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Chapter 2A. Corp. Tax Law Howard Godfrey, Ph.D., CPA Professor of Accounting Copyright © 2014 Edited January 10, 2014 C14-Chp-02-1A-Corp-Tax-Law-2014.

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Presentation on theme: "Chapter 2A. Corp. Tax Law Howard Godfrey, Ph.D., CPA Professor of Accounting Copyright © 2014 Edited January 10, 2014 C14-Chp-02-1A-Corp-Tax-Law-2014."— Presentation transcript:

1 Chapter 2A. Corp. Tax Law Howard Godfrey, Ph.D., CPA Professor of Accounting Copyright © 2014 Edited January 10, 2014 C14-Chp-02-1A-Corp-Tax-Law-2014

2 A student should understand: 1.Various business forms – corp. etc. [Pg. 2] 2.Corporate tax (compare w/ individuals). [Pg. 8] 3.Fiscal years & accounting methods. [Pg. 10] 4.Capital gains (losses). Deprec. Recapture [Page 11+] 5.Passive Losses [Page 13] 6.Charitable contributions. [Page 14] 7.Domestic Production Activities [Page 16] 8.Net operating losses. [Page 17] 9.Dividends received deduction. [Page 17] 10. Organization & start-up expenses. [Page 20] 11. Tax Rates. Also Related Corporations [Page 21+] 12. Filing requirements, payments [24] 13. Tax and book income. Acct. for Tax [Page 25+] 14. Tax planning. Transactions w/ Owner. [Pg. 35+]

3 1. Compare Business Forms. [Page 2-2] Sec. 1, 1(h), 11, 1201, 63

4 Lecture Outline A corporation is a separate taxpaying entity. This chapter discusses the rules for determining a corp's taxable income and tax liability. It also discusses how to file a corporate tax return. The corporations discussed in this chapter are regular corporations or C corporations. Corporations that are not classified as domestic -- are foreign corporations. Foreign corps are taxed somewhat like domestic corporations if they conduct a trade or business in the United States.

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7 7 FICA Rates for 2013 A combined employee-employer social security tax rate of 15.30% applies in Employers and employees are each liable for 6.20% of old age security and disability insurance tax or a total of 12.40% of the first $113,700 of wages in Employers & employees also are each liable for a 1.45% Medicare hospital insurance tax for a total of 2.90% of all wages.

8 8 You may find it helpful to get copies of the income tax returns for corporations, S corporations, partnerships and proprietorships, and enter the information on the following slides – on the tax forms. See Text-Appendix B

9 Study the worksheet on the next slide Same data can be used to compute entity & individual tax with: (1), C Corporation (2) S Corporation and (3) Proprietorship. Owner (Jan) is single with no dependent. Jan has itemized deductions of $26,100. Exemption: $3,900 Jan invested $100,000 to start this business on January 1, With C or S Corp, Jan takes a salary of $70,000. For C or S Corp, payroll tax of $20,000 includes payroll tax for all salaries. With proprietorship, Jan withdraws $70,000. For proprietorship, payroll tax of $20,000 is applicable to salary for others. Self-Employment Tax: IRS Form 1040 SE.

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18  Corporate Tax Rates  15% on first $50,000  25% on $50,001 - $75,000  34% on $75,001 - $100,000  39% (34% + 5% surtax) on $100,001 - $335,000  34% on $335,001 - $10,000,000  35% on $10,000,001 - $15,000,000  38% (35% + 3%) on $15,000,001 - $18,333,333  35% on over $18,333,333

19 19 Double Taxation The following slide shows the impact of double taxation of corporate earnings. The corporation has taxable income of $1,500,000 and distributes all after-tax income to shareholders. See Sec 301.

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23 23 2. Corporate tax law (compare with individuals). [Page 2-8] Sec. 1, 1(h), 11, 1201, 63

24 24 2. Fiscal years and accounting methods. [Pg 2-10] Sec. 441, 451

25 25 Corporate Year. When a corp. is formed there are certain elections that must be made. A. Choosing a Calendar or Fiscal Year. A new corp. may select either a calendar or fiscal year by filing its first tax return for the selected period. The corp's tax year must be the same as its annual accounting period that is used for financial accounting purposes.

