Corporate Income Tax
Tx 8120
Learning Goals
You should be able to:
1.
2.
3.
4.
5.
6.
Explain _____ and _____ of incorporating,
Calculate shareholder-level _____,
Discuss corporate _______ requirements,
Explain corporate choices in accounting
________ and methods,
Describe effects of _________ transactions
on corporations and owners, and
Determine impact of dividend received
deduction.
Corporate form
Business Form Choices
Sole proprietorships
Partnerships
C corporations
S corporations
Limited liability companies
Corporate form
Quote Worth Re-Quoting
“Decisions to embrace the corporate form of
organization should be carefully considered,
since a corporation is like a ________ ____:
easy to enter, difficult to live in, and painful
to get out of.”
Corporate form
Check the Box
• Treated as corporation if:
– _________ business entity
– Unincorporated business entity but box _________
– Publicly traded __________
• Unincorporated business entity
– ___________ if box checked or PTP
– _________ if ≥ two members and box unchecked
– _______ (sole proprietorship) if only one corporate
(individual) member and box unchecked
Corporate form
C Corporation Advantages
• Easy to create
– Simple ______ procedures
– Often done ____-free
• Limited liability
• Few restrictions on raising capital
– No limit on _______ and _____ of owners
– Multiple ________ of stock allowed
Corporate form
C Corporation Disadvantage
(Double Tax)
• Many opportunities for reducing double tax
in ______-_____ corporations
– Deferring __________
– __________ profits as salary, rent, or interest
• _______ tax effect may be small
– DRD for _________ shareholders, §243
– Individual shareholders taxed at __% or ___%
Corporate form
Reducing Double Tax
(Siphoning Strategy)
Dividends
Rate
Tax
Salary
Rate
Tax
Dividends
of $____
Profit $100
Rate
Tax
C
Salary
of $____
Profit $100
Salary
Taxable
Rate
Tax
C
Tax rate concepts
Tax Rate Terminology
Statutory Tax Rates: Appear in _____
Total Income Tax
________ Tax Rate =
Total Income
________ Tax Rate =

Incremental Income Tax
Incremental Income
Tax rate concepts
Section 11(a)
(Domestic Corporations)
(a) Corporations in general.
A tax is hereby imposed for each taxable year on the
taxable income of every corporation.
Tax base
x Tax rate
Tax
Tax rate concepts
-
Domestic
Corporation’s
U.S. Tax
Liability
-
x
+
+
+
+
-
Income
Exclusions
Gross income
Regular deductions and losses
Taxable income before special deductions
Net operating loss deduction
Dividend received deduction
Taxable income
Statutory tax rates
Income tax before credits
Credits
Recapture of prior credits
Regular income tax liability
Alternative minimum tax
Accumulated earnings tax
Personal holding company tax
Estimated tax payments
Income tax liability
Tax rate concepts
Section 882(a)
(Foreign Corporations)
(a) Imposition of tax.
(1) In general. A foreign corporation engaged in trade or
business within the United States during the taxable year
shall be taxable as provided in section 11, 55, 59A, or
1201(a) on its taxable income which is effectively
connected with the conduct of a trade or business within
the United States.
Tax base
x Tax rate
Tax
Tax rate concepts
-
Foreign
Corporation’s
U.S. Tax
Liability
U.S. taxes FCs at:
1.
2.
Regular rates on U.S.
_________ income
___% (or treaty rate) on
U.S. ___________ income
-
x
+
+
+
-
Income
Exclusions
Effectively connected gross income
Apportioned deductions and losses
Taxable income before special deductions
Net operating loss deduction
Dividend received deduction on ECI
Effectively connected taxable income
Statutory tax rates
Income tax before credits
Credits
Recapture of prior credits
Regular income tax liability
Alternative minimum tax
Investment income @ 30% tax
Estimated tax payments
Income tax liability
Tax rate concepts
Section 11(b)(1)
(b) Amount of tax.
(1) In general. The amount of the tax imposed by
subsection (a) shall be the sum of--
(A) 15 percent of so much of the taxable income as does not
exceed $50,000,
(B) 25 percent of so much of the taxable income as exceeds
$50,000 but does not exceed $75,000,
(C) 34 percent of so much of the taxable income as exceeds
$75,000 but does not exceed $10,000,000, and
(D) 35 percent of so much of the taxable income as exceeds
$10,000,000.
