Chapter 2- C- Corp Corporate Tax Flashcards
What are C Corporations?
- created formally w/an article of incorporation; once that is approved it becomes the corporate charter
- they have limited liability; all of the shareholders have limited liability
- they are a tax paying entity (form 1120) and they do pay taxes b/c they will write a check for the tax liability due
how are C corporations formed?
-no gain or loss is recognized if property is transferred to a corporation solely in exchange for stock if, immediately after the transfer, the transferors are in CONTROL of the corporation
What type of accounting does C Corporations use?
-90% GAAP accrual; 10% is an exception.
when are C Corporations tax returns due?
- March 15 or 2 and a 1/2 months after year-end
- a 52-53 week tax year is fiscal year that varies from 52 time 53 weeks and ends on the same day (but does no have to end on the last day of a month)
This is testable for JULY 2016 TESTING WINDOW:for years beginning in 2016, the return is due on 4/13 which is 3 and a half months after calendar year end and only a 5 month extension is available. Therefore for corporations that don’t have a calendar year you must count 3.5 months after their year end to get when the tax return is due and there is a 6 month extension available from that due date (the 3.5 months after fiscal year end)
how is cash or property that the C-Corp receives from contributors & the contributors gain 80% or more of the stock control?
- its tax free exchange & considered a non event and not taxable
- it has a carryover basis; if the property is subject to debt it is the net of the cash value less the debt & that is the stock basis
- has carryover holding period which means as long as the person had the cash or property the corporation gets the same amount of time ex. person owns property for 5 years then transferred it to the corp; the corp then has owned it for 5 years.
how are services given for LESS THAN 80% of stock (control of the company) that is received by the C-Corp?
- taxable income at FMV of STOCK; this results in ordinary income
- for the shareholder donating the services, they must report ordinary income on their individual tax return.
- wage expense for corporation
how are goods/services treated that the contributor gives that does not gain them any control of the company?
-taxable to all parties, similar to services
Are reorganizations of a corporation taxable?
- No, they are tax-free
- have a carryover basis
how are shares issued for cash in a C Corporation?
-the shareholders basis in the corporation is equal to the amount of cash paid
how is property in particular treated in as an exchange for stock?
two possible ways to value it:
- tax/adjusted basis which is the one generally used, it is the tax/adjusted basis of the property to the shareholder
- fair market value; this is generally ignored when the property tax/adjusted basis is used.
the transfer of property is a non-taxable to the shareholder.
The federal tax code permits this treatment as long as 80% or more of the corporate stock is in the hands of shareholders that provided either cash or property to obtain their shares.
what is the special rule related to property donated to the corporation that is less than 80% but more than 20% (no control) of the voting stock?
-property contributed is reported at the fair market value of the property on the date of the contribution, and is reported as a sale by the contributor. A gain is reported for the difference in the fair value and the tax basis property value.
what happens to the business interest transferred by the proprietor or partners?
it is considered property, so incorporation is non-taxable and the assets and liabilities of the business are carried over to the corporation as long as the owners of the previous business are given at least 80% of the voting stock of the corporation.
what does the “nonrecognition of gain” apply to when incorporating?
applies only to amounts transferred solely in exchange for stock.
what happens if the shareholder receives cash or other property in addition to stock?
gains are recognized up to the amount of cash or fair market value of other property received. Securities are considered property for this purpose
how do you treat property transferred and the contributor receives cash and stock % =>80%?
The stock is valued at the adjusted basis of the property + the cash received. and that will be the corporations basis in the property. The contributor/shareholder will have a stock basis in the amount of the property only and the cash that was received by them will be considered as a gain.
if a shareholder contributes property subject to liabilities, the shareholders basis in the stock received is reduced by the amount of liability relief. If the liabilities exceeds the shareholders adjusted basis in the property, gain is recognized on the excess and the shareholders basis in the stock is zero.
what is the basis of property exchanged for corporate stock; tax-free exchanges under section 351 transferors have at least 80% control after the exchange for the SHAREHOLDER’S BASIS in stock received?
