Ch17 - 2015

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2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible ebsite, in hole or in part.

Comprehensive Volume

1

Chapter 1!

Corporations"#ntroduction and

$perating Rules

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%he &ig 'icture (slide 1 o) 2*

+ a-antha ohnson ons /ylar/ &a/ery.

Currently, the ba/ery is operated as a sole proprietorship

and generates an annual operating pro)it o) 100,000.

+ #n addition, the ba/ery earns annual dividends o)5,000 )ro- investing ecess or/ing capital

%hese stoc/ invest-ents typically are held )or a -ini-u-

o) three to )our -onths.

+ As a result o) inco-e )ro- other business ventures

and invest-ents, a-antha is in the 334 -arginal ta

rate brac/et irrespective o) the ba/ery.

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%he &ig 'icture (slide 2 o) 2*

+ #n the past, a-antha has ithdran 50,000annually )ro- the ba/ery he regards this as reasonable pay-ent )or her services.

+a-antha has as/ed you about the ta conseuenceso) conducting the business as a regular (C*corporation. &ased on the given in)or-ation, hat ould be the annual

inco-e ta savings (or cost* o) operating the ba/ery as a

corporation6+ 7or purposes o) this analysis, use the 2018 ta rates and ignore anye-ploy-ent ta or state ta considerations.

+ Read the chapter and )or-ulate your response.

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9arious &usiness 7or-s

+ &usiness operations can be conducted in a

nu-ber o) di))erent )or-s including

ole proprietorships

'artnerships

%rusts and estates

corporations (also called ubchapter corps*

Regular corporations (also called C corps*

Li-ited liability co-panies

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ole 'roprietorship

+ :ot a separate taable entity

+ #nco-e reported on oner;s ch. C

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%he &ig 'icture

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'artnership (slide 1 o) 2*

+ eparate entity, but does not pay ta7iles in)or-ation return (7or- 10>5*

+ Most inco-e and epense ite-s areaggregated in co-puting the ordinary businessinco-e (loss* o) the partnershipCertain inco-e and epense ite-s are reported

separately to the partnerse.g., #nterest and dividend inco-e, long ter-

capital gain, charitable contributions andinvest-ent epenses

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'artnership (slide 2 o) 2*

+ 'artnership ordinary business inco-e (loss*

and separately reported ite-s are allocated to

partners according to their pro)it and loss

sharing ratios

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Corporation

+ eparate entity, only pays special taes (e.g., built=ingains* 7iles in)or-ation return 7or- 1120

+ i-ilar to partnership taation $rdinary business inco-e (loss* )los through to the

shareholders to be reported on their separate returns Certain ite-s )lo through to the shareholders and retain

their separate character hen reported on the shareholders;

returns.+ %he corporation ordinary business inco-e (loss*and the separately reported ite-s are allocated to theshareholders according to their stoc/ onershipinterests

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C Corporation

+ C corporations are sub@ect to an entity=level 7ederalinco-e ta hich results in hat is /non as adouble taxatione))ect.

C corporation reports its inco-e and epenses andco-putes ta on the taable inco-e reported on its 7or-1120

+ ses ta rate schedule applicable to corporations

Bhen corporation distributes its inco-e, the corporation;s

shareholders report dividend inco-e on their on tareturns

+ %hus, inco-e that has already been taed at the corporate level isalso taed at the shareholder level

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ividends

+ ouble taation ste-s, in part, )ro- the )act thatdividend distributions are not deductible by thecorporation

+ %o alleviate so-e o) the double taation e))ect,Congress reduced the ta rate applicable to dividendinco-e o) individuals )or years a)ter 2002 Denerally, dividends are taed at sa-e -arginal rate

applicable to a net capital gain+ %hus, individuals otherise sub@ect to the 104 or 154 -arginal ta

rate pay 04 ta on uali)ied dividends received

+ #ndividuals sub@ect to the 25, 2E, 33, or 35 percent -arginal ta ratespay a 154 ta on uali)ied dividends

