©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Chapter 11 Corporate Income Tax Income Tax Fundamentals 2007 Gerald E. Whittenburg & Martha Altus-Buller

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Corporate Tax Rates  Corporate rates are progressive, from 15% to 39%, depending on taxable income  For corporations with large income (more than $18.33 million) The rate is a flat 34% Accomplished by ‘tax bubbles’  Occurs when tax rate schedules recaptures savings from prior brackets  Qualified personal service corps taxed at flat 35% Architects, CPAs, consultants, etc.

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Corporate Capital Gains  A corporation can choose from two alternative tax treatments on capital gains Taxed at ordinary rates, or Elect to pay an alternative tax (35%) on net long-term capital gain [LTCG]  Essentially equivalent to maximum regular corporate tax [no benefit to LTCG] No difference in tax on ordinary vs. capital income

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Dividends Received Deduction  Corporations are allowed a deduction for a % of the dividends received from other corporations Attempt to alleviate triple taxation  Dividends received deduction [DRD] is allowed Percentage ownership in corporation paying dividends DRD % < 20% 70% 20% or more, less than 80% 80% > 80% 100% Deductions limited by % and other items

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Amortization of Organizational Expenditures  Examples of organizational expenditures Legal/accounting services incident to organization Incorporation fees  Expenses involved in transferring assets to the corporation are not considered organizational expenses  These fees are capitalized and then amortized over 180 months, also  Can make election to deduct up to $5,000 of organization costs in year corporation begins business $5,000 amount is reduced $1 for each $1 that organization expenses exceed $50,000

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Reconciliation of Tax to Book Income: Schedule M-1  Schedule M-1 of Form 1120 reconciles book to tax income Computed before NOLs and special deductions  Amounts added to book income Federal tax expense Capital losses Income recorded on tax return but not on books Expenses recorded on books but not on tax return  Amounts deducted from book income Income recorded on books but not on tax return Expenses recorded on tax return but not on books

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. S Corporations  Certain corporations may elect to be taxed in a manner similar to partnerships  Qualified small business corporation may elect S Corporation status if: Operates as a domestic corporation Has 100 or fewer shareholders  Shareholders may not be corporations or partnerships Has only one class of stock Has only shareholders that are US citizens or resident aliens  Corporation must make election of S status in a prior year Or within 2-1/2 months of the current tax year

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Income Reporting  Must report all elements of income and expense separately on Form 1120S  Then each shareholder reports his/her share of these items of corporate income/expense on personal return K-1 takes total shareholder income/expenses and allocates each item to each shareholder based upon his/her ownership percentage

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Loss Reporting  Each shareholder of an S Corp may also report his/her respective share of loss Cannot take a loss in excess of adjusted basis in stock If loss exceeds adjusted basis in stock plus loans, shareholder can carry it forward  If shareholder entered/departed S Corp midyear, must allocate items of income/loss on a daily basis

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Shareholder Basis in Stock  A shareholder’s initial basis in his/her stock is calculated as follows: Basis of property transferred Less Boot received Plus Gain recognized Less Liabilities transferred Basis in stock  The corporation has a carry-over basis in the property contributed equal to the basis in the hands of the shareholder, increased by any gain recognized by shareholder on the transfer