Chapter
3
The Corporate Income Tax
Tax Accounting Methods:
Accrual Method
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Accrual Method
[Reg. §1.446-1(c)(ii)] Income is taxable when:
(1) All events have occurred that fix the right to
receive income and
(2) The amount of the income can be determined
with reasonable accuracy
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Accrual Method
Prepaid income
Generally taxable when received under the Claim of
Right Doctrine (government has the right to tax income
when the taxpayer has unrestricted right to use such
income amounts)
Prepaid rent and royalty income is taxed when received
regardless of accounting method [Reg. §1.61-8]
Prepaid service income is taxed as it is earned if it is
required to be performed by the end of the tax year
following receipt, otherwise, it is taxed when received
[Rev. Proc. 71-21]
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Accrual Method
[Reg. §1.446-1(c)(ii)] Expenses are deductible
when:
(1) All events have occurred that establish the
fact of the liability
(2) The amount of the liability can be determined
with reasonable accuracy, and
(3) Economic performance has occurred
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Accrual Method
A liability (expense) is not incurred before
economic performance occurs [IRC §461(h)(2)]
Services (when provided)
Property (when used)
Workers compensation and tort liabilities (when paid)
 Tort is a wrongful act, injury or damage (not involving a breach
of contract) for which a civil action can be brought
Taxes other than real property taxes (when paid)
[Reg. §1.461-4(g)]
Exception for recurring items [IRC §461(h)(3)]
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Accrual Method
Bad debt expense [IRC §166]
Direct write-off method only is allowed for tax purposes
(GAAP requires allowance method)
Recognize income if account is repaid in a later year
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Accrual Method
Accrued compensation must be paid within 2½
months after year-end or deduction is delayed
[Reg. §1.404(b)-1T]
Matching of deductions and income for payments
to related parties [IRC §267(a)(2)]
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Example 4a: Accrued Compensation
At the end of the fiscal year ended December 31,
Y1, a corporation had accrued bonus payable of
$100,000 to its Chief Executive Officer (a cash
basis, calendar year taxpayer). How much does
the corporation deduct in Y1 and Y2 assuming the
CEO owns 2% of the corporation’s stock and the
bonus was paid January 15, Y2?
Answer:
$100,000 deducted in Y1, $0 in Y2
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Example 4b: Accrued Compensation
At the end of the fiscal year ended December 31,
Y1, a corporation had accrued bonus payable of
$100,000 to its Chief Executive Officer (a cash
basis, calendar year taxpayer). How much does
the corporation deduct in Y1 and Y2 assuming the
CEO owns 2% of the corporation’s stock and the
bonus was paid on March 30, Y2?
Answer:
$0 in Y1, $100,000 deducted in Y2
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Example 4c: Accrued Compensation
At the end of the fiscal year ended December 31,
Y1, a corporation had accrued bonus payable of
$100,000 to its Chief Executive Officer (a cash
basis, calendar year taxpayer). How much does
the corporation deduct in Y1 and Y2 assuming the
CEO owns 60% of the corporation’s stock and the
bonus was paid on January 15, Y2?
Answer:
$0 in Y1, $100,000 deducted in Y2
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Example 4d: Accrued Compensation
At the end of the fiscal year ended December 31,
Y1, a corporation had accrued bonus payable of
$100,000 to its Chief Executive Officer (a cash
basis, calendar year taxpayer). How much does
the corporation deduct in Y1 and Y2 assuming the
CEO owns 60% of the corporation’s stock and the
bonus was paid on March 30, Y2?