26 Corporate Year. A corp's first tax year may not cover a full 12-month period. In that case, a short-period tax return must be filed. A corp's final year may also cover a short period. Some corporations may be restricted in their ability to select a tax year. A member of an affiliated group of corps that files a consolidated return must use the same tax year as the group's parent corporation. A PSC may elect to use certain fiscal years even when there is no business purpose. A new PSC may elect to use a September 30, October 31, or November 30 year-end provided that it meets minimum distribution requirements to employee-owners during the deferral period.

27 Corporate Year. A personal service corporation (PSC) is defined for this purpose as a corporation whose principal activity is the performance of personal services. A corporation is not a PSC unless its employee- owners own more than 10% of the stock (by value) on any day of the year and the personal services are substantially performed by the employee-owners.

28 Corporate Year. A corporation wishing to change its accounting period must secure the prior approval of the IRS unless a change is specifically authorized under the Regulations. A request for change is filed on Form 1128 on or before the fifteenth day of the second calendar month following the close of the short period. The change will be granted if there is a substantial business purpose.

29 Corporate Change of Year. A corporation may change its tax year without the prior approval of the IRS if: 1. the corporation has not changed its accounting period within the last ten years; 2. the resulting short period does not have a net operating loss. 3. the taxable income of the short period is, if annualized, at least 80% of the corporation's taxable income for the tax year preceding the short period. 4. the corporation had a special status (i.e. personal holding company or exempt status) for the short period or the tax year prior to the short period, it has the same status for both tax years; and 5. the corporation does not elect S corporation status in the year following the short period.

30 Accounting Methods. A new corp. must select the method of accounting it will use to keep its books and records. The same method must be used to compute financial accounting income and taxable income. (At least that is what Sec. 446(a) says, but….)

31 Accrual Method. Income is reported when earned and expenses are reported when incurred. C corporations are accrual except: a. A family farming business. b. A qualified personal service corp. where substantially all of its activities involve …services in the fields of health, law, engineering, …accounting, …; and where substantially all of the stock is held by current (or retired) employees performing the services, their estates, or certain persons who inherited their stock. c. Corps with gross receipts of $5 million or less. d. S corporations.

32 Cash Method. Income is reported when received and expenses are reported when paid. This method may not be used if inventories are a material income-producing factor. Hybrid Method. The corporation uses the accrual method of accounting for sales, cost of goods sold, inventories, accounts receivable, and accounts payable. The cash method of accounting is used for all other income and expense items.

33 Cash and Accrual Method. On , Tom, (Cash basis), leased an office from Downtown Plaza (Cash basis) for 5 years starting on , for $1,000 per month. On , Tom paid $30,000, half of the lease amount, to Downtown (for 30 months). Tom made no payment during Tom’s rent deduction (in 2014): a. $ ‑ 0 ‑ b. $6,000 c. $12,000 d. $30,000 Downtown (accrual basis) reports 2014 rental income: a. $ ‑ 0 ‑ b. $6,000 c. $12,000 d. $30,000 Discuss: Downtown is on Accrual Basis? Sec. 451,

34 § , General rule for taxable year of inclusion (a) General rule. –…..Under an accrual method …, income is includible in gross income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

35 § , General rule for taxable year of inclusion (a) General rule. … Under the cash receipts and disbursements method.., such an amount is includible in gross income when actually or constructively received. Where an amount of income is properly accrued on the basis of a reasonable estimate and the exact amount is subsequently determined, the difference, if any, shall be taken into account for the taxable year in which such determination is made.

36 36 Nare, an accrual ‑ basis taxpayer, leased a building to Pine under a five ‑ year lease on Pine paid Nare $10,000 rent for 2 months of November and December, 2014, and $5,000 for the last month's rent. How much should Nare report as rental income for 2014? a. $10,000 b. $15,000 c. $40,000 d. $45,000 Sec. 451,

37 Nare, Cont’d The answer is $15,000. An accrual basis taxpayer recognizes income with all events have occurred to establish the right to receive the income. Nare has the right to receive $15,000, even though only $10,000 has been earned during the taxable year.

