [IRC §312(n)(5)]
O-16 2012 Tax Year | Small Business Quickfinder ® Handbook
Corporations must add back deferred installment gains in
computing the year of sale adjusted current earnings (ACE) adjustment
[IRC §56(g)(4)(D)]. This add back is not required if interest is charged on
the deferred installment gains under Section 453A. A C corporation (1) in
its first tax year of existence or (2) with three-year average gross receipts
of $5 million or less for its first tax year beginning after 1996 and $7.5
million or less each year thereafter, is not subject to AMT. [IRC §55(e)]
Replacement Page 01/2013
Accounting for Bookkeeping
Accounting for Income Tax
Research
and
Development
Costs
Research and development (R&D) costs should generally be
expensed in the period incurred (FASB ASC 730-10-25, Research and
Development—Recognition). Some costs related to R&D activities are
capitalized if they have alternative future uses.
Costs incurred in establishing the technological feasibility of
a computer software product that is sold, leased or otherwise
marketed are expensed in the period incurred (FASB ASC
985-20, Costs of Software to Be Sold, Leased, or Marketed).
However, the cost of purchased software having an alternative
future use should be capitalized and accounted for according to
its use. Once the technological feasibility of a software program
is established, costs for coding and testing are capitalized and (1)
amortized over the product’s economic life and (2) reported at the
lower of unamortized cost or net realizable value.
The capitalization of costs ends when the product is available to be
sold, leased or marketed.
Reasonable research and experimental costs may qualify for one of the
following methods of recovery: (1) deduction as a current expense [IRC §174(a)
(1)], (2) amortization over 60 months [IRC §174(b)(1)] or (3) amortization over a
10-year period. [IRC §174(f)(2) and §59(e)]
Research and experimental costs include expenses incurred to provide information
that would eliminate uncertainty about development or improvement of a product. The
term product for this purpose includes a formula, invention, patent, pilot model, process,
technique or similar property. For example, costs of obtaining and perfecting a patent
application are research and experimental costs, but costs to obtain another’s patent
are not. Research and experimental costs do not include costs for market research,
management surveys or normal product testing. (Reg. §1.174-2)
Credit for increasing research activities (Form 6765):
Costs of qualified research undertaken for discovering information that is
technological in nature qualify for a credit under Section 41. The application must
be intended for use in developing a new or improved business component of the
taxpayer. The expenses must qualify under Section 174, and substantially all of the
activities of the research must be elements of a process of experimentation relating
to a new or improved function, performance, reliability or quality. [IRC §41(d)]
Expired Provision Alert: The research credit expired at the end of 2011. It’s
possible Congress will extend it to 2012, but had not done so at the time of this
publication. See Expired Tax Provisions on Page Q-1 for more information.
Note: See Reg. §1.41-9 relating to the election and calculation of the alternative
simplified credit under Section 41(c)(5).
Salaries
and
Wages
Wages are generally deductible as incurred, unless they
are required to be capitalized or added to inventory based on the
services performed. An adjusting entry is usually made at the end
of the accounting period to accrue wages for services performed
by employees who have not yet been paid.
Example: The last pay day during a calendar year falls on Friday,
December 31, and covers work performed through Wednesday,
December 29. An adjusting entry is made to accrue wages that
will be paid next year for work performed on December 30 and 31.
Wages, salaries, commissions, etc., are deductible if they meet the
tests below. Wages are capitalized when they are incurred to produce capital
assets. Wages are included in inventory and deducted as part of COGS when
they are incurred to produce merchandise sold to customers.
has been extended through 2013.
Deductibility tests:
• The wages must be an ordinary and necessary expense directly connected
with carrying on a trade or business. Wages paid in connection with the start up
or organizing of a business are deductible as a current business expense up to
$5,000. The $5,000 deduction is reduced for expenditures exceeding $50,000.
Any remaining costs are amortized over 180 months.
• The wage must be paid for services actually performed by the employee, and
it must actually be paid or incurred during the tax year. For example, token
wages paid to family members who do not work for the business are not
deductible. Likewise, a sole proprietor cannot treat joint personal expenses
paid as wages to a spouse who performs services for the business.
• Reasonable compensation for shareholders. C corporations have incentive to pay
high wages to shareholders because wages are deductible by the corporation,
and therefore double taxation on the amount is avoided. However, S corporations
have incentive to pay low wages to shareholders, and pass through remaining
income to avoid FICA tax. The IRS frequently challenges whether wages paid to
shareholders are reasonable, and the issue often results in litigation. See Wages
for Shareholders on Page C-8 and Reasonable Wages on Page D-8.
Public companies. Wages paid to certain employees of publicly held corporations
are not deductible if they exceed $1 million per employee [IRC §162(m)]. This rule
applies to any employee of the taxpayer if, at the close of the tax year,
(1) the employee is the principal executive officer or acts in such capacity or
(2) total compensation of that employee for the tax year is required to be reported
to shareholders under SEC rules because the employee is among the three highest
compensated officers for that year other than the principal executive or financial
officer. Compensation of the principal financial officer for whom SEC reporting is
also required is not subject to the Section 162(m) limitation. (Notice 2007-49)
For purposes of the $1 million limit, compensation does not include qualified
retirement plan contributions, tax-free fringe benefits, performance-based
compensation meeting certain requirements or compensation paid on a
commission basis.
Compensation paid to an executive is not considered qualified performancebased compensation if the agreement/contract provides for payment of that
compensation to employees for meeting performance goals if they are terminated
without cause or for good reason or voluntarily retire (Rev. Rul. 2008-13).
Compensation paid to an executive under an incentive plan on the attainment of
performance goals under any performance share/unit awards is not considered
Section 162(m)(4)(C) performance based compensation. (Ltr. Rul. 200804004)
Executives of companies participating in the troubled assets relief program. The
deduction for compensation paid to certain top executives of publicly traded companies
selling more than $300 million of troubled assets to the federal government in the
bailout program is capped at $500,000 (instead of $1 million) for each such employee
per year [IRC §162(m)(5)]. See IRS Notice 2008-94 for more information.