Tax rate concepts
Section 11(b)(1)
In the case of a corporation which has taxable
income in excess of $100,000 for any taxable year,
the amount of tax determined under the preceding
sentence for such taxable year shall be increased
by the lesser of (i) 5 percent of such excess, or (ii)
$11,750. In the case of a corporation which has
taxable income in excess of $15,000,000, the
amount of the tax … shall be increased by an
additional amount equal to the lesser of (i) 3
percent of such excess, or (ii) $100,000.
Tax rate concepts
Statutory Tax Rates
(Lower Brackets)
Rates
34%
34%
25%
15%
$100,000
$200,000
Taxable Income
$300,000
Tax rate concepts
Statutory Tax Rates
(Upper Brackets)
35%
35%
Rates
34%
$5 million
$10 million
$15 million
Taxable Income
$20 million
Tax rate concepts
Marginal Tax Rates
Treating corporate profit as incremental income, what is a shareholder’s
marginal tax rate on corporate profit currently distributed as a dividend?
MTR sh = t c + t sh (1 - t c )
What is a shareholder’s marginal tax rate on corporate profit distributed as a
dividend in a later year?

MTR sh
t sh (1 - t c )
= tc +
(1 + d)y
Tax rate concepts
Marginal Tax Rates
(Examples)
Assume a sole shareholder’s tax bracket is 35% and her
corporation’s tax bracket is 35%. What is the shareholder’s
MTR on $100 the corporation earns and distributes?
Assume the same tax rates mentioned above except the
corporation defers paying a dividend for three years. Using
a discount rate of 10%, what is the shareholder’s MTR
now?
Procedural matters
Filing Requirements
• File Form 1120 by ___th day of __rd month
–
–
–
–
Schedule ___ is balance sheet
Schedule ___ reconciles book and taxable income
Schedule ___ reconciles retained earnings
Schedule ___ for midsize and large corporations
• Section 6012(a)(2) requires a _______, even if
taxable income is zero.
• Form 7004 provides an automatic __-month
extension
Procedural matters
Taxable Years
• Selecting initial taxable year on first return
– Choices include
• ________ year, §441(d)
• _______ year, §441(e)
• Annual period of __ or ___ weeks ending on same
day of week, §441(f)
– Income of initial and last year not __________
• Changing taxable year, §442
– Usually needs IRS ________
– Income of short period __________, §443(b)(1)
Procedural matters
Taxable Years
(Annualizing Income)
1. Taxable income for short period x
12
Short period months
2. Annualized income x statutory tax rates =
Short period months
3. Annualized tax x
12
=
=
Procedural matters
Taxable Years
(Example)
Corporation earns $100,000 taxable income during short
taxable year of 3 months. Without annualization, the
corporation’s federal income tax equals $22,250 (i.e., 22.25%
average tax rate). What is the corporation’s actual ATR?
Annualized income
= $
x
Annualized tax = $
months
months
x statutory rates = $

Tax liability
ATR =

= $
= $
x
=
months
months
= $
Procedural matters
Accounting Methods
• Corporations generally use ______ method.
• Cash method can be used by:
– Corporations with average annual gross receipts
≤ $__ million over __-year testing period for all
post-1985 years
– Qualified ________ service corporations
– Corporations in _________ business
Property transactions
Capital Gains and Losses
(Fundamentals)
• Two requirements:
– Capital _____, §1221
– _____ or __________, §1222
• Capital gain or loss is “long-term”
if taxpayer holds disposed asset >
__ _____, §1222.
Property transactions
Capital Gains and Losses
(Combining)
Short-Term
Capital Gains
Net ST Gain
Net LT Gain
Net ST Capital
Gain or Loss
Short-Term
Capital Losses
Net ST gain and
___ capital gain
or
Net ST Gain
Net LT Loss
Capital gain ________ or
___ capital loss
or
Long-Term
Capital Gains
Net ST Loss
Net LT Gain
Net LT Capital
Gain or Loss
Long-Term
Capital Losses
___ capital loss or
___ capital gain
or
Net ST Loss
Net LT Loss
___ capital loss
Property transactions
Corporate Capital Gains and Losses
(Implications)
• Net capital gains and capital gain net
income
– Taxed same as __________ income
– Beneficial since they absorb ________
__________
• Net capital losses
– Not currently _____________
– Carried back __ and forward __ years
Property transactions
Individual Capital Gains and Losses
(Implications)
• Net capital gains
• Sec. 1202 gain @ ___% (before ___% exclusion)
• Most capital gains @ ___%
• Individuals in lower brackets @ ___%
• Net capital losses
– Only ______ annual deduction
– Carried forward __________
Property transactions
Capital Gains and Losses
(Example 1)
The average tax rate of Powertie, Inc. each year is 34%. In 2006,
Powertie incurs a net capital loss of $15,000. In prior years, Powertie
reported the following amounts of capital gain net income:
2002
2003
2004
2005
(a) How much of the $15,000 loss can
Powertie deduct on its 2006 return?
