1
Chapter 3,
The Corporate
Income Tax
2
THE CORPORATE
INCOME TAX
?Tax years
?Accounting methods
?Taxable income & tax liability
?Controlled groups
?Compensation planning
?Filing requirements
3
Selecting a Tax Year
(1 of 2)
?New corp elects tax year by filing
return
?First return may be for short-period
?Some corporations restricted
–S-corporation uses calendar year
–Affiliated group member must be
same as parent
–PSCs usually calendar year
4
Selecting a Tax Year
(2 of 2)
?Changing the tax year
–Usually requires IRS approval
–Automatic approval if
?No change within last 10 years
?Short period does not have a NOL
?Annualized short period is at least 80%
of last years income
?Special status does not change
?No S election in the following year
5
Accounting Methods
?Accrual
–GAAP and normal for C corps
?Cash
–Qualified PSC,or Gross under $5M
?Usually service type business
?Inventories cannot be significant
–Family farm
6
Tax Formula,
General (1 of 3)
?Gross Income
?Minus,Deductions and Losses
?Minus,Special Deductions
?Taxable Income
(Regular and AMT)
?Times,Appropriate Rate
?Equals,Regular Tax Liability before
credits
7
Tax Formula,
General (2 of 3)
?Regular Tax Liability before credits
?Less,Foreign tax credit
?Less,Other Credits
?Plus,Credit recapture
?Equals,Regular tax liability
8
Tax Formula,
General (3 of 3)
?Regular Tax Liability
?Plus,AMT Liability
?Plus,Special Taxes (if any)
?Minus,Estimated Payments
?Equals,Refund or tax due
9
Tax Formula,
AMT (1 of 2)
?Taxable Income before NOL adjust
?Plus,Tax preference items
?Plus/minus,Adjustments to income
?Plus/minus,ACE adjustment factor
?Minus,AMT NOL deduction
?Equals,AMT taxable income
?Minus,Statutory exemption
?Equals,AMT Tax Base
10
Tax Formula,
AMT (2 of 2)
?AMT Tax Base
?Times,AMT Rate
?Equals,Tentative AMT before Credits
?Minus,AMT foreign tax credit
?Minus,AMT Investment Credit
?Minus,Regular tax liability
?Equals,AMT Liability
11
Corporate Taxable Income
(1 of 3)
?Deductions and losses
?Capital gains and losses
?Depreciation recapture
?Business expenses
?Organizational costs
?Start-up costs
12
Corporate Taxable Income
(2 of 3)
?Accrued compensation
?Charitable contributions
?Dividends received deduction
?Net operating losses
?Sequencing charitable,DRD,and
NOL deductions
13
Corporate Taxable Income
(3 of 3)
?Shareholder transactions
?At-risk rule
?Tax computation
?PSCs
14
Deductions and Losses
(1 of 3)
?No § 212 deductions
?No personal exemptions
?No standard deduction
?Not subject to hobby loss
limitations
?Not subject to investment interest
limit
15
Deductions and Losses
(2 of 3)
?Public firms not subject to PAL
limitation
?Amortization of organization costs
?Amortization of start-up costs
?Special dividends received
deduction
16
Deductions and Losses
(3 of 3)
?Net capital losses not deductible
?Casualty losses fully deductible
?Charitable contribution limits
17
Capital and § 1231 Gains and
Losses (1 of 2)
?Net capital gain taxed at ordinary
income rates
?Net capital losses cannot offset
ordinary income
?Net capital losses carryback 3
years and forward 5 years
–Expired losses are lost forever
18
Capital and § 1231 Gains and
Losses (2 of 2)
?§ 1231 property
–Certain business property subject to
depreciation & held long-term
–Gains treated as LTCG
–Losses treated as ordinary
19
Depreciation Recapture
(1 of 3)
?§ 1245 Property
–Personal property (tangible or intangible)
–Other tangible personal property used as
integral part of manufacturing,production,
extraction or in certain services
–Livestock
?§ 1245 Recapture
–All gain up to depreciation previously taken
classified as ordinary income
20
Depreciation Recapture
(2 of 3)
?§ 1250 property
–Real property subject to depreciation
under § 167 but not subject to
recapture under § 1245
–Mainly buildings and structural
components
21
Depreciation Recapture
(3 of 3)
?§ 1250 property sold at a gain
–Amount of depreciation in excess of
straight line is characterized as
ordinary income plus
–An additional 20% of all depreciation
characterized as ordinary income
under § 291
22
Business Expenses
?All ordinary and necessary expenses
reasonable in amount
?No deductions for
–Interest on loans to buy tax exempts
–Illegal bribes or kickbacks
–Fines or penalties
–Insurance premiums if corp is beneficiary
23
Organizational Costs
?Expenses incident to creating corp