Table continued on the next page
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Accounting for Bookkeeping
Accounting for Income Tax
Start-Up
Costs
A business that is in the development stage must issue the
same basic financial statements as any other business. Expenditures
are either expensed, capitalized or deferred as with an operating
business.
Certain disclosure requirements apply to a business in the
development stage.
Costs of start-up activities should be expensed as incurred. Startup activities include (1) opening a new facility, (2) introducing a
new product or service, (3) conducting business activities in a
new territory or with a new class of customer or beneficiary, (4)
initiating a new process in an existing facility and (5) starting a
new operation.
Business start-up costs generally must be capitalized, but Section 195 allows
a taxpayer to deduct up to $5,000 of start-up costs as a current business expense.
The $5,000 deduction is reduced by the amount total start-up expenditures exceed
$50,000. Any remaining costs are amortized over 180 months. The deduction must be
claimed on the first tax return of the business by the due date for the return (including
any extensions). A separate election statement is not required. Start-up costs are those
incurred in setting up an active trade or business or investigating the possibility of
creating or acquiring an active trade or business. See Organizational and Start-Up Costs
on Page M-6.
Start-up costs include:
• A survey of potential markets.
• An analysis of available facilities, labor, supplies, etc.
• Advertisements for the opening of the business.
• Salaries and wages for employees in training and instructors.
• Travel and other costs for securing distributors, suppliers or customers.
• Salaries and fees for executives, consultants or other professionals.
Start-up costs do not include interest, taxes or research and experimental costs.
State and
Local Bonds
Interest earned is included in income. See Capital Gains
and Losses on Page O-14 for reporting the sale of a bond.
Interest earned on state or local bonds is exempt from income tax (IRC
§103). A gain or loss realized on the sale of the security is included in taxable
income.
Same as tax. Exception: Interest earned from certain private activity
bonds is included in AMT income. [IRC §57(a)(5)]
Interest earned increases E&P. [Reg. §1.312-6(b)]
Stock
Options
Taxes
When stock is offered to employees at below-market
rates, it is usually part of a compensatory plan. The corporation
deducts compensation expense on its books.
GAAP treatment is provided by FASB ASC 718, Compensation—
Stock Compensation [original pronouncement was Statement of
Financial Accounting Standards (SFAS) No. 123(R), Share-Based
Payment, which replaced SFAS No. 123 and superseded APB
Opinion No. 25]. Prior to SFAS No. 123(R), SFAS No. 123 permitted
either the intrinsic value method of accounting for stock-based
compensation under APB Opinion No. 25 or the fair-value-based
method. Presently effective GAAP requires entities to recognize
the cost of employee services received in exchange for awards
of equity instruments based on the grant-date fair value of those
awards (with limited exceptions). Compensation cost is generally
recognized over the period that the employee is required to provide
service with a corresponding credit to paid-in capital.
In general, property that is exchanged for the performance of services
is taxable to the person performing the services (IRC §83) and deductible by the
business transferring the property. This rule includes nonstatutory stock options
at the time the option is granted (if FMV can be readily determined) or when the
employee exercises the option (if FMV cannot be readily determined).
However, if the option is an incentive stock option or an option granted under an
employee stock purchase plan (statutory stock options), the employee does not
recognize taxable income and the corporation does not deduct compensation expense
until the employee later sells the stock (IRC §421). See Tab 7 of the 1040 Quickfinder®
Handbook for more information about employee stock options.
Federal income tax is deductible under GAAP. The
amount of income tax expense recognized equals the income
taxes currently payable or refundable, plus or minus the change in
aggregate deferred tax assets and liabilities. When tax laws differ
from financial reporting standards, temporary differences occur
between the basis of assets and liabilities for tax and financial
reporting purposes. These temporary differences reverse in later
years when the related asset is recovered or the related liability is
settled. The differences that arise between the tax basis of assets
or liabilities and their reported amounts in the financial statements
result in a deferred tax liability or a deferred tax asset.
Example: An asset purchased for $500 is expensed under Section
179 for tax purposes. Assume the asset is depreciated SL over five
years for financial reporting purposes. This will cause accounting
income to be greater than taxable income in the first year by $400,
and taxable income to be greater than accounting income by $100
in years two through five. Assume the tax rate is 35%. The deferred
tax liability equals $140 ($100 × 35% × 4 future years). Each year,
the deferred tax liability is reduced by $35 until the end of year five,
when the tax basis and accounting basis of the asset are the same.
When the difference between revenues or expenses for accounting
and tax purposes is permanent (such as fines and penalties), there
are no deferred tax consequences associated with such difference.
Deferred tax amounts are associated only with temporary differences.
Federal income tax is deductible for E&P purposes. The
deductible amount equals the actual tax liability. Cash basis taxpayers
reduce E&P for estimated tax paid during the year irrespective of
the ultimate federal income tax liability. If a refund is received in the
following year, the corporation increases its E&P by the refund amount
for the year in which it is received. If additional tax is paid in the
following year, the corporation reduces its E&P in the year such tax is
paid. (Rev. Rul. 79-69)
Deductible taxes imposed on a business include:
• Real estate taxes.
• State and local income taxes (not deductible by an individual as a business
expense; however, they are deductible as an itemized deduction on Schedule
A of Form 1040).
• Employment taxes such as the employer’s share of FICA, FUTA and state
unemployment taxes.
• Personal property taxes.
• Fuel taxes.
• Corporate franchise taxes.
• Excise taxes.
Nondeductible taxes include:
• Federal income, estate and gift taxes.
• State inheritance taxes.
Sales tax paid on purchases is included in the cost of the item purchased and is
either deducted as a current expense, depreciated or capitalized depending on
the item purchased.
Sales tax collected from customers and paid over to the government is usually not
included in gross income or deducted as an expense. The collection of sales tax should
be set up as a liability account (for both cash and accrual method taxpayers). The
liability is reduced as the business pays over the tax to the government.
