Chapter 2: C Corporations

How are meals and travel deducted?

-50% of meals if they are not lavish or extravagant and the taxpayer or an employee was present. -All out of town travel costs.

What is the purpose of section 1202 stock and how is it taxed?

-Allows capital gains from select qualified small business stock to be excluded from federal tax. -It provides an incentive for non-corporate taxpayers to invest in small businesses -The amount of gain excluded under Section 1202 is limited to a maximum of $10 million or 10 times the adjusted basis of the stock. Requirements: -Must have held the stock for 5 years Limited to the greater of: -10 times the basis in the stock -$10,000,000 limit reduced by any previous exclusions claimed on that stock

For Corporate Capital Gains and Losses, what is the rule for how they can be carried back and forward?

-Back 3 years and forward 5 -Net Capital Losses are not deductible -Corporations cannot use capital losses to offset ordinary income, but may offset them against capital gains.

When would an investor not qualify for a dividend received deduction?

-Dividends are from a foreign corporation -Used borrowed money b/c you already got interest expense deduction -Received on tax exempt investments -Owned less than 46 days

What is the purpose of section 1244 stock and how is it taxed?

-Meant to encourage investment in start up companies -So, tax code allows losses from the sale of small, domestic corporation stock that was sold directly to individual shareholders. Section 1244 allows a taxpayer to deduct losses on qualifying small business corporation stock as ordinary losses, rather than as capital losses. The amount is limited to $50,000 for a single taxpayer and $100,000 for a married couple filing jointly, but must be sold by the original purchaser (no heirs) in order to claim the deduction. These would be classified as ordinary income loss. Any remainder is deducted as a capital loss, subject to the $3,000 per year limitation. Note: if the 1244 stock is issued in exchange for property, then your basis for the 1244 stock is reduced to the lower amount of the property or stock. This is important when calculating gain/loss.

How is interest expense deducted?

-Not deductible on tax exempt investments. -Can deduct 30% of adjusted gross income.

Are dividends deductible?

-Reported fully in gross income, but... -Dividends Received Deduction (DRD) - Schedule C -The goal is to avoid triple taxation

What is true about how the IRS thinks of FIFO and LIFO methods of inventory?

-Same method must be used for financial reporting and tax purposes -If a company wants to switch, then the IRS must be notified and grant permission

When accumulated Earnings and Profits (E&P) is negative and a company has positive E&P for a year, how are cash dividends taxed?

-The dividend is only taxed up to the positive E&P for that year. Any excess is considered a return of capital -Example: $10k of positive E&P. -Accumulated E&P is negative $100k -Issue a $30k cash dividend -Only $10k of the $30k dividend is taxable. The other $20k is a return of capital.

Why does the government allow for the dividend received deduction?

-To avoid triple taxation! -To qualify for the deduction, the upper-tier must have held the stock for at least 46 days prior to the ex-dividend date. -S corporations may not claim DRDs because they are pass-through entities that do not create triple taxation

How are property distributions to shareholders taxed?

-Will result in a gain or sale -Losses are not deductible, except in liquidation of a company -No gain or loss when the subsidiary liquidates into the parent -Take the greater of the FMV or the Liability assumed -Shareholder is taxed at the FMV of distribution, not declared amount FMV-Basis=gain/loss

When a shareholder has contributed property to obtain stock, how is this valued? What if the shareholder contributes services?

1) FMV (if less than 80%) 2) Tax Basis (80% or more (control)) Services are not included in the definition of property, because the government thinks this is a barter. As a result, it would be taxable at the FMV of the stock.

What are the two factors that help determine when the tax payer will recognize income for property receive?

1) Increases my networth 2) I accept the property and exert control over it Then I realize it at FMV

What are the two types of Personal Holding Company dividend deductions?

1) Paid dividends 2) consent dividends Things to remember:When calculating the personal holding company (PHC) tax, a corporation is allowed a dividend deduction from undistributed PHC income. The types of dividends include those paid during the tax year, those paid on or before the 15th day of the 4th month after the tax year end, and consent dividends.

What are some examples of when a company reorganization would result in a tax-free status?

1) Reincorporate in a different state (NY to CA) 2) Mergers and consolidations 3) Absorptions of subsidiaries.

