1. Taxation of Individuals and Business Entities
2019 Edition
Chapter 16
Corporate Operations

2. Corporate Taxable Income Formula (Exhibit 16-1)
Corporate Tax Formula
Individual Tax Formula
Gross income
Minus:
Deductions
For AGI deductions
Equals
Adjusted gross income
From AGI deductions
Deduction for qualified business income, and
Greater of:
Standard deduction or
Itemized deductions and
Taxable income
Times
Tax rate (21%)
Tax rates
Regular income tax liability
Add
Other taxes
Total tax
Minus
Credits
Prepayments
Taxes due (or refund)

3. Book–Tax Differences (1 of 2)
Financial income often is the starting point for computing taxable income.
Reconcile to taxable income
Book–tax adjustments for differences between financial accounting rules
Companies preparing financial statements with tax accounting methods won’t have book–tax differences.

4. Book–Tax Differences (2 of 2)
Unfavorable differences
Add-back to book income to compute taxable income.
Favorable differences
Subtract from book income to compute taxable income.
Permanent differences (never “reverse”)
Temporary differences (reverse over time)

5. Common Permanent Book–Tax Differences
Interest income from municipal bonds (Fav)
Death benefit from life insurance on key employees (Fav)
Life insurance premiums (Unfav)
Half of business-related meals (Unfav)
100% of entertainment expenses (Unfav)
Fines and penalties and political contributions (Unfav)
Excess compensation to executives (Unfav)
Federal income taxes (Unfav)
Dividends received deduction (Fav)

6. Common Temporary Book–Tax Differences (1 of 2)
Equity income
Depreciation
Gain/loss on sale of depreciable asset
Bad debt expense
§263A uniform inventory capitalization costs See #34
Organizational or start-up costs
Unearned rent revenue
Deferred compensation

7. Common Temporary Book–Tax Differences (2 of 2)
Non-qualified stock option compensation expense
Net capital loss
Carry back three years and forward five years
Net operating loss carryover #39 & #45
Goodwill acquired in an asset acquisition (goodwill with a book and tax basis) #36

8. Book–Tax Differences from Dividends (1 of 3)
Included in gross income for tax purposes if received from a domestic corporation
Eligible for a 100% dividends received deduction if received from a 10%-or-more owned foreign corporation and previously deferred from U.S. taxation

9. Book–Tax Differences from Dividends (2 of 3)
Income included in book income depends on ownership.
If ownership < 20%, unrealized gain or loss included in income for book purposes; dividends reported for book and tax purposes.
If ownership is at least 20% but not more than 50%, the shareholder corporation reports its share of joint venture’s income under the equity method; dividends reported for tax, but not book purposes.

10. Book–Tax Differences from Dividends (3 of 3)
If ownership > 50%, consolidated financial reporting; intercompany dividends are eliminated for book purposes.
If ownership ≥80%, consolidated tax reporting; dividends are eliminated for tax purposes.

11. Dividends Book–Tax Difference Example
PCC owns 30% of the stock of BCS corporation. During 2018, BCS distributed a $40,000 dividend to PCC. BCS reported $100,000 of net income for Based on this information, what is PCC’s 2018 book–tax difference relating to the dividend and its investment in BCS (ignore the dividends received deduction)? Is the difference favorable or unfavorable?

12. Dividends Book–Tax Difference Example Solution
Answer: $10,000 unfavorable book-tax difference, computed as follows:
Description
Amount
Explanation
Dividend received in 2018 (included in 2018 taxable income but not in book income)
$40,000
BCS 2018 net income
$100,000
PCC’s ownership in BCS stock
30%
PCC’s book income from BCS investment under the equity method of accounting
$30,000
(2) × (3)
Unfavorable book-tax difference associated with dividend
$10,000
(1) – (4)

13. Limitation on Net Interest Expense
Corporate net interest expense deductions are limited to 30% of taxable income before interest income or deductions (called adjusted taxable income, ATI).
Deductions disallowed are carried forward indefinitely.
This limitation does not apply to taxpayers with annual average gross receipts (AGR) less than $25 million for the prior three years.

