Chapter 8. Consolidations and related topics C11-Chp-08-1 ...

1. 1 Chapter 8. Consolidations and related topicsC11-Chp-08-1-Consol-Tax-Acctg-2011.PPTHoward Godfrey, Ph.D., CPAProfessor of Accounting Copyright Howard Godfrey, 2011.

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3. 3 What is a controlled group? What are tax consequences of being a controlled group? (Sec. 1561, 1563)

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6. 6 Controlled Groups of Corporations. Special tax rules apply to corps that are under common control to prevent them from being used to avoid taxes that would otherwise be due. A. Why Special Rules Are Needed. Multiple corporations could be used to avoid having corporate income taxed at a 35% rate. The entire group of corporations must share the benefits of the progressive tax rate schedule and pay any surcharge on the combined taxable income of the group. B. What Is a Controlled Group? A controlled group is a group of two or more corporations that are owned directly or indirectly by the same shareholder or group of shareholders.

7. 7 Parent-Subsidiary Controlled Groups. A parent-subsidiary controlled group is a group of two or more corporations where one corporation (the parent) owns directly at least 80% of the voting power of all classes of voting stock, or 80% of the total value of all classes of stock of a second corporation. There can be more than one subsidiary in the group. If the parent and/or a subsidiary own in total 80% of the voting power of all classes of voting stock, or 80% of the total value of all classes of stock of another corporation, that corporation is included in the controlled group.

8. 8 Determine whether a group of corporations is a brother-sister group.

9. 9 Brother-Sister Controlled Groups. A group of two or more corporations is a brother-sister controlled group if five or fewer individuals, trusts, or estates own (1) At least 80% of the voting power of all classes of voting stock (or at least 80% of the total value of the outstanding stock) of each corporation, and (2) more than 50% of the voting power of all classes of stock (or more than 50% of the total value of the outstanding stock) of each corporation, taking into account only the stock ownership that each person has that is common with respect to each corporation. A shareholder's common ownership is the percentage of stock the shareholder owns that is common or identical in each of the corporations.

10. 10 Brother-Sister Controlled Groups. A second definition of a brother-sister group is a broader definition. Under the 50% definition, five or fewer shareholders must satisfy only the 50% common ownership test described above. Where the 50% only definition applies, more corporations may be pulled into the controlled group than under the 50%-80% definition.

11. 11 Controlled groups must apportion lower tax rates to members of group Parent-subsidiary group � 2 or more corporations with a common parent Parent directly owns 80% of stock of at least one sub. 80% or more of stock of additional subs must be jointly or separately owned of all other corporations by parent and subsidiaries Brother-sister group 2 or more corps have 80% of more of each corp�s stock owned by 5 or few individuals and sum of lowest common ownership of each shareholder is 50% or more.

12. 12 Brother-Sister-AJCA-1 Unrelated Individuals A, B, C and D own some corporations in the percentages listed on the next slide. Each corporation has taxable income of $50,000. How is the income tax computed for each corporation?

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15. 15 In preceding slide, Corps B, C, and D meet both the 80% test and the 50% test under old law. Current law (e.g. tax rates) eliminates the 80% test for many purposes. See Corp. A on preceding slide. Sec. 1563(a)(2) vs. 1563(f)(5)

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18. 18 Brother-Sister-AJCA-3 A brother-sister controlled group means two or more corporations if five or fewer persons who are individuals, estates or trusts own (or constructively own) stock possessing (1) at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total value of all stock, and�

19. 19 Brother-Sister-AJCA-4 (2) more than 50 percent of percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of all stock, taking into account the stock ownership of each person only to the extent the stock ownership is identical with respect to each corporation.

20. 20 Brother-Sister-AJCA-5 � Reasons� Committee is concerned that taxpayers may be able to obtain benefits, such as multiple lower-bracket corporate tax rates, through the use of corporations that are effectively under common control even though the 80% test of present law is not satisfied. Committee believes it is appropriate to eliminate the 80% test for purposes of the currently effective provisions under sec. 1561 (corporate tax brackets, the accumulated earnings credit, and the minimum tax.)

21. 21 Brother-Sister-AJCA-6 Explanation of Provision Under the provision, a brother-sister controlled group means two or more corporations if five or fewer persons who are individuals, estates or trusts own (or constructively own) stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or more than 50 percent of the total value of all stock, taking into account the stock ownership of each person only to the extent the stock ownership is identical with respect to each corporation.

22. 22 Brother-Sister-AJCA-7 Explanation of Provision The provision applies only for purposes of section 1561, currently relating to corporate tax brackets, the accumulated earnings credit, and the minimum tax. The provision does not affect other Code sections or other provisions that utilize or refer to the section 1563 brother-sister corporation controlled group test for other purposes.

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24. 24 Election to Allocate Reduced Tax Rates. A controlled group may elect to apportion the tax benefits of the 15%, 25% and 34% tax rates to the member corporations in any manner that it chooses. If no special apportionment plan is elected, the $50,000, $25,000, and $9,925,000 amounts allocated to the 15%, 25%, and 34% tax rate brackets are divided equally among all the corporations in the group.

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26. 26 Combined Controlled Groups. A controlled group is a group of three or more corporations that are members of the above groups where one is a parent corporation of a parent-subsidiary controlled group and a member of a brother-sister controlled group.