Sole proprietors and partners can deduct the employer-equivalent portion of their
SE tax as an adjustment to gross income on Form 1040.
Accrued payroll taxes. An accrual method taxpayer can deduct accrued payroll
taxes in the same year as the accrued wages. (Rev. Rul. 96-51) An accrual
method taxpayer can deduct accrued payroll taxes in year one even if the related
compensation is deferred compensation not deductible until year two. (Rev. Rul.
2007-12)
For stock acquired during the year through the exercise of an incentive
stock option, any excess FMV of the stock over the amount paid for the stock is
added back to income of the employee receiving the stock (unless the stock is
subject to both restrictions on transferability and a substantial risk of forfeiture).
[IRC §56(b)(3)]
— End of Tab O —
O-22 2012 Tax Year | Small Business Quickfinder ® Handbook
Applicable Rules:
1) Partnership’s basis in property (inside basis). A partnership’s
inside basis in property contributed by a partner is
equal to the partner’s basis in the property, plus gain
recognized upon contribution (IRC §723). If the
partnership purchases property directly, inside basis
equals the purchase price. Inside basis is reduced
by the partnership’s depreciation of the property.
2) Partner’s basis in partnership (outside basis). A
partner’s outside basis is the partner’s adjusted basis
in the contributed property (IRC §722). Certain items
that affect outside basis, such as liability assumption
or relief, will not affect inside basis.
3) Section 754 election. Under a Section 754 election, inside
basis of partnership property is adjusted to reflect the buyer’s
purchase price. This reduces negative effects when basis in
acquired partnership property is less than the amount paid for
the partnership interest. The election applies only to the buying
partner. It does not change basis for other partners.
 Note: The Section 754 election applies only to sales or ex-
changes of partnership interests and to distributions. It does not
apply to contributions of property, including money, to a partnership.
Section 754 explains how and when to make the election, its
duration and to which transactions it applies. Section 754 refers to
Sections 734 and 743 for computing adjustment amounts.
Section 734 explains basis adjustments for distributions.
Section 743 explains basis adjustments for sales or exchanges.
Section 755 explains adjustment allocation among properties.
Solution: A Section 754 election can reduce the negative tax effects when basis in partnership property is less than the amount
paid for the partnership interest. Character and timing of income
can be controlled. See Section 754 Election Example on Page P-8.
Disadvantage of a Section 754 election. Once the election is
in place, the basis adjustments must be applied to every transaction that constitutes a sale, exchange or distribution. The Section
754 election remains in effect for all tax years subsequent to the
year of election and may be revoked only with IRS consent (Reg.
§1.754-1). Additional basis records must be kept showing Section
754 adjustments. This can be a recordkeeping burden for partnerships, especially those that hold a large number of assets.
Making the Section 754 election. The partnership makes the
election by submitting a statement to the IRS that contains (1) the
partnership name and address, (2) a declaration that the “Partnership elects under Section 754 to apply the provisions of Sections
734(b) and 743(b)” and (3) the signature of a partner. The election
must be filed with the partnership tax return by the return’s due
date, including extensions. The election remains in effect unless
the IRS grants permission to revoke.
Mandatory downward basis adjustments.
A downward Section 754 basis adjustment is
mandatory (rather than elective) when:
(1) a transfer of a partnership interest occurs due
to a sale or exchange or the death of a partner
and (2) the partnership has a substantial built-in loss
at the time [IRC §743(a)]. A substantial built-in loss exists when
the total adjusted tax basis of the partnership’s assets exceeds the
total FMV of those assets by more than $250,000 [IRC §743(d)].
An alternative rule applies to electing investment partnerships with
substantial built-in losses. Securitization partnerships are exempt
from these special rules. (See Section 743.) Yet another special
rule makes a downward Section 754 basis adjustment mandatory
(rather than elective) when: (1) a distribution of partnership property
occurs and (2) the distribution would have triggered a partnership
basis reduction in excess of $250,000 if a Section 754 election
had been in effect. Securitization partnerships are exempt. (See
Section 734.)
Shareholder Loan to
C Corporation
Problem: When a shareholder provides cash to a corporation, it
is often advantageous to structure the payment as a loan as opposed to a purchase of stock. Under a loan agreement, repayment
of principal is generally nontaxable to the recipient, and interest
on the loan is deductible by the corporation. However, if the loan
is not properly structured the payment is considered an equity
transaction, and repayments are treated as taxable dividends.
Applicable Rules:
1) Purchase of stock vs. loan:
•When a shareholder buys stock, basis is not recovered until
the stock is sold. Distributions to the shareholder are taxable
dividends to the extent paid out of current or accumulated
earnings and profits (E&P).
•When a shareholder loans money to a corporation, repayment
of principal is not taxable to the shareholder. Loan interest is
taxable, but is also deductible by the corporation.
2) Constructive dividends. If a corporation with E&P makes a distribution to a shareholder and does not report the payment as a
dividend, the IRS may reclassify the distribution as a constructive dividend. In the case of loan payments, instead of being
treated as a tax-free repayment of principal, the distribution
may be taxed as a dividend up to the E&P of the corporation.
See Constructive Dividends on Page C-11.
3) Disqualified debt. A corporation is not allowed to deduct interest
paid or accrued on a disqualified debt instrument, defined as
indebtedness payable in (a) equity of the issuer or a related
party or (b) equity held by the issuer or related party in another
person. [IRC §163(l)]
4) Thinly capitalized. The IRS may reclassify a loan as a capital
contribution in the case where a corporation is thinly capitalized.
This situation can occur when a corporation has a high amount
of debt in comparison with equity and the IRS determines there
is a substantial risk that the loan will not be repaid.
Solution: Loans between C corporations and shareholders must
be carefully structured to avoid constructive dividend treatment.
Loan agreements should be in proper legal form and executed in
an arm’s-length manner, with a reasonable interest rate.
