Chapter 16
Corporations
Learning Objectives
? Define a corporation
? Calculate the corporate income tax
liability and explain specific tax rules
? Apply the non-recognition of gain or
loss rules for corporate formations
Learning Objectives
? Understand the significance of earnings
and profits
? Determine the consequences of
distributions and stock redemptions
? Understand the consequences of a
corporate liquidation to shareholders and
the liquidating corporation
How A Business May Be
Organized
? Sole Proprietorship
? C (regular) Corporation
? S Corporation
? Partnership
? Limited Liability
Partnership - LLP
? Limited Liability
Company - LLC
Major Types
? TAXABLE ENTITIES
– Sole proprietorship
– C corporation
? FLOW-THROUGH
OR CONDUIT OR
PASS-THROUGH
ENTITIES
– S corporation
– Limited Liability
Companies
– Limited
Partnerships
– Partnership
Taxation Of Businesses
? Income from sole proprietorships and
flow-through entities
– is taxed once at the individual owner level
while corporate income is taxed twice,
– once at the corporate level
– and again at the shareholder level upon
dividend distributions or stock sales
Define A Corporation
? A business entity with two or more
owners is classified as either a
corporation or a partnership
? A business entity with one owner is
classified as a corporation or a sole
proprietorship
Define A Corporation
? A business entity is a corporation if it
is organized under a federal or state
statue that refers to the entity as
incorporated or as a corporation
? If a business entity incorporates,it is
a corporation
Define A Corporation
? If a business forms itself as a
Partnership,Limited Liability
Company(LLC) Or Limited Liability
Partnership(LLP),the entity can elect
to be taxed as either a partnership or
corporation
Similarities Of Individuals And
Corporations
? Similar computation
of taxable income
? Allowed to deduct
ordinary and
necessary business
expenses
? Can deduct interest
and depreciation
Differences Between Corporations
And Individuals
? Personal,consumption-type expenditures and
exemptions apply solely to individuals
? Computation of AGI applies only to individuals
? Corporation is not permitted to use standard
deduction or deduct personal and dependency
exemptions
? Corporations receive a dividends-received
deduction
? Corporate charitable deductions limited to 10%
taxable income
? Compensation deduction limitation for Publicly
Held Corporations
Computation Of Taxable
Income
? Reflects a stair-step
progression (see table
I16-1)
? Corporation income tax
is essentially a flat tax
for large corporations
? Special rules for certain
Personal Service
Corporations
Computation Of Corporate
Alternative Minimum Tax
? Designed to ensure that no
corporation with substantial
economic income can use
exclusions,deductions,and
credits to avoid significant tax
liability
? 20% of alternative minimum
taxable income (AMTI) less
than exemption amount
Exception To AMT For Small
Corporations
? For tax years after 1997 AMT does
not apply to small corporations
? $5 million gross receipts test in its
first tax year after 1996
Penalty Taxes
? Two penalty
taxes
– Accumulated
earnings tax
– Personal holding
company tax
Specific Rules Applicable To
Corporations
? Capital gains & losses
? Dividends received deduction
? Net operating losses
? Charitable contributions
? Compensation deduction limitation
for publicly held corporations
Transfers Of Property To
Controlled Corporations
? Section 351 non-
recognition
requirements
? Basis considerations
? Treatment of liabilities
? Character of gain
recognized
Capitalization Of The
Corporation
? Debt has two main tax advantages,
– Interest payments are deductible
– Principal repayments are a tax-free
return of capital
? Safe harbor rule
Earnings And Profits
? Calculation of
earnings and
profits
? Current versus
Accumulated E&P
NonMoney Distributions
? Tax consequences to the
shareholders
– Amount distributed= FMV of property (reduced
by liabilities)
– Treated as taxable dividend if corporation has
sufficient E&P
– Basis of distributed property=FMV (without
reduction for liabilities)
Nonmoney Distributions
? Tax consequences to the distributing
corporation
– General rule,the corporation recognizes no
gain or loss upon a distribution to its
shareholders
– If corporation distributes appreciated property
to its shareholders,the corporation is treated
as if it sold the property to the shareholder for
its FMV immediately before the distribution,
and the corporation recognizes any realized
gain
Stock Redemption
? Redemption
treated as a
taxable dividend
(E&P)
? Redemption
treated as an
exchange,
resulting in capital
gain or loss by
shareholder
Determining Whether A
Redemption Is A Dividend Or
Capital Gain
? Subject to capital gain or loss if any of
following met,Redemption..,
– Is not essentially equivalent to a dividend
– Is substantially disproportionate with respect
to shareholders’ interest
– Results in a complete termination of
shareholders’ interest
– Is made in partial liquidation of corporation
Corporate Distributions In
Complete Liquidation
? Tax consequences to
the liquidating
corporation
? Tax consequences to
the shareholders
? Section 332,
Liquidation of a
subsidiary corporation
Typical Misconception
? It is sometimes assumed that the
liquidation of a corporation always is
associated with the discontinuance
of business activities,Sometimes the
business is operated as a
partnership or sole proprietorship
after the liquidation
Tax Planning
Considerations
? Capital structure
and Section 1244
? Dividend policy
? Use of losses
? Charitable
contributions
? Dividends-received
deductions
Compliance & Procedural
Considerations
? Filing requirements
– Corporation must file Form 1120
– Not based on gross income
– Due date is one month earlier than
individual returns
– Due date for estimated tax installment
also one month earlier
Compliance & Procedural
Considerations
? Schedule M-1 and M-2 reconciliation
– M-1 used to reconcile financial
accounting net income with taxable
income (before NOL & dividends-
received deductions)
– M-2 reconciles the beginning year
balance in retained earnings with year-
end balance
? Maintenance of records/E&P
