Accounting 6073
Fall, 2010

Lesson 1: Introduction/Definition of a Corporation

I.  Historical Roots of the Corporate Income Tax

	A.  Congress has taxed corporate income since 1909 (4 years before amend XVI)
		1.  Tax was based on “privilege of doing business in a corporate capacity”
		2.  1% of net income over $5000.
		3.  Held not unconstitutional direct tax
4.  Amd XVI, revenue act of 1913 tax income “from whatever source derived.”

	B.  The term corporation: 7701(a)(3)-includes associations and joint stock companies.
		1.  Includes some entities that are not corps under state law.
		2.  Corporate tax not imposed on some state law corps (e.g. S corps)

C.  Corporate tax is similar to individual income tax in that it is computed with reference to the corporation’s accounting method, accounting period, gross income, deductions, credits.

	1.  Difficult corporate issues arise because of:
			a. Double taxation of distributions to shareholders.
	b. Computation of gain/loss on distributions and exchanges with respect to stock.
	c. Disguised dividends.
	d. Arms length issues on transactions b/w corp. and shareholders

II.  The Corporation as an Entity

	A.  In general, the law treats corporations as a separate entity, thus:
		1.  Corp pays tax in its own right, even if its stock owned by 1 person.
		2.  Corp’s tax year continues, even if stock changes hands.
		3.  Contrast proprietorship and flow through entity.

	B.  But exceptions to strict entity status:  Moline Properties (319 US 436 (1943)

In general a corporation will not be disregarded as an entity separate from its shareholders so long as its purpose for being organized “is the equivalent of business activity or is followed by the carrying on of business by the corporation.” (Tax avoidance is not a business purpose)

	If falls short of this standard, IRS may try to disregard as a sham.

D.  In addition, other code provisions sometimes modify the corporation’s separate entity status:

	1.  “Related party” provisions in the code (e.g. 267, 453, 1239, 7872).
		2.  Attribution rules 
	3.  Code provisions limit benefits aimed solely at corps, depends on s/hs: e.g.
			a. 269-control of corp. for principal purpose of tax avoidance.
	b. 302(d), 304-rechar certain stock sales as dividends w/ related parties
		c. 382, 383, 384 limit c/o of NOLs when ownership shifts in certain ways.
	d. 401(a)(4)-qualified plans must not discriminate in favor of shareholders.
			e. 531, 541 taxes on accumulated earnings & personal holding co.

		4.  Broad principles of taxation that may apply
			a. Assignment of income doctrine
			b. Substance over form-e. g. loan” by corp. to s/h. 
			c. business purpose (must be more than tax avoidance)
	d. Step transaction-view transaction as dynamic whole for tax purposes.			
e. Section 482-IRS may allocate income, deductions, credits between businesses “controlled by same interests.”
	f. Sec 446-taxpayer’s accounting method must “clearly reflect income.”

III. Definition of A Corporation

A.  Statute:  7701(a)(3) IRC:  Corporation includes associations and joint stock companies.

	B.  Associations in general
		1.  Case law background:
			a.  Morrissey v CIR (296 US 344) (1935): court took approach of comparing characteristics of entity under examination with characteristics of “typical” corporations.

b.  Typical characteristics (7):
	i. associates
	ii. objective to carry on a t or b
	iii. continuity of life
	iv. centralized management
	v. limited liability
	vi. free transferability of ownership interest
	vii. holding title to property as an entity

		2.  Old regulations (1960-1996) adopted 6 of these 7, and the formula:
a.  an unincorporated association was not classified as a corp. unless it had more corporate characteristics than non corporate characteristics.

b.  incorporated associations were automatically classified as corporations.

c. In evaluating the status of an unincorporated association under the old regs., one considers only points of difference between corporate and non corporate organizations (e.g. a partnership has associates and a profit motive, so these factors wouldn’t be considered in the evaluation.)

			d. Factors all given equal weight in this analysis.