(b) What tax refund can Powertie claim?
(c) How much of the $15,000 loss carries
forward?
Property transactions
Capital Gains and Losses
(Example 2)
Bob is a successful day trader who has been in the 28% tax bracket for
several years. However, the market was bad this year, and Bob incurred
a net capital loss of $40,000. Capital gain net income in prior years was:
2003
2004
2005
(a) How much of the $40,000 loss can Bob
deduct on his 2006 return?
(b) What tax refund can Bob claim?
(c) How much of the $40,000 loss carries
forward?
Property transactions
Sec. 1231 Gains and Losses
• Sale or exchange (and certain ____________
conversions) of
• Business property
– _______ and
– ____________ assets
• Held __ __ year
Property transactions
Sec. 1231 Gains and Losses
• If net §1231 loss occurs:
– Treat as _________ deduction and
– No _____ against net capital gain
• If net §1231 gain occurs:
– Treat as ________ income to extent of nonrecaptured ______ ______ in prior 5 years,
– Treat remaining net §1231 gain as long-term
_______ gain
Property transactions
Sec. 1231 Gains and Losses
(Example 1)
In preparing the corporate return for Dr. Judy’s veterinarian
practice, you calculate the following gains and losses:
Long-term capital gain
Long-term capital loss
§1231 gain
§1231 loss
Net §1231 loss from two years ago
How are these transactions reflected on the corporate return?
Property transactions
Sec. 1231 Gains and Losses
(Example 2)
In preparing the corporate return for Dr. Judy’s veterinarian
practice, you calculate the following gains and losses:
Net capital loss (before §1231)
§1231 gain
§1231 loss
Net §1231 loss from two years ago
Net capital loss from four years ago
How are these transactions reflected on the corporate return?
Property transactions
Depreciation Recapture
(Basics)
Amount
- Adjusted
gain
- Depreciation recapture
Section
gain
Treated as ___________ income
Treated as __________ ______ gain
Property transactions
Depreciation Recapture
(§1245)
• Principal categories:
– ___________ personalty
– ____________ personalty
• ____ prior depreciation is
recaptured (including _____
deductions).
Property transactions
Depreciation Recapture
(§§1250 and 291)
• Section 1250
– Applies to residential rental (nonresidential)
______ acquired before 1987 (1981)
– Recaptures only “______” depreciation over
SL
• Section 291
– Applies to §____ property of corporations
– Recaptures ___% of difference between
§_____ and §_____ recapture
Property transactions
Depreciation Recapture
(Example 1)
Hank is the sole shareholder of Middle Earth Mining, Inc.
Middle Earth experienced the following:
Gain on sonar equipment
Loss on mining carts
Middle Earth had deducted $24,000 depreciation on the sonar
equipment and $11,000 on the carts. How are these
transactions reflected on the corporate return?
Gain on sonar equipment:
§1245 income of
§1231 gain of
Loss on mining carts:
§1231 loss of
Net §1231 loss of
(ordinary) and §1245 gain of
(ordinary)
Property transactions
Depreciation Recapture
(Example 2)
Lorent, Inc. sells an apartment building for $500,000 that it
originally bought for $400,000 in 1985. Before the sale, Lorent
deducted $366,000 ACRS depreciation (straight-line would
have been $357,000). Calculate the §1231 gain, §1250
recapture, and §291 recapture.
Amount realized
Original cost
ACRS depreciation
Adjusted basis
Recognized gain
§1250 ordinary income
§291 ordinary income
§1231 gain
ACRS
SL
§1250 recapture
§1245 less §1250
§291 recapture
Property transactions
Sales to Related Persons
• Losses not deductible, §___
• Gain from selling depreciable property:
– Treated as ________ income, §1239
– Ineligible for ____________ method, §453(g)
Dividend received deduction
Section 243(a)
(a) General rule.
In the case of a corporation, there shall be allowed as a
deduction an amount equal to the following percentages of
the amount received as dividends from a domestic
corporation which is subject to taxation under this chapter:
(1) 70 percent, in the case of dividends other than dividends
described in paragraphs (2) and (3);
(2) 100 percent, in the case of dividends received by a
small business investment company…; and
(3) 100 percent, in the case of qualifying dividends….
Dividend received deduction
Section 243(b)
(b) Qualifying dividends.