Example: Nora, a shareholder in Sunrise Corporation, wants to provide
$20,000 in operating funds to the corporation. Nora expects the corporation to
earn enough within the next two years to repay the $20,000. Nora’s individual
marginal rate is 25%, and the corporation’s marginal rate is 34%.
Bona Fide Loan. The corporation executes a written loan agreement with Nora.
The agreement is in proper legal form and contains a repayment schedule with
specified maturity date. Nora will charge the corporation 5% interest, which is
a reasonable interest rate under the current economic conditions. The corporation agrees to pay Nora $83.33 per month, the monthly amount of accrued
interest, and will repay the $20,000 principal amount in 24 months. Note: There
is a de minimis exception for below-market interest on loans if the principal
balance is $10,000 or less as long as the primary reason for the loan is not
tax avoidance. [IRC §7872(c)(3)]
The corporation pays Nora $2,000 interest over the term of the loan. The
interest is taxable to Nora and is deductible by the corporation. Nora pays
$500 tax on the interest income ($2,000 × 25%). The corporation realizes tax
savings of $680 from the interest deduction ($2,000 × 34%). The principal
payment of $20,000 to Nora is not taxable.
Constructive Dividends. Assume the same facts as above, except there is not
a legally binding loan agreement executed between Nora and the corporation.
The IRS reclassifies the initial $20,000 payment as a contribution to capital.
Subsequent distributions to the shareholder are considered taxable dividends,
and the corporation is not allowed to deduct the interest.
2012 Tax Year | Small Business Quickfinder ® Handbook P-9
When the payments are reclassified as constructive dividends, Nora must
pay $3,300 tax on the distributions from the corporation ($22,000 × 15%, the
2012 tax rate on dividends). The corporation also loses the interest deduction,
costing the corporation $680. Nora’s basis in stock is increased by $20,000.
Caution: Closely held corporations are particularly susceptible to having
distributions reclassified as constructive dividends. Transactions with their
shareholders must be carefully structured in an arm’s-length manner to avoid
unwanted tax consequences.
N Observation: Qualified dividends are taxed through 2012 at a
15% or lower rate, whereas interest is taxed at the regular rates.
This, along with possible upcoming rate changes, might influence
the tax planning involved in raising capital.
Shareholder Loan to
S Corporation
Problem: Securing a loan for an S corporation often requires a
shareholder guarantee. If the loan is not properly structured, the
shareholder’s ability to deduct losses may be limited.
Applicable Rules: The amount of losses an S corporation shareholder can take is limited to the adjusted basis of the shareholder’s
stock, plus any direct loans the shareholder makes to the corporation [IRC §1367(b)(2)]. If a shareholder merely guarantees a
loan from a lender to the S corporation, there is no effect on the
shareholder’s ability to deduct losses.
Solution: If a loan is needed to provide capital for an S corporation,
the shareholder should take out a personal loan for the amount
needed and make a direct shareholder-to-corporation loan (a
back-to-back loan). With a back-to-back loan, the shareholder’s
allowable deduction for losses increases.
Example: Buzz is sole shareholder in an S corporation. His beginning basis
in stock is $10,000. Buzz needs to provide an additional $20,000 in funds
to keep the S corporation operating. By year-end, it has a loss of $28,000.
Direct Loan From Shareholder. Buzz takes out a personal loan from his bank
in the amount of $20,000. He then makes a direct loan of $20,000 to the S
corporation. Buzz’s limit for deduction of S corporation losses is now $30,000
($10,000 initial contribution + $20,000 direct loan). Buzz can deduct the S
corporation loss of $28,000 on his individual tax return because the loss does
not exceed his basis plus the amounts loaned directly to the S corporation.
Loan Guarantee. Assume the facts shown above with this exception: Instead of
making a personal loan directly to the corporation, Buzz has the bank loan funds
directly to the S corporation. In order to approve the loan, the bank requires Buzz’s
signature as guarantor. Although he is liable for repayment of the loan, Buzz’s
basis for deducting losses remains at $10,000 because he did not loan the funds
directly to the corporation. Buzz’s deduction for the S corporation loss is limited
to $10,000. The remaining $18,000 loss is suspended until his basis increases.
Note: The same result would occur if Buzz had loaned the S corporation
$20,000 from a second S corporation solely owned by Buzz. To avoid this
situation, Buzz should distribute the $20,000 from the second S corporation
and then loan the $20,000 directly to the S corporation requiring the funds.
Caution: An S corporation can have only one class of stock (IRC §1361). For
S corporations with more than one shareholder, a loan must be structured so
that a second class of stock is not created. If debt is convertible to equity, or if
loan terms are contingent on profits or dependent on the borrower’s discretion,
the loan may be considered a purchase of a second class of stock, which will
disqualify a corporation’s S status.
S Corporation Built-In Gains Tax
Problem: In a cash basis corporation, basis in accounts receivable
is zero. If the corporation elects S status, any accounts receivable
will be subject to built-in gains tax when collected. The revenue
from the accounts receivable will be subject to double taxation (as
in a C corporation). Note: The following principles also apply to
built-in gains from assets other than accounts receivable.
P-10 2012 Tax Year | Small Business Quickfinder ® Handbook
Applicable Rules:
1) When an S corporation holds assets with built-in gains, income
from the sale of those assets is subject to built-in gains tax at
a rate of 35% (IRC §1374). Net built-in gain cannot be greater
than taxable income computed as if the corporation was a C
corporation.
2) An S corporation can retain E&P from C corporation years.
Shareholders are not taxed on E&P until it is distributed. S
corporation earnings are distributed before E&P. Therefore,
as long as S corporation distributions do not exceed earnings,
there will be no distributions or tax from the E&P account.
3) Built-in gains tax applies to assets sold within 10 years from
the date of the S corporation election. [IRC §1374(d)(7)]
 Note: Special rules exist for built-in gains occurring in tax years
beginning in 2009 through 2011. See Temporary suspension on
Page D-7 for more information. The examples below illustrate the
general rule and are not year specific.