38 38 On March 1, 2014, Sharon, a cash basis sole proprietor, leased a dance studio from Shelby Rentors for 3 years at $1,200 per month. In 2014, Sharon paid $28,800 and in 2015 she paid $6,000 on the lease. She paid the remainder of the lease payment in What is Sharon’s deduction for 2015? a. $6,000 b. $11,600 c. $14,400 d. $20,400

39 39 Sharon must capitalize the payments for rent for future years and write off the cost on a monthly basis. Answer: $14,400

40 40 A consulting firm started in 2014 and adopted the accrual method. The firm had gross income of $90,000 and expense payments of $60,000 for The firm owed salaries payable of $5,000 to employees (non-owners) for December, which were not recorded at These salaries were paid in January, How much is taxable income for 2014? a. $25,000 b. $30,000 c. $35,000 d. Other (CPA)

41 41 A consulting firm- continued. The firm reported net income of $30,000, but failed to deduct an expense for salaries earned but not paid. On the accrual basis, such salaries will be deducted for the year in which the employees earned those salaries, if paid early in next year. This reduces net income to $25,000.

42 42 Mark, who gives music lessons, is a calendar year taxpayer using the accrual method of accounting. On , he received $10,000 for a one-year contract beginning on that date to provide 10 lessons. He gave 2 lessons in How much should Mark include in income in 2014? a. $--0-- b. $2,000 c. $8,000 d. $10,000

43 43 Mark-Continued. This is income received in advance and would normally be reported entirely in the year of receipt. However, this qualifies as an exception, and the taxpayer can report the income as earned, not when payment is received in advance.

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45 45 Accounting Methods Hall Co., -Continued The rent receivable of $6,000 must be included in revenue – using the accrual method. Corrected computations: Revenue$46,000 Expenses$10,000 Taxable Income$36,000 (Before Depreciation)

46 46 Timing of Deductions Accrual method – expenses deductible when: – “All events” have occurred that fix liability and – “Economic performance” occurs (property or services provided or used) Cash basis taxpayer - expenses deductible when paid: – Date check is mailed – Date charged on credit card

47 47 Accrual Accounting-1 Reg § methods of accounting …a liability is incurred, …, [when] all events have occurred that establish the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability.

48 Accrual Accounting-1 Automobile manufacturer sells an auto to dealer for a wholesale price of $30,000. Dealer sells it later that year for $40,000. Manufacturer warrants the auto for five years and estimates that the warranty cost over five years will be $4,000 per auto. Is the manufacturer permitted to recognize an expense in the year of sale and set up a “reserve” for future warranty costs (equal to $4,000 per auto sold this year)? See Reg earlier.

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55 55 Formula For Corporate Tax Liability. Each year a corporation computes its regular tax liability. A corporation may owe the alternative minimum tax, AMT, and possibly the accumulated earnings tax or personal holding company tax, PHC. The total tax liability equals the sum of the two primary corporate tax liabilities plus the amount of any special levies that are owed.

56 56 Corporate Taxable Income In defining gross income, Section 61 does not explicitly distinguish between individuals and corporations. What “individual types” of income are rarely if ever realized by a corporation? (e.g. alimony, etc.) What “individual types” of exclusions from income are rarely if ever realized by a corporation? (gift)

57 57 Similarities with Individuals. Page 8 Gross Income of a corporation and individual are very similar Includes compensation for services, income from trade or business, gains from property, interest, dividends, etc. Corp taxpayers have fewer exclusions. Nontaxable exchange treatment is similar Depreciation recapture applies to both but corp may have recapture under §291.

58 Dissimilarities with Individuals – Different tax rates apply – All deductions of corp are business deductions Corp does not calculate AGI Corp does not deduct standard deduction, itemized deductions, or personal and dependency exemptions Corp does not reduce casualty and theft loss by $100 statutory floor and 10% of AGI.

59 4. Capital gains (losses) & depreciation recapture. [Page 11] Sec. 11, 1201, 1211, , 1245, 1250

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73 73 Corporate Income Tax - Problem

74 74 Corporate Income Tax - Solution

75 Computing a Corporation's Taxable Income. If Sec property is sold at a gain, the gain will be reported as ordinary income to the extent that accelerated depreciation exceeds straight-line depreciation. This is known as "Sec depreciation recapture." (The recognition of Sec gain has been almost eliminated since the MACRS rules were introduced in 1987 that restricted depreciation on realty to the straight-line method.) Corp. must recapture as ordinary income an additional amount equal to 20% of the additional ordinary income that would have been recognized on a sale, exchange, or other disposition of the property if it had been Sec property rather than Sec property.