What is the basic taxation of a corporate liquidation?

A corporate liquidation is generally treated as the taxable sale of property to shareholders in exchange for their stock. However, if a liquidating corporation is at least 80% owned by another corporation, the transaction is a subsidiary liquidation, and no gain or loss is recognized. Otherwise, you'd take the FMV-basis to find out the taxable gain.

What's the difference between a foreign subsidiary and a foreign branch?

A foreign branch is another location of your company that operates entirely in another country. Think of it as an extension of your main office, similar to adding on an extension to your current office, but on a global scale. (subject to US federal income tax) A subsidiary, on the other hand, is a new business in a foreign country. It is considered a separate legal entity. (Not subject to US federal income tax).

What is it called when a corporation makes a dividend in excess of earnings and profits?

A return of capital to the shareholders. Preferred shareholders are always paid in full before common shareholders receive dividends.

When can you deduct expenses for a corporation?

All reasonable operating expenses can be deducted. This follows the matching principle like in GAAP. Can follow the accrual basis. -All events test: Measures the existence of a liability -Economic performance Test: Accrued items that are expected to be paid within 2.5 months after tax year end. May include: Wages, bonuses and vacation pay

Can a corporation elect to file a consolidated tax return, and what are the rules associated with consolidated returns?

An affiliated group of corporations may elect to file a consolidated return. An affiliated group is one or more corporations connected through stock ownership, with a common parent corporation owning at least 80% of the stock in at least one other includible corporation. The consolidated return is called an 1120 form. This will report the combined income, gains and losses. There cannot be any inter-company transactions

Is inventory considered an ordinary asset or a capital asset?

An ordinary asset, so its distribution (from a dividend) results in an ordinary gain or loss, not a capital gain/loss.

What's the difference between an ordinary loss and a capital loss?

An ordinary loss is fully deductible in the year of the loss. A capital loss is strictly offset against capital gains and limited to $3,000

How much can you deduct for business gifts?

Business gifts are deductible up to a maximum of $25 per recipient per year.

What type of organization has the most flexibility when choosing their accounting period?

C Corporations C corporations can choose to use a calendar year end, a fiscal year end, or a 52/53-week year end. These options are also available to S corporations, personal service corporations (PSCs), partnerships, and limited liability companies However, unlike a C corporation, these other entities must get permission from the IRS to opt for a year end other than the prescribed default year end

What are the tax year end periods for C Corps, S Corps, Parntership/LLC, and Trust/Estate?

C corporations may choose to use a calendar year end, a fiscal year end, or a 52/53-week year end. These options are also available to S corporations, personal service corporations (PSCs), partnerships, and limited liability companies. However, unlike C corporations, these other entities must get permission from the IRS to opt for a year end other than the prescribed default year end.

What's the difference between a C and S corporation?

C corps: -Pay taxes and will calculate taxable income (TI) by recognizing income and subtracting deductions. -Some amounts reported are based on rules specific to C corps (eg, deduct the lesser of charitable contributions made or 10% of TI before the deduction). S corps: -Are flow-through entities that do not pay taxes because their shareholders report entity income and deductions on their own tax returns. -Entity information is reported to shareholders as ordinary business income or separately stated items.

How do you calculate tax for a short period?

Corporate taxpayers occasionally have to calculate tax for a period shorter than 12 months (ie, a short period). This usually occurs because the taxpayer was not in existence for the entire year (eg, business formed or terminated) or because the taxpayer changed its annual accounting year end. To calculate the tax of a taxpayer for a short period, the taxpayer must first annualize its income and calculate the tax on that annualized income. The next step is to multiply the calculated tax by the number of months in the short period divided by 12. This process is necessary to ensure that the taxpayer's income is taxed in the higher brackets of a graduated tax rate system when those are in place. For example, if a corporation has $200,000 of income for 6 months, that income would be taxed at a lower rate in the graduated tax bracket than if it were not annualized. Annualizing the income pushes the taxable income into a higher tax bracket.

What are the tax consequences of a dividend distribution when the Company has positive E&P?

Dividend is taxed at the FMV (not basis) at the time of distribution.

How are 1231 gains and losses deducted?

Gains are capital and losses are ordinary

What are the rules around nontaxable exchange of property for stock?