2013
See also Built-In Gains (BIG) Tax (IRC §1374) on Page D-7.
Solution 1: Sell assets with built-in gains before converting
to an S corporation. This increases the C corporation E&P that
will be carried to the S corporation but not taxed until distributed.
This avoids transfer of built-in gains property to the S corporation.
Example #1: Rightbrain, Inc., has $30,000 accounts receivable outstanding
when it elects S status. It will collect the receivables in its first S tax year.
The built-in gains will be taxed at the rate of 35% and the tax is not reduced
by income limits. All shareholders have an individual marginal rate of 28%.
The $30,000 is first reduced by $10,500 (35% built-in gains tax). The remaining
$19,500 passes through as S corporation income to shareholders, subject to
tax of $5,460 (28%). Therefore, after-tax income on the $30,000 is $14,040.
Solution 2: Pay an accrued bonus before converting to S corporation status. This will reduce built-in gains of C corporation assets.
Applicable Rules:
1) For computing built-in gains, income and deductions are accounted for under the accrual method regardless of which accounting method is used for tax and books. [Reg. §1.1374-4(b)]
2) For 5%-or-greater shareholders, the accrued bonus must be
paid within the first 2½ months of the first S corporation year. All
events must have occurred that establish the fact of the liability
and its exact amount must be determinable [Reg. §1.1374-4(c)].
In addition, the bonus can only be deducted if it is reasonable
in view of the services rendered by the shareholder-employee.
[IRC §162(a)]
Example #2: Randy is a 40% shareholder in Rightbrain, Inc. The C corporation accrues a bonus to Randy in the amount of $30,000 before converting to
S corporation status. For built-in gains purposes, the bonus is allowed as a
deduction against built-in gain assets and reduces net built-in gains from the
corporation to zero as long as the bonus is paid within 2½ months of the start
of the S corporation tax year.
Note: Randy is a cash basis taxpayer. The deduction for the accrued bonus
only applies for built-in gains tax. An accrued bonus paid to a cash basis
taxpayer is not allowed as a deduction on the corporation’s tax return until the
amount is reported as income to the recipient.
If the corporation does not have enough cash to pay the bonus, the cost of
securing a loan may be worthwhile compared to the built-in gains tax.
S Corporation Election to
Close Books on Termination of
Shareholder’s Interest
Problem: When an S corporation shareholder’s interest is terminated during the year, the shareholder’s allocation of income, losses
and deductions is generally computed by applying a percentage to
the full-year activity of the corporation. [See Item 1) on page P-11.]
This can produce inequity, because the departing shareholder is
Replacement Page 01/2013
What's New

Tab Q Topics
2012 Tax Highlights................................................. Page Q-1
Foreign Asset Reporting......................................... Page Q-1
Estate and Gift Tax.................................................. Page Q-1
Business Tax Forms................................................ Page Q-2
Inflation-Adjusted Amounts..................................... Page Q-2
Self-Employed Health Insurance Deduction for
Medicare Premiums............................................. Page Q-2
What’s New for 2012............................................... Page Q-3
Tax Provisions That Expired December 31, 2011... Page Q-4
2012 Tax Highlights
Tax changes for 2012 and later years arise from various sources:
Congressional legislation; IRS regulations, rulings and other guidance; court decisions and the phase-in and expiration of previously
enacted legislation. The significant provisions of these tax changes
effective starting in 2012 that are most likely to affect small businesses and their owners are shown in the What’s New for 2012
table on Page Q-3.
Expired Tax Provisions
A number of tax provisions expired on December 31, 2011. Some
of these provisions have expired in the past and Congress has
extended them (in some cases, many times). At the time of this
publication, Congress had not extended any of the expired provisions, but based on past history, it is not unreasonable to expect
that some of them will be extended to be effective in 2012.
 Note: In this Handbook, we’ve retained the discussions of
these expired provisions, preceded by an “Expired Provision Alert.”
This will make it easier to see important law changes in the context
of each discussion. If legislation extends any of these provisions
to 2012 after this Handbook’s publication date, an updated version of the affected pages will be posted at www.quickfinder.com.
The Tax Provisions that Expired on December 31, 2011 table on
Page Q-4 summarizes the key provisions that affect small businesses and their owners and expired on December 31, 2011. It
describes the provisions in effect for 2011 and the provisions that,
as of the publication date, are in effect for 2012.
æ Practice Tip: If any of the expired tax provisions are extended
to 2012, an updated table will be posted to the “Updates” section
at www.quickfinder.com. Note that a provision in effect for 2011
could be modified in conjunction with any extension, so the law in
effect for 2012 might not be exactly the same as that in effect for
2011 if a provision is extended.
2) Form 8938, Statement of Foreign Financial Assets (required
by Code Section 6038D). Its purpose is to ensure that taxpayers disclose foreign assets to the IRS (and report the related
income).
Both forms are used to report similar information, but the filing of
one form does not negate the need to file the other form. Thus,
some taxpayers may have to file both forms to report the same or
similar assets, but at different times and to different government
agencies. And the penalties for failing to file either form are steep.
For a comparison of the two forms, see the Foreign Asset Reporting—Forms 8938 and TD F 90-22.1 table on Page A-16.
U Caution: Form 8938 reporting will be required of entities
(no longer only individuals) when Proposed Regulation Section
1.6038D-6 is issued as a final regulation (expected before the
end of 2012). Tax professionals should watch for developments.
Estate and Gift Tax
The 2010 Tax Relief Act included some surprising estate tax rules,
particularly reinstatement of the estate tax for 2010 but with a
higher $5 million exclusion amount. Also surprising was the new
portability rule for a married decedent's unused exclusion amount
(for deaths in 2011 or 2012).
Decedents who die in 2012. For 2012, a $5.12 million estate tax
exclusion applies along with a 35% maximum tax rate. The basis
of property transferring to heirs is its FMV at the date of death.