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80 Charitable Contributions - 1 Overall limit 10% of taxable income before – Charitable contribution deduction – Dividend received deduction – NOL or capital loss carryback. §170(b)(2), (c) Excess carried forward up to 5 years. §170(d)(2) Accrual basis corporation can deduct contributions in year accrued if – Payment authorized by board before year end – Payment made by 15 th day of 3 rd month aftter close of tax year in which accrued. §170(a)(2)

81 Charity Deductions-2 Amount deductible for property contributions depends on type of property contributed §1.170A-1(c) Long-term capital gain property deduction = FMV of property – Exception: Corporation may only deduct basis if tangible personal property contributed and not used by charity in its exempt function.

82 82 Charity Deductions-3 Long-term capital gain property deduction = fair market value of property (cont’d) – Exception: Deduction for property contribution to certain private nonoperating foundations is limited to basis in property

83 Charity Deductions-4 Ordinary income property deduction = basis in property. §170(e) – Exception: Basis plus 50% of appreciation can be deducted if inventory or scientific property is contributed which is used by charity as required by Code

84 84 Charity –Code (b)(2) Corporations. In the case of a corporation, the total deductions under subsection (a) for any taxable year shall not exceed 10 percent of the taxpayer's taxable income computed without regard to (A) this section, (B) part VIII (except section 248), (C) any net operating loss carryback to the taxable year under section 172, and (D) any capital loss carryback to the taxable year under section 1212(a)(1).

85 85 Cable-Charity Deductions-6 In 2013, Cable Corp., contributed $80,000 to charities. Cable also had carryover contributions of $10,000 from Cable's 2013 taxable income (after a $40,000 DRD [(Div. Rec. Deduction)- owned 25% of stock] but before Charity deduction was $820,000. Cable’s 2013 charity deduction is? a. $80,000 b. $82,000 c. $86,000 d. $90,000 CPANov1995

86 86 Cable-Charity Deductions-7 In 2013, Cable Corp., contributed $80,000 to charities. Cable also had carryover contributions of $10,000 from Cable's 2013 taxable income (after a $40,000 DRD) before charity deductions was $820,000. Cable’s 2013 charity deduction is? $86,000 (Charity limit is computed before DRD)

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95 7. Net operating losses. [Page 17] Sec. 172

96 96 Net Operating Losses (NOLs). An NOL is the amount by which a corporation's deductions exceed its gross income. In computing an NOL, no deduction is allowed for a carryover or carryback of an NOL from a preceding or succeeding year. If the corporation has an NOL, it also would not be allowed a U.S. production activities deduction because it has no positive taxable income. For tax years beginning after August 5, 1997, an NOL may be carried back two years and forward 20 years. Alternatively, the corporation may elect to forgo the carryback period.

97 97 Net operating loss of individual and corporation may be: – Carried back two years – Unused portion carried forward 20 years §172

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99 9. Dividends received deduction. [Page 17]

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102 102 Grant, Inc. acquired 30% of South Co.’s voting stock for $200,000 on January 1, Grant’s 30% interest in South gave Grant the ability to exercise significant influence over South’s operating and financial policies. In 2014, South earned $80,000 and paid dividends of $50,000. What amount of income should Grant include in its 2014 Federal income tax return as a result of the investment? a. $15,000 b. $24,000 c. $35,000 d. $50,000 e. $80,000 CPA Nov

103 103 Dividend Received-Green Corp -1 Green Corp. owns 25% of Cande Corp. In 2014, Green received $10,000 dividends from the Cande stock. Assuming no other limitations apply, Green’s dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $

104 104 Div. Received- Green Corp– 2 Green Corp. owns 25% of Cande Corp. In 2014, Green received $10,000 dividends from the Cande stock. Assuming no other limitations apply, Green’s dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $

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112 112 Dividends Received Ded-Code 246(b)(1) General Rule. --… deductions allowed by sec. 243(a)(1), 244(a), and subsection (a) or (b) of sec. 245 shall not exceed the percentage determined under paragraph (3) of the taxable income computed without regard to the deductions allowed by sec. 172, 243(a)(1), 244(a), subsection (a) or (b) of sec. 245, and 247, without regard to any adjustment under sec, 1059, and without regard to any capital loss carryback to the taxable year under section 1212(a)(1).