?§ 248 election filed w/ first tax return
?Amortize over ? 60 months
?Expenditures must be incurred
before end of first year of business
?Failure to file election
–Capitalize with no amortization
24
Start-up Costs
(1 of 3)
?Non-organizational
?Ordinary and necessary expenses
?Paid or incurred BEFORE the
actual start of business operations
25
Start-up Costs
(2 of 3)
?Examples of include expenses to,
–Investigate creation or acquisition of
an active trade or business
–Create an active trade or business
–Conduct an activity engaged in for
profit or production of income before
business operations begin
26
Start-up Costs
(3 of 3)
?Election to amortize costs over a
period ? 60 months required
–Election must be made by due date
for filing tax return for first year of
operation or ownership
27
Accrued Compensation
?Accrued bonuses/compensation
must be paid w/in 2-1/2 months
after close of tax year
–If paid after 2-1/2 months,payment
deemed deferred compensation and
is deductible in year paid
28
Charitable Contributions
(1 of 3)
?Timing of deduction
–Deducted in the year paid
–Accrual basis corps may elect to
include payment made w/in 2-1/2
months following the end of tax year
?Board of directors must have authorized
contribution during year it was accrued
29
Charitable Contributions
(2 of 3)
?Donated money
–Deduction equals amount donated
?Non-cash property
–Amount USUALLY equal to FMV of
property donated
–Ordinary income property
?Deduction limited to FMV less OI or
STCG that would have been recognized if
property were sold (includes recapture)
30
Charitable Contributions
(3 of 3)
?Non-cash property
–Certain inventory
?Deduction = adjusted basis + 1/2 gain
?Max deduction is 10% of,adjusted
taxable income” (ATI)
–ATI is taxable income before NOL
carryback,capital loss carryback,
dividend received deduction or charitable
contribution
31
Dividends Received
(1 of 3)
?Corps owning < 20% of a domestic
corporation deduct lesser of
–70% of Dividends Received or
–70% of taxable income before NOL,
capital loss carryback or DRD
32
Dividends Received
(2 of 3)
?Corps owning ? 20% of a domestic
corp deduct lesser of,
–80% of dividends received or
–80% of taxable income before NOL,
capital loss carryback or DRD
33
Dividends Received
(3 of 3)
?Members of a controlled group
–100% deduction for dividends
received from members of group
?No deduction is allowed if,
–Paying corp is a foreign corp
–Stock purchased w/borrowed money
34
Net Operating Loss
?Deductions exceed gross income
for the year before NOL carrybacks
?NOL may be carried back 2 yrs &
then forward 20 yrs
–Corp may elect to forgo carryback &
only carry NOL forward 20 yrs
?NOLs prior to 1998 carryback 3 and
forward 15 years
35
Sequencing Charitable,DRD,
& NOL deductions
?Charitable contributions,DRD,
NOL,and all other deductions must
be taken in the following order
–1,All other deductions
–2,Charitable contributions
–3,DRD
–4,NOL
36
Shareholder Transactions
?Special rules apply to s/h who own
>50% of corp
–§ 1239 sale of depreciable property
to corp causes gain to be ordinary
income to the controlling shareholder
–§ 267 disallows loss on sale of
property by corp to controlling s/h
?Loss may be recovered by s/h if later
sells prop at a gain
37
At-Risk Rule and Passive
Activity Limitations
?If 5 or fewer s/hs own > 50% of the
stock,the corp’s losses are limited
to amount corp has,at risk”
–Losses not currently deductible are
carried over to be used in a later year
?PSCs and closely held corps
subject to passive activity limitation
rules
38
Tax Computation
?The tax rates are graduated
?Rate surcharges eliminate benefit
of lower graduated tax rates for
lower income brackets
?Corps with income >$18.33M pay a
flat 35% on all income
39
Personal Service Corporations
(1 of 2)
?PSCs taxed at a flat 35%
?PSC is defined as a corp that,
–Substantially all of the activities
involve services in the following fields,
?Health,law,engineering,architecture,
accounting,actuarial science,
performing arts,and consulting
40
Personal Service Corporations
(2 of 2)
–Substantially all stock must be owned
by employees,former employees or
survivors of employees
41
Controlled Groups
(1 of 8)
?Two or more corps owned directly
or indirectly by same s/h or group
of s/hs
?Types of controlled groups
–Parent-subsidiary
–Brother-sister
–Combined
42
Controlled Groups
