Principles of Taxation

1. Principles of Taxation Chapter 10 The Corporate Taxpayer

2. The Corporate Taxpayer • Schedule M-1 reconciliation • Regular tax, credits, AMT • Payment and filing requirements • Double taxation • Tax incidence • Legal characteristics • Dividends-received deduction

3. Corporation Legal Characteristics • Limited liability of shareholders • How do owners of small business often become liable? • Unlimited life (compare to partnerships?) • Free transferability • How is this limited for closely held businesses? • Centralized management

4. Affiliated Groups and Consolidations. • Parent + all >= _____% subsidiaries. Do foreign subs qualify? • Is a consolidated return required? • What is the tax advantage to consolidated filing? • Like financial accounting, intercompany transactions are eliminated.

5. Nonprofit Corporations • Section 501(c)(3) organizations require IRS recognition of tax-exempt status. • Nevertheless, tax-exempt organizations may pay tax on what activity? • Thinking question: What types of business activities do tax-exempt organizations do that put them in competition with for-profit taxpayers?

6. Computing Corporate Taxable Income • Page 1 of the Form 1120 resembles a financial income statement or a Schedule C in a personal tax return (Ch 9). • Use chapters 5, 6, 7 and 8 for general rules on business income. • Other rules: • Deduct only ____% of meals and entertainment expenses. • Deduct charitable contributions up to ___% of taxable income BEFORE what deductions?

7. Dividends-Received Deduction • Ownership Deduction • < 20% of stock _____% DRD • 20%<= own < 80% _____% DRD • 80%<= own _____% DRD • Reason for DRD? • Additional details: DRD can’t create loss - tricky computations not in this text.

8. Book versus Taxable Income - Schedule M-1 • This schedule reconciles book income to taxable income. • Net book income - line ___. • Federal tax expense for books - line ____. • Lines ______ explain increases in taxable income relative to books. • Lines ______ explain decreases in taxable income relative to books. • Line 10 = taxable income before NOLD and DRD = line ____ of form 1120. • Try problem AP7.

9. Book versus Taxable Income - Schedule M-1 • Book-tax differences are scrutinized by IRS. Mills (1998 Journal of Accounting Research) shows that IRS audit adjustments are related to M-1 difference). • The Schedule M-1 contains permanent and temporary items. • The tax footnote in the financial statement contains numerous estimates of amounts that are finalized by the time the return is filed. Thus, Schedule M-1 will not exactly = amounts in F/S footnotes.

10. Computing Regular Tax • What do the surtax rates of 39% and 38% do? • Corporations with taxable income > $_______ million just pay a flat rate of 35% on all income. • Personal service corporations are taxed at a flat ____% rate.

11. Tax Credits • Why are credits better than deductions? • Tax credits are generally limited to some % of tax before credits. Often a provision permits carry back or carry forward of excess credits. • Biggest credits: R&D credit, foreign tax credit (see Chapter 12).

12. Alternative Minimum Tax - Who is Subject? • New corporation exempt in year 1. • Exempt in year 2 if year 1 sales <=$___ million. • Exempt in year 3 if average (sales1+sales2) <= $___ million. • Exempt in subsequent years if average gross receipts for _____ prior years <= $7 million. • Once corporation fails to be exempt, it is ineligible for AMT exemption for all subsequent tax years.

13. AMT Exemption Example • In which of the following years is the corporation exempt from AMT? • Year 1 sales = $4 million • Year 2 sales = $8 million • Year 3 sales = $10 million • Year 4 sales = $2 million • Subject to AMT all subsequent years.

14. Alternative Minimum Tax - Overview • 20% of income under an alternative definition of taxable income that has fewer loopholes. • Alternative minimum taxable income (See next slide.) • less (exemption) • = AMTI in excess of exemption • x 20% • Tentative minimum tax (TMT) • less (regular tax) • Alternative minimum tax (AMT)

15. Computing AMTI • Start with regular taxable income • Adjustments and preferences include: • Other differences between book and taxable income may create adjustments.

16. AMT - More Details • Exemption = $________ - 25% (AMTI - $__________). • Minimum tax credit • In future year(s), when regular tax exceeds TMT, corporation may subtract a credit equal to prior year(s) AMT. Can’t reduce regular tax below what? • See AP16 for a nice example.

17. Payment and Filing Requirements • Tax return due 15th day of ___ month, may extend to 15th day of ____th month. • Estimated payments are due on the 15th day of __th, __th, __th, and __th months. • Must pay 100% of tax due. (What is the safe harbor rule for small corporations?) • Underpayment penalty is computed like interest expense but is nondeductible.

18. Distributions to Investors • Consider interest, dividends and wages: • Which payments are deductible to the corporation? • When are payments on stock treated as taxable dividends? • Payments in excess of earnings and profits are first a return of capital and then a gain to the shareholder.

19. Distributions to Investors • Why do corporations pay dividends? (This is still a puzzle.) • Investors may prefer that the corporation keep the funds and reinvest them; sell stock for a capital gain in future. • Double taxation unlikely to change in near future. • Many corporations borrow money because interest expense is deductible.

20. Incidence of the Corporate Tax • Corporations do not pay taxes - people do. • What are examples of ways that the incidence of the corporate tax could be born by individual taxpayers in the U.S.?