Accounting 6073
Fall, 2011

Lesson 2A: Corporate Income Tax (Overview)

I.  Corporate Tax rates
	A.  See p 5-4.  Self-explanatory
	B.  Note phase outs (100-335 K, 39% rate vs. 34, 15-18.333 M, 38% vs. 35)
	C.  AMT-if “economic” income of corp. substantially higher than “taxable”
	D.  Capital Gains-max 35% rate, CLs deducted only against CGs.
	E.  Environmental tax-repealed in 96 (may come back) very large corps.

II. Corporate Taxable Income
	A.  Like individuals, corps taxed on GI as defined by section 61.
	B.  Deductions
1.  Code presumes that all corp. transactions arise in its T or B. (profit 
	motive-is characteristic of association taxable as corp.).
		2.  Therefore, unlike individuals, corporations don't compute AGI or 				itemized deductions.
		3.  Not covered by profit motive presumption:
			a. charitable contributions
			b. transactions that serve s/h interest rather than corporation's	
	C.  But corporations may not deduct every expenditure currently
		1.  Rules restricting deductibility: 263A (UCC), 274 (t & e expense)
		2.  If a payment is a disguised dividend-(potential for dispute here).
		3.  For S corps, IRC 183 (no presumption of profit motive)

	D.  Corporate Capital Gains
		1.  Taxed at maximum rate of 35%
		2.  Capital Losses deductible only to extent of capital gains
		3.  Unused capital losses carry back three years, then forward five.

	E.  Corporate Charitable Contributions limited to 10% of taxable income before:
		1.  any charitable contributions
		2.  dividend received deduction
		3.  NOL carryback
		4.  domestic manufacturing deduction
		5.  capital loss carrybacks

	F.  Corporate AMT
		1. Equal to 20% of excess of AMTI over regular tax
		2.  AMTI is taxable income adjusted for certain preference items
		3.  Smaller corporations exempt (<7.5 million gross receipts 3 year ave.)

III. Undistributed Corporate Income
	A.  Because Code treats C corp. as separate entity-shareholders taxed only when
		1. Corp distributes earnings or
		2.  Shareholders sell their stock

	B. This can be an advantage
		1. If corporate tax rate < individual rate on bus profits 
			--(historically, much less, but not today).
		2. Individuals' CG pref results in lower tax if can convert bus profits to 				CG, especially if corporation’s assets are appreciating.
		3.  Step up in basis at death (but estate tax may be owed)
		4.  15 and 25% bracket for small corps.

	C.  Limits on these potential advantages
		1.  Limits on use of lower brackets w/ controlled group
		2.  482-reallocation to clearly reflect income of related entities.
		3.  531-accumulated earnings tax if accum for tax avoidance 
		4.  541 PHC tax-if principal function is collection of div, int, passive inc
		
IV. Distributed Corporate Income
A.  General rule is double taxation (show e.g. using 30% tax rate vs. sole prop)
	B.  Mitigate by distributing funds on a tax deductible basis:
	1.  Pay salaries to shareholder employees (must be reasonable-section 162)
		2.  Pay interest on s/h loans to corp.
		3.  Pay rent on buildings owned by s/h and used by corp.
		4.  Pay royalties on patent owned by s/h and licensed to corp.
		5.  Sell stock-see below

V.  Sale/Exchange of Corporate Stock & Securities
	A.  Generally produce capital gain or loss to shareholders
	B.  In some cases, CG may be deferred
		1.  Transfer of appreciated assets to newly formed corp.
		2.  Merger under 354-exch. stock of merged corp. for stock of survivor
	C.  Some “exchanges” (e.g. “redemption” in one person corp.) may be dividend.

VI. Planning in current regime (corp tax rate near individual, no corporate CG preference, 		but individual CG preference):
	A.  Extract funds from corporation on tax deductible basis
	B.  Elect S-if available
	C.  Partnership/LLC
	D.  Allow income to accumulate in corp. and sell stock for CG.
	E.  Watch out for provisions converting CG to OI
-may lose ability to offset basis--e. g. redemption treated as dividend. 