(2 of 8)
?Parent-subsidiary
–One corp directly owns at least,
?80% of voting power of all classes of
voting stock OR
?80% of total value of all classes of stock
of subsidiary corporation
43
Controlled Groups
(3 of 8)
?Brother-sister
–If five or fewer individuals,trusts or
estates own,
?At least 80% of voting power or at least
80% of value of stock of two or more
corporations AND
?> 50% of the voting power or value is
held by identical owners
44
Controlled Groups
(4 of 8)
?Combined group
–Three or more corps which meet the
following criteria,
?Each corporation is a member of a
parent-subsidiary or brother-sister group
?At least one is both a parent and a
member of a brother-sister group
45
Controlled Groups
(5 of 8)
?Combined groups
–Following must be allocated among
the members of the controlled group,
?The benefit of the graduated tax rates
?The $250,000 minimum accumulated
earnings credit
?The $25,000 general business credit
limitation
46
Controlled Groups
(6 of 8)
?Combined groups
–Allocated items (continued)
?The $40,000 AMT exemption amount
?The $20,000 § 179 expense amount
?The $100,000 exemption for the 5%
surcharge on TI & the $15M exemption
for the 3% surcharge on TI
–No loss on sale of assets between
members
47
Controlled Groups
(7 of 8)
?Affiliated groups
–One or more chains of includible
corps connected through stock
ownership to a common parent
–Common parent directly owns ?80%
of voting power & value of at least
one includible corporation
–Each corp owned at least 80/80 by
another member of the group
48
Controlled Groups
(8 of 8)
?Affiliated groups
–An affiliated group MAY file a
consolidated return
–Capital losses offset capital gains
from other group members
–Operating losses reduce operating
income from other group members
49
Compensation Planning
?Salary payments
?Fringe benefits
?Limitation of deductible
compensation payments for s/h-
employees
50
Filing Requirements
?Return is required each year
regardless of income
?Use form 1120
?Use form 1120A if gross receipts,
total income and total assets are
each under $500,000
51
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Email Richard Newmark at Dr.Newmark@PhDuh.com
Chapter 3,
The Corporate
Income Tax
2
THE CORPORATE
INCOME TAX
?Tax years
?Accounting methods
?Taxable income & tax liability
?Controlled groups
?Compensation planning
?Filing requirements
3
Selecting a Tax Year
(1 of 2)
?New corp elects tax year by filing
return
?First return may be for short-period
?Some corporations restricted
–S-corporation uses calendar year
–Affiliated group member must be
same as parent
–PSCs usually calendar year
4
Selecting a Tax Year
(2 of 2)
?Changing the tax year
–Usually requires IRS approval
–Automatic approval if
?No change within last 10 years
?Short period does not have a NOL
?Annualized short period is at least 80%
of last years income
?Special status does not change
?No S election in the following year
5
Accounting Methods
?Accrual
–GAAP and normal for C corps
?Cash
–Qualified PSC,or Gross under $5M
?Usually service type business
?Inventories cannot be significant
–Family farm
6
Tax Formula,
General (1 of 3)
?Gross Income
?Minus,Deductions and Losses
?Minus,Special Deductions
?Taxable Income
(Regular and AMT)
?Times,Appropriate Rate
?Equals,Regular Tax Liability before
credits
7
Tax Formula,
General (2 of 3)
?Regular Tax Liability before credits
?Less,Foreign tax credit
?Less,Other Credits
?Plus,Credit recapture
?Equals,Regular tax liability
8
Tax Formula,
General (3 of 3)
?Regular Tax Liability
?Plus,AMT Liability
?Plus,Special Taxes (if any)
?Minus,Estimated Payments
?Equals,Refund or tax due
9
Tax Formula,
AMT (1 of 2)
?Taxable Income before NOL adjust
?Plus,Tax preference items
?Plus/minus,Adjustments to income
?Plus/minus,ACE adjustment factor
?Minus,AMT NOL deduction
?Equals,AMT taxable income
?Minus,Statutory exemption
?Equals,AMT Tax Base
10
Tax Formula,
AMT (2 of 2)
?AMT Tax Base
?Times,AMT Rate
?Equals,Tentative AMT before Credits
?Minus,AMT foreign tax credit
?Minus,AMT Investment Credit
?Minus,Regular tax liability
?Equals,AMT Liability
11
Corporate Taxable Income
(1 of 3)
?Deductions and losses
?Capital gains and losses
?Depreciation recapture
?Business expenses
?Organizational costs
?Start-up costs
12
Corporate Taxable Income
(2 of 3)
?Accrued compensation
?Charitable contributions