14. Book and Tax Treatment of Stock Options (1 of 2)
EXHIBIT 16-5 Book and Tax Treatment on Stock Options
Description
Book Deduction
Tax Deduction
Book-Tax Difference
Incentive stock option
Initial estimated fair value of stock options/requisite service period
No deduction
Unfavorable, permanent
Nonqualified stock option (in years before exercise)
No deduction until exercise
Unfavorable, temporary

15. Book and Tax Treatment of Stock Options (2 of 2)
Description
Book Deduction
Tax Deduction
Book-Tax Difference
Nonqualified stock option (in year of exercise)
Initial estimated fair value of stock options/requisite service period
Bargain element*
Favorable, temporary (reversing unfavorable, temporary difference in prior years)
Favorable, permanent difference if the bargain element exceeds the initial estimated value of stock options; unfavorable permanent difference otherwise
*The bargain element is the difference between the fair market value of the stock and the exercise price on the date the employee exercises the stock options.

16. Net Capital Losses #39
No current deduction for net capital losses (capital losses in excess of capital gains)
Carry back net capital losses three years and carry forward five years
Use carryover amounts on FIFO basis
Unfavorable, temporary book-tax difference in year of net capital loss
Favorable, temporary book-tax difference in year carryback or carryover is utilized

17. Net Operating Loss Deduction
No current benefit from current year loss (NOL)
NOLs from tax years beginning after 12/31/17 can be carried forward indefinitely; offset is limited to 80% of taxable income.
NOLs from pre-2018 tax years can be carried back 2 years and forward 20 years.
To compute NOL for year, no deduction for:
NOL carrybacks or carryovers from other years.
Capital loss carrybacks (carryovers are allowed).

18. NOL Example
XYZ Inc. has a net operating loss of $200,000 for the 2018 tax year. XYZ reported taxable income in 2019 of $200,000. How much of the 2018 NOL can XYZ offset against its 2019 taxable income?

19. NOL Example Solution
XYZ can offset the lesser of the 1) NOL carryover of $200,000 or 2) 80% of taxable income in XYZ can use $160,000 of the 2018 NOL carryover to offset taxable income in The remaining $40,000 of unused NOL from 2018 can be carried forward to 2020 (indefinitely).

20. Charitable Contributions (1 of 2) #47
Amount of deduction
Capital gain property
Generally fair market value
Ordinary income property
Generally adjusted basis
Accrual method corporation
Deduct when accrue if
Approved by board of directors before year-end
Paid within 3½ months after end of year

21. Charitable Contributions (2 of 2)
Deduction is limited to 10% of taxable income before deducting:
Any charitable contributions.
The dividends received deduction (DRD).
NOL carrybacks.
Domestic production activities deduction (DPAD).
Capital loss carrybacks.
Carry forward excess contributions for 5 years.

22. Charitable Contribution Example
In 2018, PCC donated a total of $700,000 of cash to the American Red Cross. PCC’s taxable income before the charitable contribution deduction, NOL carryover ($24,000), and DRD ($15,000) was $6,287,000. What is PCC’s charitable contribution deduction for the year? What is its charitable contribution carryover to next year, if any?

23. Charitable Contribution Example Solution
Answer: $626,300 charitable contribution deduction and $73,700 charitable contribution carryover, computed as follows:
Description
Amount
Explanation
Taxable income before any charitable contribution, NOL carryover from previous year, and DRD
$6,287,000
Exhibit 16-7.
NOL carryover from previous year
(24,000)
Deductible in determining taxable income limit.
Charitable contribution limit modified taxable income
$6,263,000
(1) + (2).
Total charitable contributions for year
$ 700,000
Tax deduction limitation percentage
10%
§170(b)(2)(A)
Charitable contribution deduction limitation
$ 626,300
(3) × (5).
Charitable contribution deduction for year
Lesser of (4) or (6).
Charitable contribution carryover*
$ 73,700
(4) – (7).
*The carryover expires if it has not been used during the five- year period after the current year.