Answer:
$0 in Y1, $100,000 deducted in Y2
Nontaxable Income and
Nondeductible Expenses
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Nontaxable Income
Proceeds from key man life insurance [IRC §101]
Interest on state and local bonds [IRC §103]
Income from discharge of indebtedness in the
case of insolvency or bankruptcy [IRC §108]
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Nondeductible Items
Illegal payments [IRC §162(c)]
Fines and penalties [IRC §162(f)]
Key-man life insurance premiums [IRC §264(a)]
Expenses and interest allocable to income
that is exempt from tax [IRC §265]
Capital expenditures [IRC §263]
Losses on sales or exchanges with related parties
disallowed [IRC §267(a)(1) and (d)]
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Nondeductible Items
Meals & Entertainment [IRC §274]
50% disallowed [IRC §274(n)]
Entertainment tickets and skyboxes limits [IRC §274(l)]
Other limitations and disallowances
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Nondeductible Items
Excess officers compensation [IRC §162(m)]
Applies only to publicly held corporations
No deduction allowed for compensation in excess of
$1,000,000 for “covered employees”
Exception for “performance-based” compensation
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Nondeductible Items
Start-Up Expenditures
Definition [IRC §195(c)]
General rule: No deduction allowed [IRC §195(a)]
Election to amortize [IRC §195(b)]
If the election is not made properly, expenses cannot be
deducted until the corporation is liquidated
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Example 5: Start-Up Expenditures
New Corporation was formed on March 1, 2006
and began doing business on April 25, 2006. The
corporation incurred start-up expenditures
(including depreciation, rent expense and
employee compensation incurred during the
training period before the corporation opened for
business) of $52,000.
If a proper election is not made in the first year tax
return, none of the $52,000 is deductible until the
business is liquidated
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Example 5: Start-Up Expenditures
If a proper election is made under IRC §195(b) for
the first tax year, expenses can be deducted as
follows:
2006: 3,000 + (52,000 – 3,000) x 9/180 = $5,540
2007: (52,000 – 3,000) x 12/180 = $3,267
2008 through 2020: $3,267
2021: (52,000 – 3,000) x 3/180 = $812
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Nondeductible Items
Organizational Expenditures
Definition [IRC §248(b) and Reg. §1.248-1(b)(2)]
General rule: No deduction allowed [IRC §248(a)]
Election to amortize [IRC §248(a)]
If the election is not made properly, expenses cannot be
deducted until the corporation is liquidated
Example 6: Organizational
Expenditures
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New Corporation was formed on March 1, 2006
and began doing business on April 25, 2006. The
corporation incurred organizational expenditures
of $25,000.
If a proper election is not made in the first year tax
return, none of the $25,000 is deductible until the
corporation is liquidated
Example 6: Organizational
Expenditures
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If a proper election is made under IRC §248(a) in
the first tax year, expenses can be deducted as
follows:
2006: 5,000 + (25,000 – 5,000) x 9/180 = $6,000
2007: (25,000 – 5,000) x 12/180 = $1,333
2008 through 2020: $1,333
2021: (25,000 – 5,000) x 3/180 = $338
Charitable Contributions
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Charitable Contributions
Charitable contributions are generally deducted in
the year paid [IRC §170(a)(1)]
Under IRC §170(a)(2), accrual basis corporation
may elect to deduct contributions in the year
accrued if
Authorized by BOD during the year and
Paid by the 15th day of third month after year-end
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Charitable Contributions
Deductions for property contributions are
generally based on FMV with several exceptions:
Deduction for ordinary income or STCG property is
generally limited to basis [IRC §170(e)(1)(A)]
Deduction for tangible personal property put to an
unrelated use is limited to basis [IRC §170(e)(1)(B)(i)]
Deduction for patents and other intangibles is limited to
basis (new law) [IRC §170(e)(1)(B)(iii)]
Special rules for contributions of:
 Certain inventory and other property [IRC §170(e)(3)]
 Scientific property used for research [IRC §170(e)(4)]
 Computers for education [IRC §170(e)(6)]
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Charitable Contributions
Limitation: Deduction in any tax year is limited to
10% of taxable income calculated before loss
carrybacks, dividends-received deductions, and
charitable contributions [IRC §170(b)(2)] and
before taking the IRC §199 deduction
Excess contributions carry forward for 5 years
[IRC §170(d)(2)]
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Example 7: Charitable Contributions
The XYZ Corporation has a $55,000 tax net operating loss
carryforward from last year. In addition, the corporation
reported the following income and expenses in its financial
statements for the current year:
Operating income
Dividend income (15% owned companies)
Charitable contributions
Net income before taxes per books
$1,800,000
175,000
(300,000)
$1,675,000
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Example 7: Charitable Contributions
Assuming the operating income and dividend
income is the same for tax and book purposes,
what is the corporation’s charitable contributions
deduction for the current year?
Answer:
 Pre-tax book income
$1,675,000
 Add back contributions
300,000
 Less: NOL carryforward
(55,000)
 Total
$1,920,000
 Limitation (10%)
$192,000 Deduction allowed
 Carryover to next year is $108,000