?Dividends received deduction
?Net operating losses
?Sequencing charitable,DRD,and
NOL deductions
13
Corporate Taxable Income
(3 of 3)
?Shareholder transactions
?At-risk rule
?Tax computation
?PSCs
14
Deductions and Losses
(1 of 3)
?No § 212 deductions
?No personal exemptions
?No standard deduction
?Not subject to hobby loss
limitations
?Not subject to investment interest
limit
15
Deductions and Losses
(2 of 3)
?Public firms not subject to PAL
limitation
?Amortization of organization costs
?Amortization of start-up costs
?Special dividends received
deduction
16
Deductions and Losses
(3 of 3)
?Net capital losses not deductible
?Casualty losses fully deductible
?Charitable contribution limits
17
Capital and § 1231 Gains and
Losses (1 of 2)
?Net capital gain taxed at ordinary
income rates
?Net capital losses cannot offset
ordinary income
?Net capital losses carryback 3
years and forward 5 years
–Expired losses are lost forever
18
Capital and § 1231 Gains and
Losses (2 of 2)
?§ 1231 property
–Certain business property subject to
depreciation & held long-term
–Gains treated as LTCG
–Losses treated as ordinary
19
Depreciation Recapture
(1 of 3)
?§ 1245 Property
–Personal property (tangible or intangible)
–Other tangible personal property used as
integral part of manufacturing,production,
extraction or in certain services
–Livestock
?§ 1245 Recapture
–All gain up to depreciation previously taken
classified as ordinary income
20
Depreciation Recapture
(2 of 3)
?§ 1250 property
–Real property subject to depreciation
under § 167 but not subject to
recapture under § 1245
–Mainly buildings and structural
components
21
Depreciation Recapture
(3 of 3)
?§ 1250 property sold at a gain
–Amount of depreciation in excess of
straight line is characterized as
ordinary income plus
–An additional 20% of all depreciation
characterized as ordinary income
under § 291
22
Business Expenses
?All ordinary and necessary expenses
reasonable in amount
?No deductions for
–Interest on loans to buy tax exempts
–Illegal bribes or kickbacks
–Fines or penalties
–Insurance premiums if corp is beneficiary
23
Organizational Costs
?Expenses incident to creating corp
?§ 248 election filed w/ first tax return
?Amortize over ? 60 months
?Expenditures must be incurred
before end of first year of business
?Failure to file election
–Capitalize with no amortization
24
Start-up Costs
(1 of 3)
?Non-organizational
?Ordinary and necessary expenses
?Paid or incurred BEFORE the
actual start of business operations
25
Start-up Costs
(2 of 3)
?Examples of include expenses to,
–Investigate creation or acquisition of
an active trade or business
–Create an active trade or business
–Conduct an activity engaged in for
profit or production of income before
business operations begin
26
Start-up Costs
(3 of 3)
?Election to amortize costs over a
period ? 60 months required
–Election must be made by due date
for filing tax return for first year of
operation or ownership
27
Accrued Compensation
?Accrued bonuses/compensation
must be paid w/in 2-1/2 months
after close of tax year
–If paid after 2-1/2 months,payment
deemed deferred compensation and
is deductible in year paid
28
Charitable Contributions
(1 of 3)
?Timing of deduction
–Deducted in the year paid
–Accrual basis corps may elect to
include payment made w/in 2-1/2
months following the end of tax year
?Board of directors must have authorized
contribution during year it was accrued
29
Charitable Contributions
(2 of 3)
?Donated money
–Deduction equals amount donated
?Non-cash property
–Amount USUALLY equal to FMV of
property donated
–Ordinary income property
?Deduction limited to FMV less OI or
STCG that would have been recognized if
property were sold (includes recapture)
30
Charitable Contributions
(3 of 3)
?Non-cash property
–Certain inventory
?Deduction = adjusted basis + 1/2 gain
?Max deduction is 10% of,adjusted
taxable income” (ATI)
–ATI is taxable income before NOL
carryback,capital loss carryback,
dividend received deduction or charitable
contribution
31
Dividends Received
(1 of 3)
?Corps owning < 20% of a domestic
corporation deduct lesser of
–70% of Dividends Received or
–70% of taxable income before NOL,
capital loss carryback or DRD
32
Dividends Received
(2 of 3)
?Corps owning ? 20% of a domestic
corp deduct lesser of,
–80% of dividends received or
