McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Principles of Taxation: Advanced Strategies Chapter 8 Chapter 8 Multiple Entity Business Structures Multiple Entity Business Structures Slide 8-1

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Controlled Corporate Groups Prevents groups of corporations owned by the same people from splitting income and getting benefit of progressive tax rates 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: Tax benefits must be allocated amount members of the group:  Progressive rates  Accumulated earnings credit  Alternative minimum tax exemption  Sec. 179 limit Slide 8-2

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Controlled Groups Slide 8-3 Three types: Three types:  Brother-sister  Parent-subsidiary  Combined Group

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Brother-Sister Controlled Group Two or more corporations in which five or fewer individuals estates or trusts meet both of the following ownership tests: 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 Slide 8-4

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Brother-Sister Control Group Example 1: Example 1: ShareholderLennoxJacobiIdenticalOwnership Casey20%40%20% Falcini30%5%5% Terrell25%35%25% Woo25%20%20% Total100%100%70% Slide 8-5 Total Ownership 100%; Identical Ownership 70%

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Brother-Sister Control Group Example 2: Example 2: ShareholderMarinWLTIdenticalOwnership Leigh20%10%10% Throp55%10%10% Woo25%80%25% Total100%100%45% Slide 8-6 Total ownership 100%; Identical ownership 45%

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Parent-Subsidiary Group One corporation owns directly at least 80% of the voting power or value of another corporation 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 All other corporations of which 80% of voting power or value of stock owned by another member is included in the group Slide 8-7

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Combined Control Group Group where one corporation is the parent of a parent-subsidiary group and the member of a brother-sister control group Group where one corporation is the parent of a parent-subsidiary group and the member of a brother-sister control group Slide 8-8

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc 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 Slide 8-9

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Affiliated Group Parent directly owns 80% of voting power and value of stock in at least one other corporation 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 Any other corporation of which 80% of stock is owned by one or more members included in group Slide 8-10

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Affiliated Group Gunner, Alpha, Beta and Delphi members of affiliated group Gunner, Alpha, Beta and Delphi members of affiliated group Gunner Alpha Beta Kappa Delphi 85% 35% 60% 45% 53% Slide 8-11

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Comparison to Consolidated Financial Statement Slide 8-12 Test for filing consolidated financials is 50% or more interest Test for filing consolidated financials is 50% or more interest Foreign as well as domestic corporations included in consolidated financial statements Foreign as well as domestic corporations included in consolidated financial statements

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Consolidated Return Regulations Regulations issued pursuant to code section 1502 govern returns Regulations issued pursuant to code section 1502 govern returns Affiliated group filing consolidated return referred to as consolidated group Affiliated group filing consolidated return referred to as consolidated group Parent acts as agent for entire group Parent acts as agent for entire group Slide 8-13

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Income on Consolidated Tax Return Parent’s income for entire year Parent’s income for entire year All income for other members while they were part of the affiliated group All income for other members while they were part of the affiliated group Each subsidiary must adopt parent’s tax year Each subsidiary must adopt parent’s tax year Slide 8-14

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Consolidated Taxable Income Each member computes income on separate company basis Each member computes income on separate company basis Separate income adjusted for intercompany transactions Separate income adjusted for intercompany transactions Take items such as capital gains, 1231 gains, charitable contributions out of separate income 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 Add separate incomes together with consolidated capital gains, 1231 gains, charitable contributions Slide 8-15

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Intercompany Items Generally treated same way as if corporations were not members of a consolidated group 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 Slide 8-16

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Matching Rule Examples: Examples:  Performance of service where recipient capitalizes payment  Sales of assets between members  Sales of depreciable property  Intercompany dividends Slide 8-17

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Consolidated Return Mechanics Slide 8-18 Tax liability, credits and alternative minimum tax determined on a consolidated basis Tax liability, credits and alternative minimum tax determined on a consolidated basis Parent files return and pays estimated taxes Parent files return and pays estimated taxes

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Basis Adjustments Adjustments necessary to ensure income is not taxed twice Adjustments necessary to ensure income is not taxed twice Slide 8-19

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Positive Basis Adjustments Subsidiary’s share of taxable income Subsidiary’s share of taxable income Tax-exempt income Tax-exempt income Capital contributions Capital contributions Slide 8-20

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Negative Basis Adjustments Losses used to reduce consolidated taxable income Losses used to reduce consolidated taxable income Nondeductible expenses Nondeductible expenses Distributions Distributions Slide 8-21

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Excess Loss Accounts Losses generated by subsidiary in excess of basis Losses generated by subsidiary in excess of basis Recaptured if subsidiary sold outside consolidated group Recaptured if subsidiary sold outside consolidated group Slide 8-22

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc 338(h)(10) Elections Allows sale of subsidiary outside group with full set-up of assets to fair market value 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 Treated as a sale of assets by old consolidated group No gain on stock sale No gain on stock sale Tax paid by selling group with resulting lower purchase price Tax paid by selling group with resulting lower purchase price Slide 8-23

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Loss Disallowance Rules Prevents duplication in losses on sale of subsidiaries due to unrealized losses Prevents duplication in losses on sale of subsidiaries due to unrealized losses No loss allowed on sale of stock outside consolidated group No loss allowed on sale of stock outside consolidated group Slide 8-24

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Qualified Subchapter S Subsidiaries Corporation that meets all S corporation eligibility requirements except it is owned by another S corporation Corporation that meets all S corporation eligibility requirements except it is owned by another S corporation Treated as operating division of S corporation owner Treated as operating division of S corporation owner Slide 8-25

McGraw-Hill/Irwin Copyright (c) 2002 by the McGraw-Hill Companies Inc Single Member LLCs Normally treated as a disregarded entity for tax purposes Normally treated as a disregarded entity for tax purposes Slide 8-26