Generally, an exchange of property for property is a sale, and the transferor recognizes gain or loss on the difference between the FMV of the property received and the basis of the property transferred. But, the exchange can be considered non-taxable if.. -the transferor exchanges cash or property solely for stock, and -the transferor or transferor group is in control (ie, owns at least 80%) of the corporation after the exchange Why? The "solely for stock" requirement provides nonrecognition because the transferor has continued investing in the transferred property as a shareholder. However, a transferor that also receives "boot" (ie, cash or property other than transferee stock) in effect partially sells the property and therefore must recognize in income the lesser of any realized gain or the FMV of boot received

What's the calculation for a 351 exchange, shareholder stock basis?

Generally, an exchange of property for property is taxable. Each transferor recognizes gain or loss on the difference between the FMV of the property received and the adjusted basis in the property transferred. However, an exchange of property for stock may qualify as nontaxable to the extent that: -a transferor exchanges property, including cash, solely for stock, and -the property transferor, or transferor group, controls the corporation immediately after the exchange (ie, owns at least 80% of the transferee corporation). In a nontaxable exchange, a transferor's basis in the stock received includes the amount of cash and the transferor's adjusted basis (not FMV) in the property transferred. Stock basis reflects property basis because the transferor's investment in the property continues through stock ownership.

When a company issues a non liquidating dividend (cash or property), when would they recognize a gain or loss?

Generally, corporations do not recognize gain or loss when making nonliquidating (ie, current) distributions to shareholders. However, if appreciated property is distributed, the distribution is treated as a hypothetical sale and the corporation must recognize gain equal to the excess of the property's FMV over adjusted basis. If the property's FMV is less than its basis, no loss is recognized, thus preventing any potential manipulation of gross income. If more than one item is distributed, each item is analyzed separately.

What is Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI), and what is the calculation for it?

Global Intangible Low-Taxed Income (GILTI) is a wide-ranging category of income designed to tax foreign income at a low rate immediately (rather than it being deferred). It applies to certain income generated by a controlled foreign corporation (CFC).

What is the concept of apportionment? Relates to state and local taxation

If an entity operates in more than one jurisdiction, it may be subject to income tax in more than one of those various jurisdictions. To avoid being taxed on the same income by multiple jurisdictions, business income is divided among the jurisdictions based on an apportionment formula that generally considers the ratio of the entity's property holdings, payroll, and sales in each jurisdiction compared to the entity's total property holdings, payroll, and sales, respectively.

When do you have a personal holding company PHC?

If an individual shareholder's income tax rate is higher than a corporation's rate, the corporation has incentive to accumulate, rather than distribute, earnings. To encourage distribution, a C corporation's accumulation of earnings may incur a penalty tax in addition to regular corporate income tax. The personal holding company (PHC) tax is aimed at undistributed passive and investment income.

What are the different types of reorganizations?

In a corporate reorganization, a security holder will not recognize a gain or loss when the stock or securities of a corporation that is involved in the reorganization are exchanged solely for stock or securities in the same corporation or another one that is part of the reorganization. Type A: mergers or consolidations Type B: Use of voting stock of the acquiring corporation to acquire at least 80% of the voting power and 80% of each class of nonvoting stock of the target corporation Type C: Use of voting stock to acquire substantially all of the target's net assets Type D: Transfer of assets by an acquiring corporation to acquire controlling interest in a target corporation Type E: Recapitalization to change the capital structure of a single corporation, non taxable Type F: Mere change of identity, form, or state of incorporation Type G: Transfer of assets of an insolvent corporation, including as part of bankruptcy proceedings, to former creditors

When should income be recognized?

In the year received or when cash is collected (like a prepayment)

How much in salary expenses can a company deduct?

Includes: Salaries, Wages, Bonuses, & Vacation pay (if paid within 2 ½ months of year-end), payroll taxes, fringe benefits Can deduct up to $1M of compensation Other notes: -Premiums on life insurance to benefit an employee's family are deductible as a fringe benefit. A corporation can deduct as long as they are not the beneficiary. -Employee Achievement Awards for length of service or safety may be deducted up to $400 under nonqualified plans and up to $1,600 for qualified plans per employee.

How are Bad Debt, Warranty Expense, & Other Estimated Losses deducted?

