McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Chapter 9 9 Multiple-Entity Business Structures

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-3 Reasons Limit Liability Multi-state Operations Avoid Dilution of Ownership Interests Separate Financial Reporting Divergence in Owner’s Interests

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-4 Controlled Corporate Groups Prevents groups of corporations owned by the same people from splitting income and getting benefit of progressive tax rates Tax benefits must be allocated amount members of the group: Progressive rates Accumulated earnings credit Alternative minimum tax exemption Sec. 179 limit Limit for using cash method of accounting

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-5 Controlled Groups Three types: Brother-sister Parent-subsidiary Combined Group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-6 Brother-Sister Controlled Group Two or more corporations in which five or fewer individuals estates or trusts meet both of the following ownership tests: 80% or more of voting power or value of stock owned collectively by the individuals 50% or more of voting power or value of stock owned identically by shareholders Identical ownership: shareholder’s lowest ownership percentage in corporation in the group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-7 Brother-Sister Control Group Example 1: ShareholderLennoxJacobiIdentical Ownership Casey20%40%20% Falcini30%5% Thorsen25%35%25% Woo25%20% Total100% 70% Total Ownership 100%; Identical Ownership 70%

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-8 Brother-Sister Control Group Example 2: ShareholderMarinWLTIdentical Ownership Leigh20%10% Tsu55%10% Weinstein25%80%25% Total100% 45% Total ownership 100%; Identical ownership 45%

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-9 Parent-Subsidiary Group One corporation owns directly at least 80% of the voting power or value of another corporation All other corporations of which 80% of voting power or value of stock owned by another member is included in the group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-10 Combined Control Group Group where one corporation is the parent of a parent-subsidiary group and the member of a brother-sister control group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-11 Consolidated Tax Returns Members of an affiliated group may elect to file a consolidated tax return Once a group files a consolidated return it must continue filing consolidated returns

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-12 Affiliated Group Parent directly owns 80% of voting power and value of stock in at least one other corporation Any other corporation of which 80% of stock is owned by one or more members included in group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-13 Gunner, Alpha, Beta and Delphi members of affiliated group Affiliated Group Gunner Alpha Beta Kappa Delphi 85% 35% 60% 45% 53%

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-14 Comparison to Consolidated Financial Statement Test for filing consolidated financials is 50% or more interest Foreign as well as domestic corporations included in consolidated financial statements

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-15 Consolidated Return Regulations Regulations issued pursuant to code section 1502 govern returns Affiliated group filing consolidated return referred to as consolidated group Parent acts as agent for entire group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-16 Income on Consolidated Tax Return Parent’s income for entire year All income for other members while they were part of the affiliated group Each subsidiary must adopt parent’s tax year

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-17 Consolidated Taxable Income Each member computes income on separate company basis Separate income adjusted for intercompany transactions Take items such as capital gains, § 1231 gains, charitable contributions out of separate income Add separate incomes together with consolidated capital gains, § 1231 gains, charitable contributions

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-18 Intercompany Items Generally treated same way as if corporations were not members of a consolidated group Exception: Matching rule-timing of transaction different for different members of the group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-19 Matching Rule Examples: Performance of service where recipient capitalizes payment Sales of assets between members Sales of depreciable property Intercompany dividends

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-20 Consolidated Return Mechanics Tax liability, credits and alternative minimum tax determined on a consolidated basis Parent files return and pays estimated taxes

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-21 Basis Adjustments Adjustments necessary to ensure income is not taxed twice

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-22 Positive Basis Adjustments Subsidiary’s share of taxable income Tax-exempt income Capital contributions

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-23 Negative Basis Adjustments Losses used to reduce consolidated taxable income Nondeductible expenses Distributions

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-24 Excess Loss Accounts Losses generated by subsidiary in excess of basis Recaptured if subsidiary sold outside consolidated group

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide (h)(10) Elections Allows sale of subsidiary outside group with full set-up of assets to fair market value Treated as a sale of assets by old consolidated group No gain on stock sale Tax paid by selling group with resulting lower purchase price

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-26 Qualified Subchapter S Subsidiaries Corporation that meets all S corporation eligibility requirements except it is owned by another S corporation Treated as operating division of S corporation owner

McGraw-Hill© 2005 The McGraw-Hill Companies, Inc. All rights reserved. Slide 9-27 Single Member LLCs Normally treated as a disregarded entity for tax purposes