\+adjusted basis (meaning not the fair market value) of property transferred \+recognized gain \+cash paid \+liabilities assumed \+transaction costs and fees -cash received -FMV of property received -liabilities transferred.
what is the basis of property exchanged for corporate stock; tax-free exchanges under section 351 transferors have at least 80% control after the exchange for the CORPORATION’S in stock received?
+adjusted basis of the property in the hands of the transferor
+gain recognized by the transferor
how does properties transferred with a carryover basis that exceeds its aggregate FMV, how is it treated?
the corporate transferee’s aggregate basis for the property is generally limited to its aggregate FMV immediately after the transaction (generally the lesser value). any required basis reduction is allocated the transferred properties in proportion to their built-in loss immediately before the transaction. The transferor’s basis in the stock would still be the carryover basis of property (generally the higher value)
what is the irrevocable election to limit the basis in stock received by the transferor?
that the stock received by the transferor is at the aggregate FMV of the transferred property (which is generally the lesser value). The transferor would then have a basis that is less than what the corporation’s basis in the property is. basically the corporations basis would be higher.
how do reorganizations work in regards to taxes?
- basically the transfer of virtually all the assets and liabilities of one corporation to another in exchange for stock in the new corporation, and are generally non-taxable with the shareholders having the same basis in the stock of the new corporation as they did in the old. Tax-free status examples include:
- **changes in the place of organizations (for ex. the assets of a new your corp are all transferred into a corporation with a Florida charter)
- **mergers and consolidations of businesses
- **absorption of subsidiaries (the assets and liabilities of a controlled subsidiary are transferred to the parent)
-all require that a standard of 80% ownership be met for parties providing consideration other than services for their stock. it is the standard of CONTROL for tax purposes and is the minimum ownership level required to identify an investee company as a controlled subsidiary and allow the preparation of consolidated tax returns. it is optional to complete a consolidated tax return.
when does GAAP consider control of a corporation to take place?
when a majority of the voting stock is owned, or when other acceptable standards are met, and require the preparation of consolidated financial statements when such circumstances arise.
***REMEMBER FOR ACCOUNTING PURPOSE MAJORITY RULE IS 50%
AFTER a corporation is formed, how is a donation of additional property to the corporation handled?
- the shareholder will recognize NO GAIN OR LOSS on the transfer and will increase the tax basis in the stock by the TAX BASIS OF THE PROPERTY TRANSFERRED
- the shareholder’s tax basis in the transferred property will carry over to the corporation and become its tax basis in the property.
What is included in a corporate income tax return form (1120)
Gross income (world-wide) -ordinary deductions =INCOME B4 SPECIAL DEDUCTIONS -charitable contribution -dividend received deduction =TAXABLE INCOME x tax rate =GROSS TAX LIABILITY -foreign tax credit =NET REGULAR TAX LIABILITY \+Personal Holding Company Tax \+Accumulated Earnings Tax \+Alternative Minimum Tax =TOTAL TAX LIABILITY
what are considered revenues under c-corparations?
- its recognized at the earlier of when earned or collected
- rental income received in advanced is considered revenue for tax purposes when it was received
- interest income received in advance (not municipal bond interest)
- royalty income in advance
Monies received related to life insurance proceeds on key employee
- if the corp is the beneficiary, the premiums paid on such policies are not deductible, since the proceeds are not taxable
- premiums on life insurance to benefit employee’s family (the employees family is the beneficiary) are deductible because it is part of the fringe benefits
- company owned life insurance (COLI) the beneficiary may exclude from gross income benefits received only up to the total amount of premiums and other amounts paid by the policyholder for the contract, any excess would be taxable. there are exceptions which are director or highly compensated employee
what are deductions for the c-corporation?
- generally claimed in the same manner as GAAP regarding the matching principle.
- an accrual basis taxpayer can accrue an expense if the transaction meets both an all-events test and an economic performance test.
These may only be deducted when accrued if they are paid within 2&1/2 months of the close of the corporations tax year. this applies to wages, bonuses, vacation pay, charitable contributions.
when is the all events test met for claiming expense for a c-corporation on the accrual basis of accounting & tax purposes?
when the existence of a liability is established and the amount of liability can be determined with reasonable accuracy.
when is the “economic performance test” for claiming expense for a c-corporation on the accrual basis of accounting & tax purposes?
in the event that another person is to provide the taxpayer with property or services, the economic performance test is satisfied when the property or service are ACTUALLY PROVIDED.
under a c-corporation, what are considered organizational expenses?