+ #ndividuals sub@ect to the 3F.>4 -arginal ta rate pay a 204 ta on

uali)ied dividends

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Medicare urta

+ &eginning in 2013, G 1811 i-poses a 3.E4 Medicare

surta on a tapayer;s net invest-ent inco-e in

ecess o) -odi)ied ad@usted gross inco-e o)

200,000 (250,000 i) -arried )iling @ointly* %hus, )or high=inco-e tapayers, the double taation o)

dividend inco-e is increased by this surta

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Corporate #nco-e %a Rates

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:onta #ssues in electing

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Li-ited Liability Co-panies (LLC*

+ LLCs have proli)erated since 1FEE hen #R

ruled it ould treat uali)ying LLCs as

partnerships

Ma@or nonta advantage

+ Allos oners to avoid unli-ited liability

Ma@or ta advantage

+ Allos uali)ying business to be treated as apartnership )or ta purposes, thereby avoiding double

taation associated ith C corporations

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(slide 1 o) 2*

+ Chec/=the=bo Regulations

Allos tapayer to choose ta status o) entity

ithout regard to corporate or noncorporate

characteristics

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(slide 2 o) 2*

+ Chec/=the=bo Regulations (cont;d*

#) no election is -ade, -ulti=oner entities treated

as partnerships, single person businesses treated as

sole proprietorships

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Co-parison o) Corporate and #ndividual

%a %reat-ent (slide 1 o) 3*

+ i-ilaritiesDross #nco-e o) a corporation and individual are

very si-ilar

+ #ncludes co-pensation )or services, inco-e )ro- tradeor business, gains )ro- property, interest, dividends, etc.

+ Corp tapayers are alloed )eer eclusions

+ :ontaable echange treat-ent is si-ilar

&usiness deductions o) a corporation andindividual also are very si-ilar

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Co-parison o) Corporate and #ndividual %a

%reat-ent(slide 2 o) 3*

+ issi-ilarities

i))erent ta rates apply

All deductions o) corp are business deductions

+ Corp does not calculate AD#

+ Corp does not deduct standard deduction, ite-iHed

deductions, or personal and dependency ee-ptions

+Corp does not reduce casualty and the)t loss by 100statutory )loor and 104 o) AD#

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Co-parison o) Corporate and #ndividual %a

%reat-ent(slide 3 o) 3*

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peci)ic 'rovisions Co-pared

+ #n co-paring the inco-e taation o) individuals and

corporations the )olloing areas arrant special

discussion"

Accounting periods and -ethods Capital gains and losses

Recapture o) depreciation

'assive losses

Charitable contributions

o-estic production activities deduction

:et operating losses

pecial deductions available only to corporations

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Accounting 'eriods and Methods(slide 1 o) 2*

+ Accounting periods

Most C corporations can use calendar year or )iscal

year ending on last day o) a calendar -onth (or 52=

53 ee/ year*

corps and 'ersonal ervice Corporations ('C*

are li-ited in available year ends

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Accounting 'eriods and Methods(slide 2 o) 2*

+ Accounting -ethods Cash -ethod can;t be used by C corp. unless"

+ #n )ar-ing or ti-ber business

+ Juali)ied 'C

+ KAve. Annual Dross receipts 5,000,000

As a -atter o) ad-inistrative convenience, the #R illper-it

+

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%he &ig 'icture

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%he &ig 'icture

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Capital Dains and Losses(slide 1 o) 2*

+ #ndividuals

:et capital gains sub@ect to the )olloing

pre)erential ta treat-ent

+ :et short=ter- gains sub@ect to regular ta rates

+ :et long=ter- gains -a ta rate 204

:et capital losses deductible up to 3,000 ith

re-ainder carried to )uture years+ Carryovers do not lose their identity but re-ain either

long ter- or short ter-

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Capital Dains and Losses (slide 2 o) 2*