–80% of taxable income before NOL,
capital loss carryback or DRD
33
Dividends Received
(3 of 3)
?Members of a controlled group
–100% deduction for dividends
received from members of group
?No deduction is allowed if,
–Paying corp is a foreign corp
–Stock purchased w/borrowed money
34
Net Operating Loss
?Deductions exceed gross income
for the year before NOL carrybacks
?NOL may be carried back 2 yrs &
then forward 20 yrs
–Corp may elect to forgo carryback &
only carry NOL forward 20 yrs
?NOLs prior to 1998 carryback 3 and
forward 15 years
35
Sequencing Charitable,DRD,
& NOL deductions
?Charitable contributions,DRD,
NOL,and all other deductions must
be taken in the following order
–1,All other deductions
–2,Charitable contributions
–3,DRD
–4,NOL
36
Shareholder Transactions
?Special rules apply to s/h who own
>50% of corp
–§ 1239 sale of depreciable property
to corp causes gain to be ordinary
income to the controlling shareholder
–§ 267 disallows loss on sale of
property by corp to controlling s/h
?Loss may be recovered by s/h if later
sells prop at a gain
37
At-Risk Rule and Passive
Activity Limitations
?If 5 or fewer s/hs own > 50% of the
stock,the corp’s losses are limited
to amount corp has,at risk”
–Losses not currently deductible are
carried over to be used in a later year
?PSCs and closely held corps
subject to passive activity limitation
rules
38
Tax Computation
?The tax rates are graduated
?Rate surcharges eliminate benefit
of lower graduated tax rates for
lower income brackets
?Corps with income >$18.33M pay a
flat 35% on all income
39
Personal Service Corporations
(1 of 2)
?PSCs taxed at a flat 35%
?PSC is defined as a corp that,
–Substantially all of the activities
involve services in the following fields,
?Health,law,engineering,architecture,
accounting,actuarial science,
performing arts,and consulting
40
Personal Service Corporations
(2 of 2)
–Substantially all stock must be owned
by employees,former employees or
survivors of employees
41
Controlled Groups
(1 of 8)
?Two or more corps owned directly
or indirectly by same s/h or group
of s/hs
?Types of controlled groups
–Parent-subsidiary
–Brother-sister
–Combined
42
Controlled Groups
(2 of 8)
?Parent-subsidiary
–One corp directly owns at least,
?80% of voting power of all classes of
voting stock OR
?80% of total value of all classes of stock
of subsidiary corporation
43
Controlled Groups
(3 of 8)
?Brother-sister
–If five or fewer individuals,trusts or
estates own,
?At least 80% of voting power or at least
80% of value of stock of two or more
corporations AND
?> 50% of the voting power or value is
held by identical owners
44
Controlled Groups
(4 of 8)
?Combined group
–Three or more corps which meet the
following criteria,
?Each corporation is a member of a
parent-subsidiary or brother-sister group
?At least one is both a parent and a
member of a brother-sister group
45
Controlled Groups
(5 of 8)
?Combined groups
–Following must be allocated among
the members of the controlled group,
?The benefit of the graduated tax rates
?The $250,000 minimum accumulated
earnings credit
?The $25,000 general business credit
limitation
46
Controlled Groups
(6 of 8)
?Combined groups
–Allocated items (continued)
?The $40,000 AMT exemption amount
?The $20,000 § 179 expense amount
?The $100,000 exemption for the 5%
surcharge on TI & the $15M exemption
for the 3% surcharge on TI
–No loss on sale of assets between
members
47
Controlled Groups
(7 of 8)
?Affiliated groups
–One or more chains of includible
corps connected through stock
ownership to a common parent
–Common parent directly owns ?80%
of voting power & value of at least
one includible corporation
–Each corp owned at least 80/80 by
another member of the group
48
Controlled Groups
(8 of 8)
?Affiliated groups
–An affiliated group MAY file a
consolidated return
–Capital losses offset capital gains
from other group members
–Operating losses reduce operating
income from other group members
49
Compensation Planning
?Salary payments
?Fringe benefits
?Limitation of deductible
compensation payments for s/h-
employees
50
Filing Requirements
?Return is required each year
regardless of income
?Use form 1120
?Use form 1120A if gross receipts,
total income and total assets are
each under $500,000
51
Comments or questions about PowerPoint Slides?
Email Richard Newmark at Dr.Newmark@PhDuh.com