Married individuals who don’t use up their estate tax exclusions
are able to pass along unused amounts to surviving spouses. In
other words, unused exclusions of individuals who die in 2012
are “portable.”
The election to allow a surviving spouse to use the unused exclusion is made by timely filing the deceased spouse’s estate tax
return. Thus, a complete Form 706 must be filed, even if it otherwise would not be required. Also, making the election extends the
statute of limitations on the deceased spouse’s estate tax return.
See Portability Election on Page H-15 for more information.
Gift tax. For 2012, the estate and gift tax exclusions are unified
so a combined estate and gift tax exclusion of $5.12 million applies. And as described previously, this amount may be increased
by a deceased spouse’s unused exclusion amount (if the spouse
dies in 2012).
Foreign Asset Reporting
The IRS continues its focus on identifying foreign assets held by
U.S. taxpayers. See the Types of Foreign Assets and Whether
They are Reportable table on Page A-16 to determine foreign assets that may be reportable.
Two different regimes govern foreign asset reporting:
1) Form TD F 90-22.1, Report of Foreign Bank and Financial
Accounts (referred to as FBAR). Its purpose is to gather information to help the government uncover money laundering and
other illegal schemes.
2012 Tax Year | Small Business Quickfinder ® Handbook Q-1
are significantly less than gross payments shown on Forms 1099K, return preparers should consider, as part of their due diligence,
asking the taxpayer for an explanation.
Business Tax Forms
Form 1099-K
For 2011 and later, payment settlement entities are
required to report all payments made in settlement
of payment card (for example, credit and debit card)
transactions on Form 1099-K. Payment settlement
entities are generally banks or other organizations contractually obligated to make payments in settlement of payment
card transactions. It’s likely that businesses that accept debit
or credit cards will receive a 2012 Form 1099-K.
For 2011, it appeared that the IRS intended to require taxpayers
to separately report Form 1099-K payments on their tax returns.
In an FAQ posted to its website, the IRS states that there will be
no reconciliation required on the 2012 Form 1099-K amounts, nor
does it intend to require reconciliation in future years.
æ Practice
Tip: The amount reported on Form 1099-K is the
gross dollar amount of total reportable payment transactions with
no adjustment for credits, discounts, fees or refunded amounts.
Thus, the amount reported on Form 1099-K is often not the amount
that should be reported as income. However, even without a
reconciliation requirement, a business would be well advised to
contact the Form 1099-K provider concerning reported amounts
that significantly exceed those reflected in the business’s books
and records. Moreover, when gross receipts reported by a taxpayer
Inflation-Adjusted Amounts
For a summary of inflation-adjusted amounts for 2012 (plus 2013,
2011 and prior years), see the Business Quick Facts Data Sheet
on Page A-1.
Self-Employed Health Insurance
Deduction for Medicare Premiums
The IRS has clarified that premiums paid for all parts of Medicare
count as insurance for the health insurance deduction for selfemployed individuals. In the past, it was unclear whether premiums
paid for parts other than Part B could be counted. Furthermore, the
IRS said that Medicare premiums paid for the taxpayer, his spouse,
dependents and other children under age 27 at the end of the year
also count as self-employed health insurance. Amended returns
can be filed if Medicare premiums were not deducted in an earlier
year (assuming the statute of limitations is still open and that all
the other rules for deducting health insurance for a self-employed
person are met). See Self-Employed Health Insurance Deduction
on Pages B-6, D-15 and K-10.
Notes
Q-2 2012 Tax Year | Small Business Quickfinder ® Handbook
Additional IRS guidance.
The IRS is apparently starting
to use the information reported
on Form 1099-K. In a late-2012
posting to its website, the IRS
discusses the new notices
related to Form 1099-K that it
is sending to taxpayers. Search
for “New Notices Related to
Form 1099-K” at www.irs.gov for
tips on how to respond to these
notices and information on how
the IRS is going to use Form
1099-K data.
Replacement Page 01/2013
What’s New for 2012
This table summarizes selected tax law changes affecting businesses first effective in 2012 or enacted since last year’s Handbook
was published. See the Business Quick Facts Data Sheet on Page A-1 for the inflation-adjusted amounts for various 2012 tax items.
Item
Effective Date
QF
Page
New Law
Prior Law
J-3
Generally, a Section 179 election
can only be revoked with IRS
consent. However, the ability to
irrevocably revoke a Section 179
election without IRS consent for any
property is extended for one year, to
tax years beginning after 2002 and
before 2013. [IRC §179(c)(2)]
The one-time ability to revoke a
Section 179 election applied to years
beginning after 2002 and before
2012.
—
5-5,1
11-41
Off-the-shelf computer software
qualifies for Section 179 expensing
for an additional year. Off-the-shelf
software is eligible for the Section
179 election if it is placed in service
in a year beginning after 2002 and
before 2013. [IRC §179(d)(1)(A)(ii)]
Off-the-shelf computer software was
Section 179 property if placed in
service in a year beginning after 2002
and before 2012.
Business Property—Depreciation and Section 179 Expensing
Section 179—
Election Can
Be Revoked
Tax years
beginning
before 2013
2014
Section 179—
Expensing for
Off-the-Shelf
Software Extended
Software placed
in service in a
year beginning
before 2013
2014
Section 179—
Expensing Limit
Property placed
in service in
2012
J-3
500,000
and 2013
Special (Bonus)
Depreciation—
Allowance
Special (Bonus)
Depreciation—
Corporate Election
to Accelerate
Certain Credits in
Lieu of Claiming
Property
acquired and
placed in
service before
2013
Property placed
in service in
2012
J-6
2014
2-111
and 2013
(Round Two) or
2012 (Round Three)
or Round Three
1
The Section 179 deduction and
qualifying property limits are
$139,000 and $560,000. In
addition, off-the-shelf computer
software continues to qualify
for Section 179 expensing and
taxpayers can amend or irrevocably
revoke a Section 179 election.
[IRC §179(b), (c) and (d)]
For 2012, the special depreciation
allowance is 50%. For longproduction-period property and
certain aircraft, the placed-in-service
dates are extended one year.