Losses can't actually be deducted until REALIZED. So you can't deduct estimated losses.

What's the difference between a schedule M-1, M-2, and M-3?

M-1: Shows reported differences between GAAP and tax items M-2: Shows the statement of R.E to see if any prior period adjustments may need amended tax returns M-3: For corporations with total assets of $10 million or more, this schedule is prepared in lieu of Schedule M-1 and is, in essence, simply a more detailed form of that schedule. This will report the temporary or permanent differences.

What's the difference between an M-1, M-2, and M-3 reconciliation?

M-1: This focuses on temporary and permanent differences M-2: Examines retained earnings and if any prior period adjustments are subject to taxation M-3: This is for companies with $10M or more in total assets. It is a much more detailed version of the M-1. For example, depreciation and depletion are broken out.

Are net operating losses deductible?

NOLs generally may only be carried forward indefinitely and are limited to 80% of taxable income for the year to which it is carried. 1) Gross income - excess allowable deductions + any NOLs carried forward to that year = Current Year NOL 2) Carryforward NOL allowed = Taxable income before NOL × 80% Note: The 2020 CARES Act temporarily repealed the 80% limitation for tax years beginning before 2021; thus, for 2018 - 2020, NOLs may offset 100% of taxable income.

What are the rules around a C Corporations nonliquidating distributions of property? (Unencumbered and encumbered)

No gain or loss is recognized when a corporation makes a nonliquidating distribution of its stock or property to a shareholder, unless the property is appreciated property.

Is a foreign subsidiary subject to US Federal Income Tax?

No- Foreign subsidiaries and foreign branches have very different tax consequences. Since a foreign branch is a business operation carried on by a U.S. entity, it is subject to U.S. federal income tax, and therefore may also take advantage of certain tax benefits, such as using losses of the branch to offset its income, the foreign tax credit, and the dividends-received deduction. A foreign subsidiary, however, is a separate company incorporated under the laws of the foreign country where it is located, and cannot be consolidated with its U.S. parent company; therefore, the tax benefits of loss deductions and the foreign tax credit are also not available. However, since TCJA enacted several new international tax rules to encourage the repatriation of foreign income, including a 100% dividends received deduction (referred to as the "participation exemption"), dividends from a foreign subsidiary are now generally eligible for a 100% dividends received deduction.

Can you have an ordinary loss from inherited stock?

No- To determine the amount of ordinary loss deductible for the year, the task is to understand the special considerations for Code Sec. 1244 stock. In general, a decline in value of Sec. 1244 stock is considered an ordinary loss up to $50,000 ($100,000 for married filing jointly). However, to receive the ordinary loss treatment, the stock must be sold by the original purchaser.

For tax purposes, can a corporation use the reserve method for credit losses? Can they deduct these expenses?

No- A Corporation must use the direct charge off method. This means bad debt expense/credit losses are only deductible to the extent that they have been written off. Yes they are deductible per the comment above.

Are corporate entertainment expenses deductible?

No- Entertainment expenses are generally no longer deductible after 2017.

Are fines deductible?

No- b/c the government is trying to punish you.

Can corporations use capital losses to offset ordinary income?

No.

Are redemption losses allowed if you own more than 50% of the Company? Do you remember what a redemption is? This will be different than a share repurchase

No. When a shareholder directly or indirectly owns (through their spouse) more than 50% at the time of the redemption, losses are disallowed. Redemptions are when a company requires shareholders to sell a portion of their shares back to the company. For a company to redeem shares, it must have stipulated upfront that those shares are redeemable, or callable.

What is the tax treatment for intercompany transactions?

Non taxable and you carry over the basis. When an affiliated group of C corporations elects to file a consolidated tax return (Form 1120) rather than separate returns for each corporation (ie, member), the group is treated as a single taxable entity. Intercompany transactions are considered self-dealing (ie, selling to yourself), which are nontaxable and are eliminated (ie, not recognized) to determine a group's aggregated taxable income, including gains/losses, deductions, and tax credits.

Are federal taxes deductible?

Not deductible, but they are an expense for the book.

How much in organization expenses can a company deduct?