- c corp may elect to deduct up to 5K of organization expenses for each expenditure and start up costs. the 5K amount is reduced by the amount by which the organizational expenditures or start up costs exceeds 50K respectively dollar for dollar.
- any cost not currently deductible are amortized over 180 months (15years) beginning in the month in which the active trade or business begins (basically if you don’t start amortizing in the first month then you don’t get to take the deduction)
- the entity must elect to amortize the organization costs in the period of the organization
- if no election is made, costs are capitalized and remain until the entity is liquidated
DO NOT INCLUDE THESE AS ORGANIZATION EXPENSE BECAUSE THEY AINT!
-costs of issuing, printing, and selling stock (including legal accounting fees related to the offering of securities) are NOT organizational expenses. The are a reduction to additional paid in capital (APIC). ex cash debit, credit commons stock, credit APIC (net of stock issuing cost)
what are the deduction rules related to salaries and wages for a c-corp?
- payroll taxes and fringe benefits
- can only deduct up to 1 Million of compensation expense for each of the 5 highest paid EXECUTIVE OFFICERS of a public corporation (1125-E) (500K if under TARP)
- entertainment expenses for officers, directors, and 10% or greater owners may be deducted only to the extent that they are included in the individuals gross income.
- bonsues and vacation pay CAN BE DEDUCTED, if paid within 2&1/2 months of year end (3/15; March 15)
what are the deduction rules related to estimated losses for a c-corp?
they are NOT deductible! -bad debts not claimed until actual DIRECT WRITE-OFF ex. a/r sales journal: *debit- A/R *credit-Sales *debit-bad debt expense *credit-allowance for doubtful acct: for TAX Purposes you can only deduct the revenue when you write the account off the account: Direct Write-OFF debit- bad debt expense credit - A/R
these are temporary differences and they show up on the the M-1 statement
-Warranty costs NOT claimed until ACTUAL REPAIRS; (for book, both accrued & for tax purposes it is the direct write off method
Is interest expense deductible under a c-corporation?
No; if the loan proceeds used for tax-exempt investments like municipal bonds. So they must be added back to taxable income on the Schedule M-1.
how are reimbursed employee expenses treated for c-corporations?
50% of meals and entertainment
- **when reimbursed meals and entertainment is treated by the employer as compensation and wages, it is fully deductible to the entity.
- **the payee will be taxed on the amount of the reimbursement and be allowed to deduct 50% of the meals and entertainment as an unreimbursed business expense.
- all travel costs
- the cost of a luxury skybox is DISALLOWED TO THE EXTENT COSTS EXCEEDS THE COST OF THE MOST EXPENSIVE NON LUXURY SEAT IN THE VENUE
- **the limit does not apply if the skybox is rented for one event only
- **rental of a skybox for more than one event in the same sports arena, such as a series of playoff tickets, is subject to the limitation
how are casualty losses handled for tax purposes under a c-corp?
- business property-adjusted basis immediately before the casualty
- note that $100 floor and 10% of adjusted gross income limitations DO NOT APPLY
what are things are NEVER deductible for a c-corporation?
- government fines, fees, and penalties, including interest penalties
- federal income taxes (you can deduct state and local taxes on the FEDERAL RETURN
how are goodwill, franchises and trademarks treated for tax purposes for C-Corporations?
deductions are amortized over 15 years & for book it is still tested annually for impairment
how are research and development cost deductions handled for c-corporations?
-they can be deducted IMMEDIATELY or over a minimum of 60 months OR 5 YEARS
how are dividends treated under c-corporations? (remember dividends are not an expense because it comes out of retained earnings so its taxed)
from other taxable DOMESTIC corporations:
- reported fully in gross income
- dividends received deductions this is to avoid triple taxation on dividends.
how are dividend received deductions calculated? this is special deduction
**less than 20% of ownership in the corporation = 70% deduction and you get taxed on 30% of the amount
This is called and UN-AFFILIATED COMPANY
**greater than or equal to 20% but less than 80% = 80% deduction and 20% will be taxed. so multiply the amount by 20%.
**greater than 80% or equal to =100%; it is considered control of the company and all 100% of dividends received are deductible. They may also file a consolidated tax return and eliminate inter-company dividends which will give the same effect as 100% deductions.