+ Corporations

:o special ta rates apply to capital gains

+

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epreciation Recapture

+ #n general, the recapture rules under GG 1285 and1250 are eually applicable to both individual andcorporate tapayers Noever, corporations -ay have -ore depreciation

recapture (ordinary inco-e* on the disposition o) G 1250property than individuals

+ nder G 2F1, a corporation has additional ordinaryinco-e eual to 204 percent o) the ecess o)

epreciation recapture that ould arise i) property asG 1285 property over depreciation recapture co-putedunder G 1250 (ithout regard to G 2F1*

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'assive Losses

+ 'assive loss rules apply to"#ndividuals and personal service corps

+ Cannot o))set passive losses against active or port)olio

inco-e corps and partnerships

+ 'assive inco-e and loss )los through to oners andrules applied at oner level

Closely held C corps+ May o))set passive losses against active inco-e, but notport)olio inco-e

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Charitable Contributions(slide 1 o) 5*

+ &oth corporate and noncorporate tapayers

-ay deduct charitable contributions in year

paid

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+ A-ount deductible )or property contributions

depends on type o) property contributed

+ Long=ter- capital gain property deduction P

)air -ar/et value o) property

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+ Long=ter- capital gain property deduction P

)air -ar/et value o) property (cont;d*

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+ $rdinary inco-e property deduction P basis in

property

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+ Corporate charitable contribution deduction is

li-ited to 104 o) taable inco-e be)ore"

Charitable contribution deduction,

:$L or capital loss carrybac/,

ividends received deduction, and

o-estic production activities deduction

+ Contributions in ecess o) 104 li-it can be

carried )orard )or 5 years

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o-estic 'roduction

Activities eduction

+ %he A-erican obs Creation Act o) 2008created a ne deduction based on the inco-e)ro- -anu)acturing activities

%he do-estic production activities deduction isbased on the )olloing )or-ula"

+ F4 Q Lesser o) Juali)ied production activities inco-e

%aable (or ad@usted gross* inco-e+ %he deduction cannot eceed 504 o) an e-ployer;s

B2 ages related to uali)ied production activitiesinco-e

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:et $perating Loss

+ :et operating losses o) corporations and individuals-ay be" Carried bac/ to years nused portion carried )orard 20 years

+ nli/e individuals, a corporation does not" Ad@ust its ta loss )or capital losses, since a corporation

cannot deduct net capital losses Ma/e ad@ust-ents )or any nonbusiness deductions

+ A corporation is alloed to include the dividendsreceived deduction (discussed belo* in co-putingits :$L

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ividends Received eduction(slide 1 o) 3*

#) corporation ons stoc/ in another corporation

and receives dividends, a portion o) dividends -ay

be deducted )ro- inco-e"

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+ %he dividends received deduction is li-ited to a

percentage o) the taable inco-e o) a corporation

7or this purpose, taable inco-e is co-puted ithout

regard to+ %he :$L deduction+ %he do-estic production activities deduction

+ %he dividends received deduction, and

+ Any capital loss carrybac/ to the current ta year

%he percentage o) taable inco-e li-itation corresponds to

the deduction percentage

Noever, the taable inco-e li-itation does not apply i)

the corporation has an :$L )or the current taable year

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%he )olloing steps are use)ul in calculating thedividends received deduction

1. Multiply dividends received by deductionpercentage

2. Multiply taable inco-e by deductionpercentage

3. ubtract 1. )ro- taable inco-e=#) entity has inco-e be)ore R, but R creates :$L,

a-ount in 1. is R (the :$L rule*=#) R does not create :$L, deduction is li-ited to lesser

o) 1. or 2.

