Principles of Taxation
Chapter 10
The Corporate Taxpayer
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The Corporate Taxpayer
Slide 10-2
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Legal characteristics
Dividends-received deduction
Schedule M-1 reconciliation
Regular tax, credits, AMT
Payment and filing requirements
Double taxation
Tax incidence
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•Corporation Legal
Characteristics
Slide 10-3
• Limited liability of shareholders
– Owners of closely-held corporations
often are required to sign personal
liability on bank debt.
• Unlimited life
• Free transferability
– Closely-held corporations:buy-sell
agreement may prevent transferability.
• Centralized management
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Affiliated groups and
consolidations.
Slide 10-4
 Parent + all >= 80% domestic subsidiaries.
 Affiliated groups may elect to file a
consolidated tax return - applies to all
members of affiliated group.
 Advantage: losses and profits of affiliated
members offset. Like financial accounting,
intercompany transactions are eliminated.
 If the same individual(s) own 80% or more of
more than one corporation, these corporations
may not filed a consolidated return, but the
tax bracket benefits are limited.
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Nonprofit corporations
Slide 10-5
 Section 501(c)(3) organizations require IRS
recognition of tax-exempt status.
 Nevertheless, tax-exempt organizations may
pay tax on “unrelated business taxable
income.”
 Thinking question: what types of business
activities do tax-exempt organizations do that
put them in competition with for-profit
taxpayers?
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Computing Corporate Taxable
Income
Slide 10-6
 Page 1 of the Form 1120 resembles a financial
income statement or a Schedule C in a personal
tax return (Ch 9).
 Use chapters 5, 6, 7 and 8 for general rules on
business income.
 Deduct only 50% of meals and entertainment
expenses.
 Deduct charitable contributions up to 10% of
taxable income BEFORE charity and before
dividends-received deduction.
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Dividends-received
deduction
Slide 10-7
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Ownership
Deduction
< 20% of stock
70% DRD
20%<= own < 80%
80% DRD
80%<= own
100% DRD
Reason for DRD? Mitigate “triple” taxation.
Additional details: DRD can’t create loss tricky computations not in this text.
©The McGraw-Hill Companies, Inc., 2000
Book versus taxable income Schedule M-1
Slide 10-8
 This schedule reconciles book income to
taxable income.
 net book income - line 1
 federal tax expense for books - line 2
 lines 3 - 6 explain increases in taxable income
relative to books.
 lines 7 - 9 explain decreases in taxable income
relative to books.
 line 10 = taxable income before NOLD and
DRD = line 28 form 1120
 Try problem AP4.
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Book versus taxable income
Slide 10-9
 Book-tax differences are scrutinized by IRS.
Mills (1998 Journal of Accounting Research) shows that
IRS audit adjustments are related to M-1 difference).
 The Schedule M-1 contains permanent and
temporary items.
 The tax footnote in the financial statement
contains numerous estimates of amounts that
are finalized by the time the return is filed.
Thus, Schedule M-1 will not exactly =
amounts in F/S footnotes.
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Computing regular tax
Slide 10-10
 The surtax rates of 39% and 38%
eliminate progressivity at high levels of
corporate income.
 Corporations with taxable income >
$18.33 million just pay a flat rate of 35%
on all income.
 Personal service corporations are taxed
at a flat 35% rate.
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Tax credits
Slide 10-11
 Credits directly reduce computed tax.
Deductions only reduce the income subject to
tax. Thus, $1 of credit provides $1 of benefit.
$1 of deduction only provides $1 x the tax
rate.
 Tax credits are generally limited to some % of
tax before credits. Often a provision permits
carry back or carry forward of excess credits.
 Biggest credits: R&D credit, foreign tax
credit (see Chapter 12).
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Alternative minimum tax overview
Slide 10-12
 20% of income under an alternative
definition of taxable income that has
fewer loopholes.
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Alternative minimum taxable income
less (exemption)
= AMTI in excess of exemption
x 20%
Tentative minimum tax (TMT)
less (regular tax)
Alternative minimum tax (AMT)
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Alternative minimum tax AMTI
Slide 10-13
 Start with regular taxable income
 Adjustments and preferences include:
 Accelerated depreciation - AMT
depreciation using slower methods.
 Excess of % depletion > cost depletion.
 Deduction for NOL carryforward is
limited to 90% of AMTI.
 Other differences between book and
taxable income may create adjustments.
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AMT - more details
Slide 10-14
 Exemption = $40,000 - 25% (AMTI $150,000).
 Minimum tax credit.
 In future year(s), when regular tax
exceeds TMT, corporation may subtract
a credit equal to prior year(s) AMT. See
AP14.
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Payment and filing
requirements
Slide 10-15
 Tax return due 15th day of 3rd month, may
extend to 15th day of 9th month.
 Estimated payments are due on the 15th day of
4th, 6th, 9th, and 12th months.
 Must pay 100% of tax due (small corporations
may use safe-harbor rule of paying 100% of prior
year tax).
 Underpayment penalty is computed like interest
expense but is nondeductible.
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Distributions to investors
Slide 10-16
 Interest payments are deductible.
 Payments on stock are non-deductible.
 Payments on stock are taxable dividends to
the shareholder if the corporation has either
current or cumulative earnings and profits.
 Payments in excess of earnings and profits
are first a return of capital and then a gain to
the shareholder.
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Distributions to investors
Slide 10-17
 Nondeductibility of dividends makes
paying dividends hard to explain.
 One result is the high leverage of many
corporations, because interest expense is
deductible.
 Investors may prefer that the corporation
keep the funds and reinvest them; sell
stock for a capital gain in future.
 Double taxation unlikely to change in near
future.
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Incidence of the corporate tax
Slide 10-18
 Corporations do not pay taxes - people
do.
 What are examples of ways that the
incidence of the corporate tax could be
born by individual taxpayers in the
U.S.?
 higher consumer prices
 lower employee wages
 lower dividends
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