**exception to the dividend deduction rules is if the dividend reduction is $70 or greater before taxable income before the dividend reduction is $80 but less than dividend of $100 then the dividend is limited to $80x70% = $56)
what is the rare limitation related to dividend deductions rules?
rare limitation is that the amount of DRD applicable to investments that qualify for the 70% or 80% DRD. This limitation applies when the income before DRD is less than the amount of the dividend itself, but not lower than the dividend multiplied by the applicable percentage. in these cases, the DRD % is applied to income before the DRD instead of the dividend itself.
basically if your DRD is less than your taxable income and your taxable income is LESS THAN THE DIVIDEND you are only going to get 70% OF THE TAXABLE INCOME MEANS THAT YOU CAN DEDUCT 70% OF THE TAXABLE INCOME AND 30% OF THE INCOME IS TAXED.
how are charitable contributions treated under a c-corp? THIS IS CONSIDERED A SPECIAL DEDUCTIONS
- they are claimed after all others deductions EXCEPT for “special deductions”
- they are limited to 10% of income before claiming deduction (meaning the adjusted taxable income ATI- ADJUSTED TAXABLE INCOME IS NET INCOME ADJUSTED BACK FOR CHARITY, DIVIDEND RECEIVED DEDUCTION, ANY KIND OF NET OPERATION LOSS CARRYBACK OR ANY KIND OF CAPITAL LOSS THIS WILL GIVE THE INCOME BEFORE SPECIAL DEDUCTION)
- unused amount can be carried forward 5 years
- a pledge may be accrued if paid within 2&1/2 months of year end (MARCH 15)
what is the adjusted taxable income (ATI) for a c-corp?
Net Income adjusted for the following:
- Charity
- Dividend Reduction
- Capital loss carryback
what are the charitable contribution rules for INDIVIDUALS?
- Maximum deductions are are 50% of AGI
- Unused portion forward 5 years
what is the summary for charitable contributions?
Gross Income
-Ordinary deductions
=Income B4 Special deductions (ATI; adjusted taxable income)
-Charity (limited to 10% of ATI WHICH IS BEFORE THE SPECIAL DEDUCTIONS MULTIPLIED BY 10%)
-Dividend Reduction
=TAXABLE INCOME
how are capital gains & losses handled for a c-corp?
when a corporation sells assets that are held for investment, the difference between the tax bases and proceeds from sale are recognized as capital gains and losses.
- if the assets are held for one year or less, gains and losses are treated as ordinary income or losses
- if the assets are held for more than one year, losses are treated as ordinary losses which are offset by gains, losses are not deductible to a corporation and gains are treated as long-term capital gains
what are the rules for losses for c-corps
- may only offset capital gains per IRC 1211 (No net Cap. Loss)
- unused carried back 3 years and forward 5 years
- all loss carrybacks and carryforwards are considered short term
-Net Operating Losses are carried back 2 years (amend the return in the prior two years to offset some gains in the 2 prior years) and forward 20 years.
how are capital losses for individuals treated?
-can claim up to 3,000 per year & the rest can be carried forward indefinitely.
what are non-deductible items for a c-corp?
- federal income taxes (these are treated as offsets against the federal tax owed, and not as deductions. state and local taxes are fully deductible on a normal accrual accounting basis)
- government fines and penalties (since the intention of these are punishment, no deduction is allowed even though such penalties may appear to be in the form of interest)
- cost of issuing stock (these are treated as adjusted to the proceeds from sale)
- lobbying cost (corporations are discouraged from political involvement and may claim no costs associated with influencing candidates and legislation)
- compensation (over 1 million to the top executive officers of a public corporation; however pay to other employees is unlimited
- club dues (these are considered too personal in nature to qualify as business expenses)
- meals and entertainment are considered to have personal as well as business elements so only 50% of these cost are deductible.