(1) In general. For purposes of this section, the term
“qualifying dividend” means any dividend received by a
corporation-(A) if at the close of the day on which such dividend is
received, such corporation is a member of the same
affiliated group as the corporation distributing such
dividend….
Dividend received deduction
Section 243(c)
(c) Retention of 80-percent dividends received deduction
for dividends from 20-percent owned corporations.
(1) In general. In the case of any dividend received from
a 20-percent owned corporation-(A) subsection (a)(1) of this section, …
shall be applied by substituting “80 percent” for “70
percent”.
Dividend received deduction
MTR Example
Jody owns 100% of PCo, which owns 70% of SCo.
SCo earns profit and distributes the entire after-tax
amount as a current dividend. PCo, in turn, pays
the entire amount received (after tax) to its sole
individual owner. What is the maximum MTR of
Jody related to SCo’s profit?
MTRJody = tSCo + tPCo (1 - tSCo) (1 - DRD) + tJody [1 - tSCo - tPCo (1 - tSCo) (1 - DRD)]
MTRJody =
Dividend received deduction
Jody
100%
PCo
70%
SCo
MTRJody =
Dividend received deduction
Dividend Received Deduction
Ownership
< 20%
≥ 20% but < 80%
≥ 80% (affiliated)
DRD Percentage
___%
___%
___%
DRD may be limited or disallowed if:
• Taxable income is ____,
• Dividend received from ______ corporation,
• Stock is held for ______ time, or
• Stock is acquired with _____ financing.
Dividend received deduction
Section 246(b)
(b) Limitation on aggregate amount of deductions.
(1) General rule. Except as provided in paragraph (2),
the aggregate amount of the [dividend received]
deductions allowed … shall not exceed the percentage …
of the taxable income computed without regard to the
deductions allowed by sections 172, 199, [dividend
received deduction] … and without regard to any capital
loss carryback ….
(2) Effect of net operating loss. Paragraph (1) shall not
apply for any taxable year for which there is a net
operating loss (as determined under section 172).
Dividend received deduction
DRD When Taxable Income Low
Taxable income before _______ deductions
+ U.S. ___________ activities deduction (§____)
+ Capital loss carryback deductions
Taxable income
x
percentage
_______ on dividend received deduction
However, “unlimited”
DRD allowed when
_____ results.
-
Ownership
DRD Percentage
< 20%
≥ 20% but < 80%
Taxable income before ________ deductions
Dividend received times
percentage
Net operating loss
70%
80%
Dividend received deduction
DRD Limit
(Example)
Border, Inc. earned $30 million in consulting fees, but
incurred $32 million of business deductions and losses.
Border also received $___ million dividend income from
minority interests (< 20%) in several corporations. Compute
Border’s taxable income.
Ignoring
DRD Limit
Net business loss
Dividend income
DRD
Taxable income
Considering
DRD Limit
Dividend received deduction
Section 245(a)
(a) Dividends from 10-percent owned foreign
corporations.
(1) In general. In the case of dividends received by a
corporation from a qualified 10-percent owned foreign
corporation, there shall be allowed as a deduction an
amount equal to the percent (specified in section 243 for
the taxable year) of the U.S.-source portion of such
dividends.
U.S. Source Portion = Dividend Received x
Post -1986 Undistributed ECI
Post -1986 Undistributed E & P
Dividend received deduction
Dividend from Abroad
(Example)
Global, Inc. owns 12% of ForCo (organized in Asia) from
which Global receives $100 dividends. ForCo’s E&P
shows:
Foreign
E&P
E&P (2006)
E&P (1987-2005)
$ 200
600
E&P from
ECI
$ 500
700
To what DRD is Global entitled?
DRD = Dividend x

E & P from ECI
x DRD percentage
All E & P
Dividend received deduction
Section 246(c)(1)
(c) Exclusion of certain dividends.
(1) In general. No deduction shall be allowed under
section 243, 244, or 245, in respect of any dividend on
any share of stock-(A) which is held by the taxpayer for 45 days or less
during the 91-day period beginning on the date which is
45 days before the date on which such share becomes exdividend with respect to such dividend …
Dividend received deduction
Dividend Chronology
•
•
•
•
____________ date is when the Board of Directors commits to pay a
dividend and records liability as “_________ ________.” “_________
_________” are set aside.
____________ date occurs a few days before record date and is the first
day shares trade without the declared dividends.
_______ date is when the Board “________” list of shareholders who
receive the declared dividend.
________ date is when corporation writes dividend check to shareholders
of record and satisfies “_________ ________.”