VII. Note that effect of certain provisions may vary with size of corporation:	
	A.  Rates
		1.  phase-out of lower regular rate, AMT exemption for “large” corp.
		2.  limited to one set of lower rates where mbr of ctld. group
		3.  lower rates denied completely where personal service corp.
	B. “Small” corp. may avoid AMT regime (< 7.5 M gross receipts 3 yr ave)
	C. “Small” corp. (< 5M gross receipts) exempt from accrual accounting.
	D. 263A and restrictive LTK rules N/A where receipts < 10 million.
	E.  In general, publicly traded corps cannot use anything but C corp. regime.

VIII. Accumulated Earnings Tax	
	A.  Historically, individual top rate 22 to 65 points higher than top corp. rate.	
	B.  Thus, incentives not to pay dividends, but to let income accumulate and:
		1.  Sell the stock at a CG
		2.  Exchange it in a tax free merger
		3.  Hold stock for transfer to heirs w/ stepped up basis
	
	C.  Since individual and corporate rates are similar now, the incentive is 				less, still AE tax is in the code.
	
	D.  Features of AE tax
		1.  Imposed on every corp. formed or availed of for the purpose of
			 avoiding the income tax with respect to its shareholders by allowing E&P to accumulate instead of being distributed.
		2.  If investment co, prima facia evidence of purpose to avoid.
		3.  If e&p accumulates beyond reasonable needs, rebuttable presumption
		4.  Tax not self-assessed, but arises on deficiency assessment
		5.  Tax is = to top individual rate on the amount deemed to be 	“accumulated taxable income”-it is triple taxed
		6.  Lifetime maximum exemption of 250K (150K for PSC )+ reasonable  			needs of business.

IX. Election Under Subchapter S:

	A.  Introduction
		1. Purpose: Allow businesses to select form free of undue tax influence.
		2. Rules have been liberalized since 1958 (increase # of shareholders)
3. Assuming corporate form is desirable vs. P/S or LLC, S-election is almost always advantageous if eligible to elect.

	B.  Once election is made
		1.  Corp income/loss pass thru to shareholders, distributed or not
		2.  Basis of stock incr for income taxed to s/h decrease for dists to s/h
		3.  S corp. subject to subchapter C for many important purposes.

	C.  Eligibility 
		1.  No more than 100 shareholders
			a. HW and their estates = one shareholder
			b. beneficial owner is s/h if stock held by nominee
			c. stock owned by p/s not imputed to partners (thus can’t elect S).

		2.  Types of shareholders
			a. individuals
			b. estates
			c. certain trusts (6 categories)
-basically grantor trusts, and trusts related to admin of estate, QSST and EBST see p 6-9.
			d. 501c3 may now hold stock of S corp.

		3.  One class of stock
			a. this is so income can easily be apportioned to s/hs.
			b. all shares must give identical rights to dist and liq proceeds 
c. right to dist/liq proceeds determined by ref to stock governing provisions…other agreements (e.g. lease) not relevant unless designed to circumvent one class of stock rule.
			d. Safe harbor for certain debt, even if considered equity for
			 other 	purposes, unless designed to avoid these rules (p. 6-12).

		4.  No non-resident alien shareholders (why?)

		5.  Not an ineligible corp.
			a. Corps with a corporate shareholder
			b. Before 1997, members of affil group.
			c. Financial Institutions, Insurance Companies
			d. Corps electing under 936
			e. Current or former DISC

X.  Subchapter S: Pass thru of Corporate Income and Loss to Shareholders

	A.  In general, corporate income is taxed to shareholders whether dist. or not
		1.  Income, loss, deduction, credit retain corporate level character
		2. Allocated to shareholders on a per share per day basis
		3.  Items treated by s/hs as attributable directly to source that generated

	B. Taxation of S corps-S Corps pay tax only in very limited circumstances
		1.  In general-IRC 1363(a)
			a. no tax except built in gains and excess P.I.I.
		i. B.I.G. tax:  to avoid C corporation with appreciated assets making S-election.

				ii. P.I.I. Tax:  if has C E&P & 25% P.I.

			b. But must still file annual information return
c. Income is divided between ordinary business income and separately stated items.