- no estimates of bad debts (are only deductible at the time individual debts are written off. allowance approach is NOT permitted
- no estimated warranty expenses (the actual cost of repairs and replacements of products under warranty are deductible when costs are incurred)
- no estimated lawsuit costs (losses may not be deducted until paid. the tax code does not permit the deduction of losses just because they are probable and estimate.)
- no marketable securities changes; changes in the market value are not reported on the tax return. gains and losses are only recognized at the time of sale
- no inventory valuation declines are deductible until disposal of the inventory takes place.
what is the formula for the foreign tax credit for c-corporations?
u.s. tax liability x (foreign country income/worldwide income or total income) = foreign tax credit
** foreign tax credit is to never exceed actual foreign taxes actually paid. it is the lesser of the tax liability due or taxes paid in the foreign country
what is the foreign tax credit?
a credit available to US Corporations for income taxes paid to foreign countries on income that is also reported on the U.S. return. The credit is limited to the portion of the U.S. gross tax that applies that the income on which the foreign tax was assessed. the excess can be carried back one year or carried forward 10 years
**A corporation may elect to claim the entire amount of foreign taxes as a deduction from taxable income instead of claiming the credit.
when a corporation has an unused net capital loss that is carried back or carried forward to another tax year?
it is treated as a short-term capital loss whether or not it was short-term when sustained.
what is the accumulated earnings tax (AET) penalty tax?
a penalization of corporations that accumulate earnings beyond the reasonable needs for expansion, retirement of debt and working capital needs. they are taxed at the capital gains rate 20% on this money. So the corp pays corporate tax + 20%.
- allows certain amounts to be retained for the following:
- ***$250,000 for manufacturing co + the federal taxes due (only $150,000 for personal service corporations like health services, law services, accounting services, consulting services etc + the federal tax liability)
- **additional sums retained for the purpose of paying federal income taxes.
- ***retained earnings appropriated is money “reserved for” schedule must be attached to say what the funds are reserved for
NOTE: The sum of these two amounts is known as the minimum accumulated earnings credit.
what criteria does the IRS use to decided whether they will assess the accumulated earnings tax?
- excessive retained earnings in the judgement of the IRS
- not self assessed (by an audit) so the IRS looks at the audited financial statements and determines what the retained earnings should be by what is appropriated and whats not appropriated for the business. they look at the unappropriated amount and makes sure it is not over a set amount. anything over the set amount is taxed at 20%
- tax on unidistributed income only (20% rate)
Note: the tax can be reduced or eliminated if any of the following are paid:
- *actual dividend
- *consent dividend which is a hypothetical dividends you pay taxes on, even though no money was actually received. So this means that the shareholder agrees to pay the tax for the dividend hypothetically received.
- *if already paid PHC tax
what does the safe harbor allow?
- allows certain amounts to be retained for the following:
- ***$250,000 for manufacturing co + the federal taxes due (only $150,000 for personal service corporations like health services, law services, accounting services, consulting services etc + the current federal tax liability)
- **additional sums retained for the purpose of paying federal income taxes.
NOTE: The sum of these two amounts is known as the minimum accumulated earnings credit.
what is the personal holding company tax (PHC)?
it is to discourage the sheltering of certain types of passive income in corporations if both of the following apply:
1) 5 or fewer individuals own more than 50% of stock
2) 60% or more of revenue from passive income sources (taxable interest, dividends, rental & royalty income; it is where you sit back and watch your money grow i.e. not working for it)
* **tax on undistributed personal holding company income (UPHCI) only (20% rate)
* ***self assessed by filing form with return (1120 PHC)
Note: It can be avoided if you actually pay dividends or have a consent dividend (a hypothetical dividend) So you can avoid getting hit with the PHC tax by doing this.
why was the personal holding company tax created?
to prevent individuals in high individual tax brackets from establishing corporations to hold their personal investments and benefit from lower c orporate tax rates on income. the tax only applies to UNDISTRIBUTED INCOME of the corporation after deducting corporate taxes and net long-term capital gains to arrive at UPHCI, and the tax can be reduced or eliminated by sufficient dividend distributions. This results in individual shareholders paying taxes on the dividends received.