24. Dividends Received Deduction
Deduction to mitigate more than two levels of tax
Own less than 20%: 50% DRD
Own at least 20% but less than 80%: 65% DRD
Own 80% or more: 100% DRD
Limitation: deduction is limited to the lesser of:
Dividend × DRD%, or
DRD modified taxable income × DRD%.
Modified taxable income = taxable income before DRD, any NOL, and capital loss carrybacks.
If full DRD increases or creates an NOL, this limit does not apply.
Creates favorable, permanent book–tax difference

25. Dividends Received Deduction Example
Description
Scenario A
Scenario B
Explanation
Taxable income before the dividends received deduction (includes dividend income)
$50,000
$25,000
NOL carryover
3,000
DRD modified taxable income
$53,000
$28,000
(1) + (2).
Dividend income
$30,000
Dividends received deduction percentage based on ownership
50%
§243(a).
Dividends received deduction before limitation
$15,000
(4) × (5).
Dividends received deduction limitation
$26,500
$13,500
(3) × (5).
DRD deductible
Lesser of (6) or (7).

26. Regular Tax Liability For taxable years beginning after 12/31/18
Flat tax rate of 21% (blended for corporations with fiscal years beginning before 12/31/18 and ending in 2019)
Apple, Inc. has a September 30, 2018 year-end (92 days in 2017, 273 days in 2018).
Blended rate for 2018 = 92/365 x 35% + 273/365 x 21% = 24.52%

27. Compliance Corporations report taxable income on Form 1120.
Small corporations complete Schedule M-1.
Large corporations complete Schedule M-3.
Book–tax differences referred to as M adjustments.
Corporate returns are due 3½ months after the close of the tax year (June 30 year-end exception).
Automatic five month extension for filing (September 15 for calendar-year corporations)
Consolidated tax returns
Affiliated groups essentially treated as one corporation.

28. EXHIBIT 16-9 Form 1120, Schedule M-1

29. Estimated Payments (1 of 4)
Corporations with a federal income tax liability of $500 or more are required to pay their estimated income tax in four monthly installments.
Installments due on the 15th day of
4th month (25% of required annual payment)
6th month (50% of required annual payment)
9th month (75% of required annual payment)
12th month (100% of required annual payment)
Corporations may owe a penalty for underpayment.
Payments based on required annual payment.

30. Estimated Payments (2 of 4)
Required annual payment
100% of tax liability on prior-year return
Doesn’t apply if no liability in prior year
100% of current-year tax liability
100% of estimated current-year tax liability using annualized method
Rules for large corporations
$1,000,000 of taxable income in prior three years
May use prior-year liability for first quarter payment only

31. Estimated Payments (3 of 4)
EXHIBIT Estimated Taxable Income Computation under Annualized Income Method
Installment
(1)
Taxable Income (first_months of year)
(2)
Annualization Factor
× (2)
Annual Estimated Taxable Income
First quarter 3
12/3 = 4
Second quarter
Third quarter 6
12/6 = 2
Fourth quarter 9
12/9 =

32. Estimated Payments (4 of 4)
EXHIBIT Estimated Taxable Income Computation under Annualized Income Method
Installment
(1)
Annual Estimated Taxable Income
(2)
Tax on Estimated Taxable Income
(3)
Percentage of Tax Required to Be Paid
(4)
(2) × (3)
Required Cumulative Payment
(5)
Prior Cumulative Payment
(4) – (5)
Required Estimated Tax Payment
First quarter
25%
Second quarter 50
Third quarter 75
Fourth quarter
100

33. Alternative Minimum Tax (1 of 3)
Tax paid in addition to regular tax liability
Repealed for tax years beginning after 12/31/17

34. Alternative Minimum Tax (2 of 3)
EXHIBIT Corporate AMT Formula

35. Alternative Minimum Tax (3 of 3)
AMTI × 20% = tentative minimum tax
AMT = tentative minimum tax minus regular tax liability
Minimum tax credit
Amount of AMT creates credit
Carry forward indefinitely
When regular tax > tentative minimum tax, credit can offset regular tax down to tentative minimum tax amount

36. Minimum Tax Credit Example
Corporations with a MTC carryover can offset regular tax liability for any taxable year to which the AMT no longer applies. For tax years beginning in 2018, 2019, and 2020, 50 percent of the minimum tax credit in excess of the regular tax liability is refundable. Any remaining credit is fully refundable in 2021.

37. End of Presentation