Organizational expenditures include state incorporation fees and accounting and legal fees related to incorporation -May deduct up to $5,000 in the same year. -The $5,000 amount is reduced by the amount by which the organizational expenditures exceed $50,000 -Any costs not currently deductible are amortized over 180 months. -Or, the corporation may also elect not to deduct the $5,000 and instead amortize the total amount of organizational expenditures over 180 months Note: Costs of issuing, printing, and selling stock (including legal and accounting fees related to the offering of securities) are not organizational expenses (reduction of APIC).

What is the matching tax treatment rule for expenses towards related parties?

Owner-employees who own 50% or more of a corporation, along with the corporation itself, are considered related parties by the Internal Revenue Code. According to these rules, an accrual-method corporation cannot deduct an expense for a liability owed to a cash-basis related owner-employee until that related party recognizes the income. Instead, the corporation must match the taxpayer's use of the cash method for recognizing the rent payment. Otherwise, one related party (ie, the owner-employee in this scenario) could defer recognizing income to a later tax period while the other related party (ie, Stone) deducts the full expense in the earlier tax period. In this scenario, Stone and the taxpayer are related parties because the taxpayer owns 55% of Stone. Under the tax rules, Stone's use of the accrual method of accounting for this transaction is ignored. Because the taxpayer reported the $2,250 payment (1/2 of the $4,500) as income in Year 2 (ie, the year it was received), Stone is required to deduct the matching amount of $2,250 in Year 2.

What is a redemption and How are stock redemptions taxed?

Redemptions are when a company requires shareholders to sell a portion of their shares back to the company. For a company to redeem shares, it must have stipulated upfront that those shares are redeemable, or callable. -Generally treated as a capital gain as long as it is not equivalent to a dividend. Take the redemption amount minus the adjusted basis to figure out your capital gains taxed.

What is subpart F, foreign based income?

Subpart F income occurs when a) the controlled foreign corporation (CFC) performs the services or makes sales on behalf of a related party such as its corporate parent and b) the CFC performs the services or makes the sales outside of its country of organization.

What are some common expenses not deductible for a corporation?

Taxpayers are generally permitted to deduct ordinary and necessaryexpenses incurred in operating their businesses. Note: Legal expenses for challenging a fine are deductible.

What is the basic calculation for accumulated taxable income?

The accumulated earnings tax (AET) is an additional tax imposed on corporations to penalize them for accumulating retained earningsbeyond their reasonable business needs for expansion, retirement of debt, and working capital. Loans to suppliers, customers, or shareholders are not considered reasonable business needs. The tax is imposed on a corporation's accumulated taxable income. The basic calculation of accumulated taxable income is federal taxable income less these three amounts: -An accumulated earnings credit of $250,000 (or $150,000 for a personal service corporation) -Any dividends actually paid to shareholders or dividends the shareholders consented to be taxed on for the taxable year -Any sum retained to pay federal income taxes owed for the tax year

What is the general business tax credit?

The general business credit is designed to combine several tax credits, including the low-income housing credit, the alcohol fuel credit, and the targeted jobs credit. The purpose of the combination is to provide uniformity related to the deduction of the credit for the current, carryback, and carryover years.

How does the personal holding company tax and the accumulated earnings tax compare?

The personal holding company (PHC) tax was created to discourage the sheltering of certain types of passive income (eg, dividends, interest, rent) in corporations. This sheltering generally occurs when individuals in high tax brackets establish corporations to hold their personal investments so they can benefit from lower corporate tax rates on the income. The PHC tax is a self-assessed penalty tax paid in addition to a corporation's regular income tax liability. Another type of penalty tax corporations pay is the accumulated earnings tax (AET). The AET is imposed on corporations during an IRS audit to penalize them for accumulating retained earnings beyond their reasonable business needs for expansion, retirement of debt, and working capital. The purpose of both taxes is to discourage taxpayers from using corporations to keep earnings inside the corporation instead of paying dividends, which would be taxed at the shareholder level. Given the similar purpose of the two taxes, IRS rules provide that, for any tax year a corporation pays the PHC tax, it is not also subject to the AET for that year.

What is the personal holding company income test?