2.  Elections (e.g. depr, acc method) made at corporate level
		3.  Separately stated items treated as realized directly from their source.
		4.  Calendar year unless estab. bus purpose for diff yr. or make req. pmts.
		5.  Disputes re income of S corp. resolved at s/h level w/ ltd xcptns.

	C. Under IRC 1366(a) shareholders must take into account their share of 
		1.  Non-separately computed income/loss of corp.
		2.  Separately stated items that could affect liability of any shareholder
			(e.g. tax exempt income, LT, ST CG or L, contrib, foreign taxes, other items that may be limited on indiv. returns (e.g. N.I.I.).  

	D.  Basis adjustment to shareholder stock, debt
		1.  Stock-IRC 1367(a)(1)--
			a. Increase basis for income passed thru (=dist + recontrib to cap)
				contingent on inclusion in s/h gross income
			b. Reduce basis (not below 0) for corp. deductions & losses
			c. adjustments made on a per share per day basis
			d. Adj made at year end, unless s/h disposes of stock
					
		2.  Basis adjustment for Debt
			a. Once basis reduced to 0, additional losses generate reduction of 
				basis of shareholder loans to corp.
			b. No basis increase for guarantee of corp. debt unless s/h performs  (Contrast ltd P  who guarantees non-recourse debt).
			c. Basis restored by pos adj in subseq years, before incr in stk basis

		3.  If s/h losses exceed basis in stock and debt:
			a. no deduction on indiv return for excess
			b. Un-deducted losses c/o, can use when addtl basis is acquired

	E.  Distributions-usually received tax free
		1.  Reduces basis in stock
		2.  Excess of distributions over basis treated as gain on sale of stock
		3.  If former C corp. with e&p, rules are different.

	F.  See Examples pp 6-36, 6-37

XI. Subchapter S-Taxation of distributions

	A.  Key question: are there earnings and profits?
	
	B.  Sources of earnings and profits: (think of it as tax basis R/E)
		1.  C corp. before electing S status
		2.  S corp. before 1983
		3.  Inherit E&P via merger, spin off, split off, split up
		4.  S corp. income generally does NOT create e&p.

	C.  If no accumulated e&p, it’s simple
		1. Distributions excluded from s/h income up to basis of stock
		2. Excess, if any, treated as gain from sale or exch of capital asset.
3. Dist of appreciated prop triggers gain at corp. level-(311(b) IRC),
a. thus increase in s/h basis,
b. so distribution itself is tax free to s/h
c. but 311(b) gain will pass thru.

D.  If S-Corp has accumulated E&P, concern that former C corp. E&P could be distributed tax free to s/h, thus, 
		1. Accumulated adjustments account (AAA): 1368 (e)(1)-a record of adjustments for most recent sub S period after 1982).

2.  Practically speaking, AAA=S Corp’s cumulative income, less deductions, less tax free distributions.
	
		3.  3 tier system
			a. Tier 1-up to AAA, distributions tax free up to basis, then CG.
			b. Tier 2-dividend to extent of accumulated E&P.
			c. Tier 3-remainder is taxed same as Tier 1.

XII. Comparison among C and S corps and Partnerships
	A.  S corp. rules similar to subchapter K re: ordinary business operations
	B.  But they differ as to eligibility
	C.  Extraordinary S transactions bring subchapter C into play (e.g. distribution of 
		appreciated property, S Corp with E&P).
	D.  Key difference: get basis for entity debt in Sub K, not in Sub S.
	E.  See table p 6-79 thru 6-81 for comparison re: eligibility, election, treatment of 		entity and owners.