Corporations
Learning Objectives
? Define a corporation
? Calculate the corporate income tax
liability and explain specific tax rules
? Apply the non-recognition of gain or
loss rules for corporate formations
Learning Objectives
? Understand the significance of earnings
and profits
? Determine the consequences of
distributions and stock redemptions
? Understand the consequences of a
corporate liquidation to shareholders and
the liquidating corporation
How A Business May Be
Organized
? Sole Proprietorship
? C (regular) Corporation
? S Corporation
? Partnership
? Limited Liability
Partnership - LLP
? Limited Liability
Company - LLC
Major Types
? TAXABLE ENTITIES
– Sole proprietorship
– C corporation
? FLOW-THROUGH
OR CONDUIT OR
PASS-THROUGH
ENTITIES
– S corporation
– Limited Liability
Companies
– Limited
Partnerships
– Partnership
Taxation Of Businesses
? Income from sole proprietorships and
flow-through entities
– is taxed once at the individual owner level
while corporate income is taxed twice,
– once at the corporate level
– and again at the shareholder level upon
dividend distributions or stock sales
Define A Corporation
? A business entity with two or more
owners is classified as either a
corporation or a partnership
? A business entity with one owner is
classified as a corporation or a sole
proprietorship
Define A Corporation
? A business entity is a corporation if it
is organized under a federal or state
statue that refers to the entity as
incorporated or as a corporation
? If a business entity incorporates,it is
a corporation
Define A Corporation
? If a business forms itself as a
Partnership,Limited Liability
Company(LLC) Or Limited Liability
Partnership(LLP),the entity can elect
to be taxed as either a partnership or
corporation
Similarities Of Individuals And
Corporations
? Similar computation
of taxable income
? Allowed to deduct
ordinary and
necessary business
expenses
? Can deduct interest
and depreciation
Differences Between Corporations
And Individuals
? Personal,consumption-type expenditures and
exemptions apply solely to individuals
? Computation of AGI applies only to individuals
? Corporation is not permitted to use standard
deduction or deduct personal and dependency
exemptions
? Corporations receive a dividends-received
deduction
? Corporate charitable deductions limited to 10%
taxable income
? Compensation deduction limitation for Publicly
Held Corporations
Computation Of Taxable
Income
? Reflects a stair-step
progression (see table
I16-1)
? Corporation income tax
is essentially a flat tax
for large corporations
? Special rules for certain
Personal Service
Corporations
Computation Of Corporate
Alternative Minimum Tax
? Designed to ensure that no
corporation with substantial
economic income can use
exclusions,deductions,and
credits to avoid significant tax
liability
? 20% of alternative minimum
taxable income (AMTI) less
than exemption amount
Exception To AMT For Small
Corporations
? For tax years after 1997 AMT does
not apply to small corporations
? $5 million gross receipts test in its
first tax year after 1996
Penalty Taxes
? Two penalty
taxes
– Accumulated
earnings tax
– Personal holding
company tax
Specific Rules Applicable To
Corporations
? Capital gains & losses
? Dividends received deduction
? Net operating losses
? Charitable contributions
? Compensation deduction limitation
for publicly held corporations
Transfers Of Property To
Controlled Corporations
? Section 351 non-
recognition
requirements
? Basis considerations
? Treatment of liabilities
? Character of gain
recognized
Capitalization Of The
Corporation
? Debt has two main tax advantages,
– Interest payments are deductible
– Principal repayments are a tax-free
return of capital
? Safe harbor rule
Earnings And Profits
? Calculation of
earnings and
profits
? Current versus
Accumulated E&P
NonMoney Distributions
? Tax consequences to the
shareholders
– Amount distributed= FMV of property (reduced
by liabilities)
– Treated as taxable dividend if corporation has
sufficient E&P
– Basis of distributed property=FMV (without
reduction for liabilities)
Nonmoney Distributions
? Tax consequences to the distributing
corporation
– General rule,the corporation recognizes no
gain or loss upon a distribution to its
shareholders
– If corporation distributes appreciated property
to its shareholders,the corporation is treated
as if it sold the property to the shareholder for
its FMV immediately before the distribution,
and the corporation recognizes any realized
gain
Stock Redemption
? Redemption
treated as a
taxable dividend
(E&P)
? Redemption
treated as an
exchange,
resulting in capital
gain or loss by
shareholder
Determining Whether A
Redemption Is A Dividend Or
Capital Gain
? Subject to capital gain or loss if any of
following met,Redemption..,
– Is not essentially equivalent to a dividend
– Is substantially disproportionate with respect
to shareholders’ interest
– Results in a complete termination of
shareholders’ interest
– Is made in partial liquidation of corporation
Corporate Distributions In
Complete Liquidation
? Tax consequences to
the liquidating
corporation
? Tax consequences to
the shareholders
? Section 332,
Liquidation of a
subsidiary corporation
Typical Misconception
? It is sometimes assumed that the
liquidation of a corporation always is
associated with the discontinuance
of business activities,Sometimes the
business is operated as a
partnership or sole proprietorship
after the liquidation
Tax Planning
Considerations
? Capital structure
and Section 1244
? Dividend policy
? Use of losses
? Charitable
contributions
? Dividends-received
deductions
Compliance & Procedural
Considerations
? Filing requirements
– Corporation must file Form 1120
– Not based on gross income
– Due date is one month earlier than
individual returns
– Due date for estimated tax installment
also one month earlier
Compliance & Procedural
Considerations
? Schedule M-1 and M-2 reconciliation
– M-1 used to reconcile financial
accounting net income with taxable
income (before NOL & dividends-
received deductions)
– M-2 reconciles the beginning year
balance in retained earnings with year-
end balance
? Maintenance of records/E&P