The personal holding company (PHC) tax was created to discourage the sheltering of certain types of passive income in corporations. This sheltering generally occurs when individuals in high tax brackets establish corporations to hold their personal investments so they can benefit from lower corporate tax rates on the income. The PHC tax applies in any tax year in which a corporation meets both of the following tests: 1) Passive income test: 60% of the corporation's adjusted ordinary gross income comes from passive sources (eg, dividends, interest, rent, royalties). 2) Stock ownership test: Five or fewer individuals own more than 50% of the corporation's stock.

How do you reconcile from book income to taxable income?

To arrive at taxable income, a corporation must adjust its accounting (ie, book) net income for certain income and expense items that are treated differently for tax purposes (eg, municipal bond interest, excess capital losses, federal income taxes).

How can a business avoid paying the multiple state income taxes on the same income?

To avoid being taxed on the same income in multiple jurisdictions, income will be allocated among the jurisdictions in which the entity is subject to income tax. The model that is used for allocating income is the Uniform Division of Income for Tax Purposes Act (UDITPA).

What is included on the M-1 Reconciliation of book income to taxable income?

To determine taxable income, a corporation's accounting (ie, book) net income must be adjusted for income and expense items that are treated differently for tax purposes. A corporation reconciles book income to taxable income on Schedule M-1 to account for these differences; before any special deductions! There are two types of differences: [1] Temporary differences result from the same item's being calculated differently for accounting (eg, GAAP) than for tax purposes (eg, different book/tax depreciation methods) in any given reporting year. These differences eventually work themselves out over time. [2] Permanent differences are items that are income or deductions in the year for either book or taxable income but not both (eg, tax-exempt interest). These differences do not reverse over time.

How much in Start Up expenses can a company deduct?

Up to $5,000 in the same year

What are the types of personal holding corporations?

Usually anything in the professional services.

What are the rules around liquidating property distribution of a corporation?

When a corporation distributes property to a shareholder in a complete liquidation, it reports gains and losses as if the assets were sold to the shareholder at FMV. The corporation will recognize a gain if the FMV of the property exceeded its tax basis. If the FMV is lower than the tax basis, the corporation recognizes a loss. If the distributed asset is subject to a liability (eg, mortgage), the liability reduces the amount of the distribution.

When is a stock redemption considered dividend income?

When the redemption is equivalent to the corporations E&P.

Are state taxes paid fully deductible?

Yes for corporations and individuals

Are the fees associated with dissolving/terminating a corporation deductible?

Yes they are

Is R&D deductible?

Yes, immediately

When a company establishes nexus, are they subject to state income tax?

Yes- A state may impose an income tax on an entity that is doing business in that state if the entity establishes nexus in a state. Usually buying an office building to conduct business would indicate the company has a physical presence in the state, a connection sufficient for the state to tax the company. But, selling tangible property, hiring employees to sell items, or purchase raw materials within the state may not be sufficient for taxation.

Can a corporate leader's salary be considered unreasonable?

Yes- And, therefore you may need to classify it as a dividend. Things to remember:Corporations are allowed a salary deduction for the amount that represents reasonable compensation for the value of services performed by shareholder-employees. Any salary deemed excessive is reclassified as a dividend paid to the shareholder-employee. The shareholder-employee has taxable income that is divided between wages earned and dividend income.

Are state franchise taxes deductible for tax and book purposes?

Yes- State franchise tax is fully deductible for both financial statement and tax purposes; thus, no adjustment is required on Schedule M-1 to reconcile book net income to taxable income.

Do corporations need to recognize rents received in advance?

Yes. Even though Pierce Corp. is on the accrual basis for financial reporting purposes, for tax purposes it must recognize all rents received in advance in the period of receipt. Therefore, the $250,000 in advanced rental payments must be recognized as income in the year they are received for tax purposes. For financial reporting purposes, they would not be recognized until the following year when the earnings process is complete.

Are charitable contributions deductible?

Yes: -Claimed after all ordinary deductions -Limited to 10% of Adjusted taxable income -Unused deductions may be carried for 5 years Note: It is taken before charitable contributions, NOL or loss carry back, dividend received deduction

How do you account for a reasonable accrual of income that becomes actualized?

You just report it in the following year. (example, accrued income in year 2, received in year 3, then pay tax on it in year 3). When there is a difference between a reasonable estimate of income in one year and the realization of that income in a succeeding year, the difference is recognized as income in the year of realization.