Chapter 11

1. Chapter 11 Corporate Income Tax Income Tax Fundamentals 2007 Gerald E. Whittenburg & Martha Altus-Buller

2. Corporate Tax Rates • Corporate rates are progressive, from 15% to 39%, depending on taxable income • For corporations with large income (more than $18.33 million) • The rate is a flat 34% • Accomplished by ‘tax bubbles’ • Occurs when tax rate schedules recaptures savings from prior brackets • Qualified personal service corps taxed at flat 35% • Architects, CPAs, consultants, etc.

3. Corporate Capital Gains • A corporation can choose from two alternative tax treatments on capital gains • Taxed at ordinary rates, or • Elect to pay an alternative tax (35%) on net long-term capital gain [LTCG] • Essentially equivalent to maximum regular corporate tax [no benefit to LTCG] • No difference in tax on ordinary vs. capital income

4. Dividends Received Deduction • Corporations are allowed a deduction for a % of the dividends received from other corporations • Attempt to alleviate triple taxation • Dividends received deduction [DRD] is allowed • Percentage ownership • in corporation paying dividends DRD % • < 20% 70% • 20% or more, less than 80% 80% • > 80% 100% • Deductions limited by % and other items

5. Amortization of Organizational Expenditures • Examples of organizational expenditures • Legal/accounting services incident to organization • Incorporation fees • Expenses involved in transferring assets to the corporation are not considered organizational expenses • These fees are capitalized and then amortized over 180 months, also • Can make election to deduct up to $5,000 of organization costs in year corporation begins business • $5,000 amount is reduced $1 for each $1 that organization expenses exceed $50,000

6. Reconciliation of Tax to Book Income: Schedule M-1 • Schedule M-1 of Form 1120 reconciles book to tax income • Computed before NOLs and special deductions • Amounts added to book income • Federal tax expense • Capital losses • Income recorded on tax return but not on books • Expenses recorded on books but not on tax return • Amounts deducted from book income • Income recorded on books but not on tax return • Expenses recorded on tax return but not on books

7. S Corporations • Certain corporations may elect to be taxed in a manner similar to partnerships • Qualified small business corporation may elect S Corporation status if: • Operates as a domestic corporation • Has 100 or fewer shareholders • Shareholders may not be corporations or partnerships • Has only one class of stock • Has only shareholders that are US citizens or resident aliens • Corporation must make election of S status in a prior year • Or within 2-1/2 months of the current tax year

8. Income Reporting • Must report all elements of income and expense separately on Form 1120S • Then each shareholder reports his/her share of these items of corporate income/expense on personal return • K-1 takes total shareholder income/expenses and allocates each item to each shareholder based upon his/her ownership percentage

9. Loss Reporting • Each shareholder of an S Corp may also report his/her respective share of loss • Cannot take a loss in excess of adjusted basis in stock • If loss exceeds adjusted basis in stock plus loans, shareholder can carry it forward • If shareholder entered/departed S Corp midyear, must allocate items of income/loss on a daily basis

10. Shareholder Basis in Stock • A shareholder’s initial basis in his/her stock is calculated as follows: Basis of property transferred Less Boot received Plus Gain recognized Less Liabilities transferred Basis in stock • The corporation has a carry-over basis in the property contributed equal to the basis in the hands of the shareholder, increased by any gain recognized by shareholder on the transfer