2,000,000
The limits would have fallen to
$25,000 and $200,000 for property
placed in service in a tax year
beginning after 2011. Also, off-theshelf software would not qualify
for Section 179 expensing and the
election could only be amended or
revoked with IRS consent.
and 2013
50% special depreciation was due to
expire for property placed in service
after 2010.
The election to forego the special
Expired for property placed in service
depreciation allowance and instead
after 2009 (2010 for long-productionincrease the limit on certain credits is period property and certain aircraft).
available for assets placed in service
2014
in 2012 (2013 for long-productionperiod property and certain aircraft)
or Round Three
[IRC §168(k)(4)(D)]. The election
(available only to corporations) can
be made for Round Two property,
which is property eligible for the
special depreciation allowance solely
because it meets the requirements
under the extension of the special
depreciation allowance deduction
for certain property placed in service
after 2010. However, corporations
that have already made this election
for an earlier year can elect to
not apply the election to Round
Two property. Also, for Round
Two property, the limit on unused
research credits cannot be increased
by making this election.
Reference is to the 2012 Depreciation Quickfinder® Handbook.
Replacement Page 01/2013
2012 Tax Year | Small Business Quickfinder ® Handbook Q-3
Tax Provisions That Expired December 31, 2011
Not Available in 2012 (Unless Extended by Legislation)
Note: This table summarizes significant tax provisions that affect businesses and expired on December 31, 2011. It’s possible that
Congress will extend some or all of them to 2012, but had not done so at the date of this publication. Quickfinder will post an update
at www.quickfinder.com if any of these provisions are extended to 2012.
Description
IRC §
QF
Page
Provision in Effect for 2012
Provision in Effect for 2011
2011 Law
Extended
to 2012?1
Business Property—Depreciation and Section 179 Expensing
Qualified
Real Property
Assigned a
15-Year Recovery
Period
168(e)(3)
J-3, No special provisions for qualified
10-132 leasehold improvements, qualified
restaurant property and qualified
retail improvement property placed
in service in 2012. These are
nonresidential real property with
a 39-year (40 for ADS) recovery
period.
Qualified leasehold improvements,
qualified restaurant property and
qualified retail improvements placed
in service in 2011 were assigned a
15-year recovery period (39 years for
ADS).
Yes
Qualified Real
Property Eligible
for Section 179
179(f)
J-3, Qualified leasehold improvements,
10-102 qualified restaurant property and
qualified retail improvements placed
in service in a tax year beginning in
2012 are not eligible for Section 179
expensing.
Qualified leasehold improvements,
qualified restaurant property and
qualified retail improvements placed
in service in a tax year beginning in
2011 were eligible for Section 179
expensing.
Yes
Section 179—
Expensing Limit
179(b)
J-3, Expensing limit and qualifying
10-102 property threshold are $139,000 and
$560,000, respectively, for tax years
beginning in 2012.
Expensing limit and qualifying
property threshold were $500,000 and
$2,000,000, respectively, for tax years
beginning in 2011.
Yes
J-6,
10-82
For qualified property placed
in service in 2012, the special
depreciation rate is 50% (100% for
certain long-production property and
noncommercial aircraft).
The special depreciation allowance
equaled 100% of the adjusted basis of
qualified property placed in service in
2011.
No
Book Inventory by 170(e)(3)
Corporations
C-14
None. Deduction not available after
2011.
C corporations could take an abovebasis deduction for charitable
donations of book inventories to public
schools.
No
Computer
Inventory by
Corporations
170(e)(6)
C-14
None. Deduction not available after
2011.
C corporations could take an abovebasis deduction for charitable
donations of computer technology and
equipment for educational purposes.
No
Food Inventory
170(e)(3)
C-14
Special provision for contributions
of food inventory not available after
2011 for taxpayers other than C
corporations. Deduction amount for
contributed inventory is generally
equal to taxpayer’s basis.
Taxpayers in a trade or business could
take an above-basis deduction for
donations of apparently wholesome
food inventory.
Yes
Qualified
Conservation
Contributions
170(b)
N-15,
5-132
Qualified conservation contributions
are subject to the 30%-of-AGI limit
and are carried forward for five
years.
Qualified conservation contributions
were subject to the 50%-of-AGI limit
(100% for farmers and ranchers) and
can be carried forward for 15 years.
Yes
S Corporations—
Basis Reduction
for Property
Donations
1367(a)
—
S corporation shareholders reduce
their stock basis by the pro rata
share of any charitable deduction
claimed for a donation of S
corporation property.
S corporation shareholders reduced
their stock basis by the pro rata
share of the corporation’s adjusted
basis in any property donated by the
corporation to charity.
Yes
Special
Depreciation
Allowance
168(k)(5)
Charitable Contributions
1
2
Use this column to indicate whether a provision is extended to 2012 or not.
Reference is to the 2012 1040 Quickfinder® Handbook.
Table continued on the next page
Q-4 2012 Tax Year | Small Business Quickfinder ® Handbook
Replacement Page 01/2013
Tax Provisions That Expired December 31, 2011 (Continued)
Not Available in 2012 (Unless Extended by Legislation)
Note: This table summarizes significant tax provisions that affect businesses and expired on December 31, 2011. It’s possible that
Congress will extend some or all of them to 2012, but had not done so at the date of this publication. Quickfinder will post an update
at www.quickfinder.com if any of these provisions are extended to 2012.
Description
IRC §
QF
Page
Provision in Effect for 2012
Provision in Effect for 2011
2011 Law
Extended
to 2012?1
Credits—Employment Tax
Empowerment
Zone Employment
1396
O-9
None. Credit not available after
2011.
A credit was available for certain
wages paid to employees in selected
geographic areas.
Yes
Indian
Employment
45A
O-9
None. Credit not available after
2011.
A credit was available to employers
who made qualifying payments to
certain Indian tribe members.