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R

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$rganiHational

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$rganiHational

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$rganiHational

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tart=up

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tart=up

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Corporate %a 7or-ula

Dross inco-e

Less" eductions (ecept charitable, iv. Rec;d, :$L

carrybac/, %CL carrybac/*

%aable inco-e )or charitable li-itationLess" Charitable contributions (T P 104 o) above*

%aable inco-e )or div. rec;d deduction

Less" ividends received deduction

%aable inco-e be)ore carrybac/s

Less" :$L carrybac/ and %CL carrybac/

%AUA&L< #:C$M -onth etensions are available by

)iling 7or- !008

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Corporate 7iling Reuire-ents(slide 2 o) 2*

+ Must -a/e esti-ated ta pay-ents eual to

lesser o)"

1004 o) corporation;s ta )or the current year, or

1004 o) ta )or preceding year

+ :o esti-ated ta pay-ents reuired i) ta

liability epected to be less than 500

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chedule M=1

+ Corporations -ust reconcile )inancialaccounting inco-e ith taable inco-e onch M=1, 7or- 1120

Co--on reconciling ite-s include"+ 7ederal inco-e ta per boo/s

+ :et capital losses

+ #nco-e reported )or ta but not boo/ inco-e (e.g.,

prepaid inco-e* and vice versa+

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chedule M=2

+ Corporations -ust reconcile retained earnings

at beginning o) year ith retained earnings at

end o) year using ch M=2, 7or- 1120

chedule L (balance sheet*, chedules M1 andM2 o) 7or- 1120 are not reuired )or

corporations ith less than 250,000 o) gross

receipts and less than 250,000 in assets

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chedule M=3

+ Corporate tapayers ith total assets o) 10 -illion

or -ore are no reuired to report -uch greater

detail regarding di))erences in )inancial accounting

inco-e (loss* and taable inco-e (loss* Reported on chedule M3

+ chedule M3 should

Create greater transparency beteen corporate )inancial

state-ents and ta returns Nelp the #R identi)y corporations that engage in

aggressive ta practices

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Consolidated Returns

+ Corporations that are -e-bers o) a parent=

subsidiary a))iliated group -ay be able to )ile

a consolidated inco-e ta return )or a taable

year

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Re)ocus $n %he &ig 'icture (slide 1 o) 5*

+ Conducting /ylar/ &a/ery as a corporation ouldsave a-antha F,3!5 in inco-e taes annually,co-puted as )ollos"

Bakery Operated as Sole Proprietorship

$perating pro)it o) 100,000" %a on 100,000 W 334 33,000

ividends o) 5,000"

%a on 5,000 W 154 !50

Bithdraals o) 50,000" :o ta 0

%otal inco-e ta hen operated as sole

proprietorship 33,!50

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Tax - Bakery Operated as Regular Corporation

Corporate taable inco-e 51,500

%a on 50,000 W 154 !,500%a on 1,500 W 254 3!5

%otal corporate inco-e ta !,E!5

a-antha;s salary o) 50,000"

%a on 50,000 W 334 1>,500%otal inco-e ta hen operated as

C corporation 28,3!5

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+ Co-putation o) corporate taable inco-e"

$perating pro)it 100,000

ividends 5,000

Less" alary to a-antha (50,000*

ividends rec;d deduction (!04* (3,500*

%aable inco-e 51,500

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+ %he ea-ple illustrates the ta savings available

hen a high=inco-e individual ta/es advantage o) the

loer -arginal ta rates o) C corporations.

+ Noever, other issues also should be considered,such as

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+ Bhat i) the ba/ery beco-es a corporation and

generates a 10,000 short=ter- capital loss (%CL*6

Regular corporations can only deduct capital losses against

capital gains.

+ %hus, the 10,000 %CL ould not be deductible currently by the

corporation

+ #nstead, it ould be carried )orard )or up to 5 years.

#) the ba/ery is operated as a sole proprietorship, a-antha

ould report the capital loss on her individual return.+ he could use the 10,000 %CL to o))set any capital gains she

-ay have, and deduct up to 3,000 o) the loss against ordinary

inco-e.

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Ch17 - 2015