27. 27 Determine whether a group of corps can file a consolidated return. Pg. 12

28. 28 Source of Consolidated Return Rules Code Secs. 1501 through 1504 are the primary statutory provisions governing the filing of consolidated tax returns. The statute is very general and primarily defines the composition of affiliated groups that are eligible to elect to file a consolidated tax return. Regulations provide the guidance needed to file consolidated tax returns.

29. 29 II. Definition of an Affiliated Group 1. Only an affiliated group of corporations can elect to file a consolidated return. Stock ownership requirements are: (1) a parent must directly own stock having at least 80% of the total voting power of all classes of stock entitled to vote and at least 80% of the total value of all outstanding stock in at least one includible corporation; (2) for each other corp eligible to be included in the affiliated group, stock having at least 80% of the total voting power of all classes of stock entitled to vote and at least 80% of the total value of all outstanding stock must be owned directly by the parent & other group members

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33. 33 Comparison with Controlled Group Definition. There are three types of controlled groups: brother-sister groups, parent-subsidiary groups, and combined groups Brother-sister groups cannot file a consolidated tax return. Parent-subsidiary groups and the parent-subsidiary portion of combined controlled group can elect to file a consolidated tax return. Difference Between Definitions. Only affiliated groups can elect to file consolidated tax returns. Four differences between the definitions of Sec. 1504 and Sec. 1563 (parent-sub controlled group) do exist. These differences cause some members of a controlled group to be excluded from the affiliated group.

34. 34 Consolidated Tax Returns. Most parent-subsidiary controlled groups are eligible to file a consolidated return. An election is made to file a consolidated tax return by combining all of the income and expenses of each member on a Form 1120. Each corporate member of the affiliated group must consent to the election. For brother-sister corporations, the broader 50% only definition applies for limiting the reduced tax rates.

35. 35 Advantages of Consolidations What advantages to you see on the next slide for filing a consolidated income tax return?

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37. 37 Consolidated Returns Affiliated group � parent corporation must own directly 80% or more of subsidiary�s stock (by voting and value) Can include more than 2 corporations if 80% of stock owned by one or more corporations that are part of affiliated group Consolidated return reports combined results of operations of all corporations in the group All subs must consent and must have or change to same tax year as parent.

38. 38 Consolidated Net Income Affiliated corporations viewed as divisions of parent requiring modification for deferred intercompany transactions and intercompany dividends Items subject to limitations and netting are determined on a consolidated basis. Capital gains and losses Section 1231 gains and losses Charitable contributions deductions

39. 39 Consolidated Tax Returns Advantages Intercompany dividends are eliminated from gross income Gains on intercompany transactions are eliminated Deductions subject to limitation may be allowed when consolidated

40. 40 Consol. Returns Advantages- Cont�d Losses of one corporation can offset gains of another Income from one corporation can offset losses of another Limitations based on consolidated income permit greater use of deductions or credits

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44. 44 Intercompany Transactions An intercompany transaction takes place during a consolidated return year between corporations that are members of the same group immediately after the transaction. Property Transactions. In general, gains and losses on intercompany transactions involving the sale or exchange of property between two group members are recognized in calculating the group member's separate taxable income. Recognized gain or loss (an intercompany item) is deferred until a corresponding item Corresponding items that can trigger the recognition of an intercompany item include sale of the property outside the group.

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47. 47 Remainder of this file is optional review of some important concepts already covered in this course- concepts that often are now well understood

48. 48 Reconciling taxable income and book income. Also, accounting for income taxes.

49. 49 An accrual basis Big Manufacturing Corporation had federal taxable income of $20,000 during its first year of operations. In the computation of taxable income, the corporation made the appropriate adjustment related to its total entertainment expense of $2,000 for the year. Big is subject to the normal tax rates applicable to corporations, and does not qualify for credits. Do not consider any penalty for underpayment of estimated tax. What is the balance to be shown on line 8 of Schedule M-2 on Form 1120? a. $19,000 b. $18,000 c. $17,000 d. $16,000 e. None of these

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63. Realty Corp. Rental Income-Slide 1 Realty Co. was organized on Jan-1, year 1. Realty bought a building on that date for $400,000, having an estimated 40-year life with no salvage. The S/L depreciation method is used for tax & GAAP. Depreciation is $10,000 per year on the tax return and in the GAAP statements. Realty rented the building to IBM for 2 years at $20,000 per year. Rent of $40,000 was received on Jan-1, year 1. Realty�s income tax rate is 40%. Year 1 operations are described on the next slide.

67. 67 Turtle Co. Slide 1 of 3 Turtle Co. bought equipment on Jan-1 year 1, for $50,000. The equipment had an estimated 5-year service life and no expected salvage value. Turtle uses the 200% double-declining depreciation method. What is accumulated depreciation at the end of year 2? a. $30,000 b. $32,000 c. $39,200 d. $42,000

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74. See previous & following Bug Co. Slides Assuming the company starts operations on 12-1-06. The company had no revenue other than the revenue from this contract. The company has expenses of only $1,000 in December, 2006. What will the income statement look like? What will the company report as taxable income. (All income received in advance is generally subject to tax when received.) (40% tax bracket)

77. 77 The End