		3.  In practice, these factors were the most analyzed:

a. Continuity of life -present unless death, insanity, bankruptcy, removal or withdrawal of any member of the organization would cause dissolution.

			b. Centralized management in rep capacity-management decision making power concentrated in a group composed of less than all members-these have the authority to act on behalf of the organization independently of its members.

			c. Limited Liability -owners not liable for corporate debts except to extent of equity investment.  Not present if creditors could seek satisfaction against any individual member.

			d. Free transferability - present if principal owners can assign their interest without the consent of the other members. (Must not be a dissolution under local law).  Right of first refusal for other shareholders gives this factor less weight.

		4.  This formula repealed in 1996, replaced with elective status regime.

C. Current law allows a “status election” for unincorporated businesses:  The “Check the Box” regulations)

		1.  Initial questions:
			a. First question: is there an entity separate from owners?
			b. Second:  If so, is the entity a “trust?”
			c. Third: if not a trust, because a “business entity, (because it has associates and a profit motive), then one of two consequences:”

				-Per Se corporation in certain cases (domestic corps, banks, and insurance companies).
				
				-Thus, if entity is a Texas corporation, cannot elect status.

				-if not, eligible entity which can elect status.

		2.  If eligible entity:
			a. With multiple members, may elect partnership or corp.
			b. With a single member, may elect corp., proprietorship or division
			c. If fail to elect
				-domestic entities: 
					--p/s if multiple members
					--sole prop if one member (bias toward conduit)
				-foreign entities:
					-- corp. if all members have ltd liability.
					-- p/s if not, 
					--sole prop if single member w/o ltd liability.
		3.  Change of form under new rules:
			a. Corp to non corp.-complete liquidation
			b. Non corp. to corp.-section 351

IV.	Other Entities as “Associations”—They Can Be Taxed as Corporations in Some Cases

A.	Trusts:
1.	Share some characteristics in common with corporations (central mgt, ltd liability, continuity of life, free transferability)
2.	Distinguished by presence/absence of associates and profit motive
3.	Ordinary trust=protect and conserve prop for beneficiaries who accept benefit
4.	Business trust-device to carry on activity normally carried on by corp. or p/s
a.	power to diversify? (e.g. investment trust)-may be taxed as a corporation.
b.	liquidating trust-not business trust if activities consistent w/winding up.

B.	Partnerships:
1.	Shares common characteristics with corp.:  (associates and profit motive)
2.	Distinguished by presence/absence of 4 factors under old regulations
3.	But now, eligible entities that may elect their status (see above)
4.	But certain “publicly traded” may not be eligible to elect their status.  They may be taxed as corporations.  See Code Section 7704:

C.	LLCs 
1.	 Not corporation, but owners have limited liability.

2.	Under old regulations-either P/S or corp. depending on terms			of organizing agmt (See Rev Rul 93-38).

3.	But now-eligible entity that may elect status

4.	Most multiple member LLCs taxed as P/S, as this is default rule 		under CTB regulations.

5.	LLCs have broad appeal:
a.	those who don’t qualify for S
b.	those who want to include entity debt in their basis
c.	avoid limits on mgt participation in Ltd PS
d.	but publicly traded LLCs may be classified as corps-7704 IRC.

D.	Personal service corps—
1.	IRS may try to disregard if earnings due to shareholder services.
2.	Little incentive for Prof/Pers Service C corps today because the top corporate and individual rates are the same.
3.	But these may come back into vogue if individual rates rise as predicted.
		
	E.  Nominee and dummy corps.  
1.  Corporations are taxed on their income and loss unless they are agent/nominee for another.  In such a case, the principal is taxed on the income earned by the nominee. 

2.  A nominee corporation must establish itself as agent by evidence other than s/h ctl. 
	(National Carbide (1949)-six factors)  

3.  Bollinger (1988) reaffirms Natl. Carbide, but uses 3 factors
	a. written agreement
	b. functions as agent
	c. held out to others as agent