Yes
Military Wage
Differential
45P
O-9
None. Credit not available after
2011.
A credit was available for certain
payments to activated military
reservists.
Yes
Work Opportunity
51(c)
O-9
For employees hired in 2012, the
credit is only available for wages
paid to qualified veterans.
A credit was available for wages paid
to employees in several targeted
groups.
Yes3
30C(g)(2)
O-8
Credit not available (other than for
hydrogen refueling property) after
2011.
A credit was available for certain
alternative fuel vehicle refueling
property.
Yes
Appliance
Manufacturers
45M
O-10
None. Credit not available after
2011.
A credit was available for the
manufacture of qualifying energy
efficient dishwashers, clothes washers
and refrigerators.
Yes3
Energy Efficient
Homes
45L
O-10
None. Credit not available after
2011.
Builders of energy-efficient homes
were allowed a $2,000 credit per
qualifying home.
Yes
Plug-In Electric
Vehicles—
Low-Speed and
2- and 3-Wheeled
Vehicles
30(f)
O-10
None. Credit not available after
2011. Note: The Section 30D credit
for plug-in electric drive motor
vehicles is still available.
A credit was available for purchasing
certain low-speed and 2- or 3-wheeled
plug-in electric vehicles.
Yes3
Plug-In Vehicle
Conversion
30B
O-8
None. Credit not available after
2011.
A credit was available for converting a
vehicle to a plug-in electric drive motor
vehicle.
No
40(e)
O-9
None. Credit not available after
2011.
A credit was available for sale of
straight alcohol or certain mixtures as
fuel or use in business.
No
Biodiesel and
Renewable Diesel
Fuels
40A
O-9
None. Credit not available after
2011.
Credits were available for biodiesel
fuel and for biodiesel or renewable
diesel used to produce a qualified
mixture.
Yes
Mine Rescue
Team Training
45N
O-9
None. Credit not available after
2011.
A credit was available for training
program costs for qualified employees.
Yes
New Markets
45D
O-9
None. Credit not available after
2011.
A credit was available for investment in
community development entities.
Yes
Railroad Track
Maintenance
45G
O-9
None. Credit not available after
2011.
A credit was available for costs
incurred to maintain certain railroad
track, roadbed, bridges, etc.
Yes
Credits—Energy Tax
Alternative Fuel
Vehicle Refueling
Property
Credits—Other Tax
Alcohol Fuels
1
2
Use this column to indicate whether a provision is extended to 2012 or not.
Reference is to the 2012 1040 Quickfinder® Handbook.
3
With modifications.
Replacement Page 01/2013
Table continued on the next page
2012 Tax Year | Small Business Quickfinder ® Handbook Q-5
Tax Provisions That Expired December 31, 2011 (Continued)
Not Available in 2012 (Unless Extended by Legislation)
Note: This table summarizes significant tax provisions that affect businesses and expired on December 31, 2011. It’s possible that
Congress will extend some or all of them to 2012, but that had not done so at the date of this publication. Quickfinder will post an
update at www.quickfinder.com if any of these provisions are extended to 2012.
Credits—Other Tax (Continued)
Description
IRC §
QF
Page
Refined Coal
45(d)(8)
O-9
Research and
Development
41
O-9
Provision in Effect for 2012
Provision in Effect for 2011
2011 Law
Extended
to 2012?1
None. Credit not available after
2011.
A credit was available for refined coal
production (other than used to produce
steel industry fuel).
Yes
None. Credit not available after
2011.
A credit was available for increasing
research activities.
Yes
Other Business Provisions
Domestic
Producers
Deduction—
Puerto Rican
Activities
199(d)(8)
O-5,
6-222
None. Provision not available after
2011.
Income attributable to production
activities in Puerto Rico was treated as
domestic production income.
Yes
198
O-2
None. Provision not available after
2011.
Taxpayers could elect to expense
qualified environmental remediation
costs, which otherwise would be
capitalized.
No
132(f)
K-7,
4-32
The exclusion for employer-provided The exclusion for employer-provided
mass transit benefits (transportation mass transit benefits was $240 per
in a commuter highway vehicle and month.
any transit pass) is $125 per month.
Yes
FUTA Tax—Surtax
Imposed
3301(1)
I-1
None. Provision expired on 6/30/11.
0.2% surtax was added to the FUTA
tax.
No
Percentage
Depletion—
Suspension of Net
Income Limit
613A(c)
The 100% of net income limit on
percentage depletion for oil and gas
from marginal wells was suspended
for tax years beginning in 2011.
No
Environmental
Remediation
Costs
Fringe Benefit—
Employer
Provided Mass
Transit
Qualified Small
Business Stock
(QSBS)—
Increased
Exclusion
S Corporations—
Reduced
Recognition
Period for Built-In
Gains Tax
1
2
J-10, The 100% of net income limit applies
12-242 to percentage depletion for oil and
gas from marginal wells for tax years
beginning in 2012.
1202(a)(4)
C-7
QSBS acquired in 2012 qualifies for
50% (60% if an empowerment zone
business) gain exclusion (if five-year
holding period met). A percentage of
the excluded sale is an alternative
minimum tax (AMT) preference item.
QSBS acquired between 9/28/10
and 12/31/11 qualifies for 100% gain
exclusion (if five-year holding period
met). Also, the excluded sale is not an
AMT preference item.
Yes
1374(d)
D-7
The built-in gains tax applies
during the first 10 years following a
conversion from a C corporation to
an S corporation. A C corporation
that elects to be taxed as an S
corporation is taxed at the highest
corporate rate on all gains that were
built-in at the time of the election if
the gains are recognized during the
recognition period.
The recognition period was reduced
from the corporation’s first 10 years as
an S corporation to its first five years.
Yes
Use this column to indicate whether a provision is extended to 2012 or not.
Reference is to the 2012 1040 Quickfinder® Handbook.
— End of Tab Q —
Q-6 2012 Tax Year | Small Business Quickfinder ® Handbook
Replacement Page 01/2013