113 113 Div. Received Ded-Code 246(b)(1) General Rule. … (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 §172).

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116 116 Spring Corporation Spring Corp. has income from business of $500,000 & expenses of $750,000. Spring also received dividends from the Acme Corp. of $100,000. Spring owns 25% Acme. What is Spring’s NOL for the year? a. ($150,000) b. ($0). c. ($220,000) d. ($230,000).

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119 119 Spring Corporation Spring Corp. has income from business of $500,000 & expenses of $750,000 for the year. Spring also received dividends from the Acme Corp. of $100,000. Spring owns 25% Acme. What is Spring’s NOL for the year? ($230,000)

120 120 Pack Corporation This year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for this year? a. $50,000 b. $30,000 c. $20,000 d. $10,000

121 121 Pack Corporation This year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for current year? $30,000

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123 10. Organization & start-up expenses. [Page 20] Sec. 248, 195.

124 Organizational Expenditures. Organizational expenses must be capitalized unless an election is made under Sec. 248 to amortize them. If the election is made a corp. can deduct the first $5,000 of organizational expense. A corporation must reduce the $5,000 by the amount by which cumulative organizational expenditures exceed $50,000, although the $5,000 cannot be reduced below zero.

125 125 Organizational Expenditures. Remaining organizational expenditures can be amortized over a 180-month period beginning in the month it begins business. The election must be made in a statement attached to the tax return for the year in which the corporation began to conduct business. If the election is not made, the organizational expenses cannot be deducted until the corporation is liquidated.

126 126 Organ. Expenses-1 Costs of issuing or selling stock and transferring assets to the corporation reduce the amount of capital raised and are not deductible

127 127 Organ. Expenses-2 Which of the following costs are amortizable organizational expenditures? a. Professional fees to issue the corporate stock. b. Printing costs to issue the corporate stock. c. Legal fees for drafting the corporate charter. d. Commissions paid by the corporation to an underwriter. CPA Nov. 1994

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132 132 Start-up expenditures are ordinary and necessary business expenses that are paid or incurred to investigate the creation or acquisition of an active trade or business, to create an active trade or business, or to conduct an activity engaged in for profit or the production of income before the time the activity becomes an active trade or business. The expenditures must be such that they would be deductible if they were incurred in conduct of a trade or business.

133 Start-Up Expenditures. Under Sec. 195, a corporation may elect to deduct the first $5,000 of start-up expenditures. However, this amount is reduced (but not below zero) by the amount by which the cumulative start-up costs exceed $50,000. The remainder of the start-up costs can be amortized over a 180-month period beginning in the month it begins business. [For 2010, $5,000 was changed to $10,000 and $50,000 to $60,000.] What is the difference between an organization expenditure and a start-up expenditure?

134 Organization and Startup-New rules Example: New business incurs $53,000 of startup costs and $50,000 of organization costs on January 1, Two immediate deductions -$2,000 for startup costs and -$5,000 for organization costs Startup costs of $51,000 amortized over 15 years. $3,400 Organization costs of $45,000 amortized over 15 years. $3,000

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136 136 Pine Corporation Pine Corp. has opened for business in 2014 and has elected to amortize its startup expenses. What is the minimum number of months over which the start up costs can be amortized? a. 60 Months. b. 180 Months. c. 6 Months. d. 36 Months.

137 12+. Tax liability Computations Reconcile Book to tax. [Page 21+] Tax Planning. Owner transactions. [Pg.38+] 137

138 Joe owns 100% of the stock of two corporations: § 1561(a) (1) The Furniture Place in Gastonia. (2) The Appliance Place in Monroe. Each corporation has taxable income of $100,000 (total of $200,000). How much total federal income tax is paid by these two corporations for the year? a.$30,000 b. $35,000 c. $61,250

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140 Transactions with related parties. Sec

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142 The End


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