…
…
Ex-Dividend
Declaration
Payment
Record
NYSE sets at __
business days
______ usually establishes
Varies, but often about __ weeks
Dividend received deduction
45-Day Rule Prohibits DRD
Rationale:
Prevents corporation from buying stock just before ________ date
and selling stock immediately afterwards
Target, Inc.
declares $__ per
share dividend
Arbitrage, Inc. buys
21% of Target @
$__ per share
Arbitrage sells all
Target stock @
$__ per share
Results Absent §246(c)(1)
• Dividend’s MTR =
• _________ loss (equal to dividend)
deductible against capital gains subject to
MTR of ____%
Dividend received deduction
Section 246A(a)
(a) General rule.
In the case of any dividend on debt-financed portfolio
stock, there shall be substituted for the percentage which (but
for this subsection) would be used in determining the amount
of the deduction allowable under section 243, 244, or 245(a) a
percentage equal to the product of-(1) 70 percent (80 percent in the case of any dividend
from a 20-percent owned corporation …), and
(2) 100 percent minus the average indebtedness
percentage.
Average indebtedness percentage
=
Average
Average
Dividend received deduction
Debt Financing Reduces DRD
Rationale:
Prevents corporation from _______ interest while paying ____
____ on related dividend income
Corporation
Buy stock
(< 50% or, if
Target closely
held, < 20%)
Results Absent §246A(a)
Target
• Dividend’s MTR =
• Related interest deductible against
income subject to MTR of ___%
Dividend received deduction
Section 1059(a)
(a) General rule.
If any corporation receives any extraordinary dividend with respect
to any share of stock and such corporation has not held such stock for
more than 2 years before the dividend announcement date-(1) Reduction in basis. The basis of such
corporation in such stock shall be reduced
(but not below zero) by the nontaxed portion
of such dividends.
(2) Amounts in excess of basis. If the
nontaxed portion of such dividends exceeds
such basis, such excess shall be treated as
gain ….
Dividend received deduction
Lind et al., pp. 192-93
TargetCo declares
$1 per share
dividend
June 1
June 3 June 5
(declaration)
(ex-dividend)
ArbitCo receives
$1,000 dividend
June 8
(record)
June 27
(payment)
ArbitCo buys 1,000
shares of TargetCo
for $15 per share
(a) What might ArbitCo be seeking to accomplish?
What is the actual tax result?
June 30
ArbitCo sells 1,000
shares of TargetCo
for $14 per share
Dividend received deduction
Lind et al., pp. 192-93
(continued)
TargetCo declares
$1 per share
dividend
ArbitCo receives
$1,000 dividend
…
June 1
June 3 June 5
(declaration)
(ex-dividend)
ArbitCo buys 1,000
shares of TargetCo
for $15 per share
June 8
(record)
June 27
(payment)
Dec. 1
ArbitCo sells 1,000
shares of TargetCo
for $14 per share
(b) What if ArbitCo waits until Dec. 1 to sell TargetCo stock?
Dividend received deduction
Lind et al., pp. 192-93
(continued)
TargetCo declares
$2 per share
dividend
ArbitCo receives
$2,000 dividend
…
June 1
June 3 June 5
(declaration)
(ex-dividend)
ArbitCo buys 1,000
shares of TargetCo
for $15 per share
June 8
(record)
June 27
(payment)
Dec. 1
ArbitCo sells 1,000
shares of TargetCo
for $13 per share
(c) In addition, what if dividend is $2 per share instead of $1?
Dividend received deduction
Lind et al., pp. 192-93
(continued)
TargetCo declares
$2 per share
dividend
ArbitCo receives
$2,000 dividend
…
June 1
June 3 June 5
(declaration)
(ex-dividend)
ArbitCo buys 1,000
shares of TargetCo
for $15 per share
June 8
(record)
June 27
(payment)
Much later
ArbitCo sells 1,000
shares of TargetCo
for $13 per share
(d) In addition to assuming the dividend equals $2 per share,
what if ArbitCo waits until 25 months after the dividend to
sell its TargetCo shares?
Miscellaneous items
Net Operating Losses
Carryback __
Years or Forgo
Gross income
- Regular deductions and losses
Taxable income <loss> before special deductions
- Dividend received deduction
Carryforward
Net operating loss, §___
__ Years
Election to forgo:
1.
Made by due date (including extensions)
2.
__________ but applies only to that year
Miscellaneous items
Charitable Contributions
• If ________ basis, donations the ______
authorizes during year are deductible if paid
by return’s ________ due date
• Limited to ___% of taxable income before:
– Charitable contribution deduction,
– Dividend received deduction, and
– NOL and capital loss carryback
• Carryforward __ years (_____ basis)