TAX EXAM
Charitable contributions
Corporations can deduct charitable contributions made to qualified organizations. Deduction limits exist based on the type of contribution and the recipient organization. Generally, deductions are limited to a percentage of taxable income.
Accounting periods and methods
Corporations must choose an accounting period (calendar year or fiscal year) and accounting method (cash or accrual). Changes in accounting methods require IRS approval. Some special rules may apply based on the chosen period and method.
Form 1120
Corporations must file Form 1120 annually, usually by the 15th day of the third month after the end of their tax year (e.g., March 15th for calendar-year corporations).
Dividends received deduction
Corporations that receive dividends from other corporations may be eligible for a dividends received deduction (DRD). The deduction percentage varies depending on the ownership percentage and type of dividend-paying corporation.
Administrative (treasury/IRS)
The accountants that get to give incite on how to make these things actually work. Clarify things for rulings.
Other considerations
include environmental concerns, international competitiveness, and political considerations. An example is imposing a carbon tax to reduce fossil fuels and encourage clean energy initiatives.
primary sources of tax laws
legistaltive (congress) Admisistrative (treasury/HR) Judicial (us district and us tax courts)
Revenue needs
refer to the governments requirement for funds to finance its operations, services, and obligations. An example could be the government may implement higher sales tax to generate more revenue to support unemployment benefits and social services for those effected by job losses.
what are the whys of tax laws
revenue needs economic considerations social considerations equity considerations other considerations
Organizational expense deductions
Corporations can deduct certain costs associated with organizing the business entity. These deductions are subject to limitations and must be amortized over time.
Bonus depreciation
100% bonus depreciation will phase out after 2022, with qualifying property getting only an 80% bonus deduction in 2023 and less in later years.
Rachel has $50,000 of QBI from her local jewelry store (a sole proprietorship). Rachel's proprietorship paid $20,000 in W-2 wages and has $10,000 of qualified property. Rachel's spouse (who we will learn who he is tonight!) earned $35,900 of wages as an employee, they earned $2,000 of interest income during the year and have no other income or deductions. Rachel and her spouse will file jointly and use the standard deduction (assume $27,700). What is her QBI deduction?
20% of QBI ($50,000 * 20%) = $10,000 OR 20% of modified taxable income ($50,000 + $2,000 + $35,900 - $27,700 standard deduction = $60,200 * 20% = $12,040) Answer: $10,000 The phaseout for 2022 is $340,100 for married taxpayers and $170,050 for all other taxpayers.
ND Inc., is a calendar year C corporation with taxable income of $20,000,000 in 20X1 and $35,000,000 in 20X2. Assuming all payment dates fall on a weekday and non-holiday, what is ND Inc.'s 20X2 tax installment payment schedule?
4/15/20X2: $20M*21% / 4 = $1,050,000 6/15/20X2: $35M*21% / 4 = $1,837,500 + (1,837,500-1,050,000) = $2,625,000 9/15/20X2: $35M*21% / 4 = $1,837,500 12/15/20X2: $35M*21% / 4 = $1,837,500
Vikings Corporation (a calendar year taxpayer) has taxable income of $300,000, and its financial records reflect the following for the year: Federal income tax refund: $110,000 Net operating loss carryforward deducted currently 70,000 Gain recognized this year on an installment sale from a prior year 44,000 Depreciation deducted on tax return (ADS depreciation would have been $20,000) 90,000 (70k) Interest income on Baltimore city bonds 8,000 What is Vikings Corporation's current E&P?
514,000
Capital gains and losses
Capital gains and losses are categorized as either short-term or long-term. Net capital gains may be taxed at a different rate than ordinary income. Capital losses can offset capital gains, and any excess can be used to offset ordinary income up to certain limits.
Social considerations
A deduction is allowed for contributions to qualified charities. The deduction shifts some of the financial and administrative burden of socially desirable programs from the public (the government) to the private sector. One measure of equity is whether a tax is progressive (e.g., the Federal income tax on individuals) or regressive (e.g., a gasoline excise tax). The determination is made by calculating the percentage of a taxpayer's income that is used to pay a tax.
The AZ Co. purchases all of the assets of Wildcat Inc. The assets purchased are as follows:
AZ Co. pays $80,000 for the purchase of these assets. What is the basis in each asset? Building: $40,000 / $100,000 = 40% * 80,000 = $32,000 E1: $10,000/ $100,000 = 10% * 80,000 = $8,000 E2: $20,000/$100,000 = 20% *$80,000 = $16,000 Land: $30,000/$100,000 = 30%*80,000 = $24,000
Josh and Stefon form Bills Corporation. Josh transfers land (basis of $1,680,000 and fair market value of $1,700,000); Stefon invests cash ($1,600,000). They each receive 300 shares in Bills Corporation worth $1,600,000, but Josh also receives $100,000 in cash from Bills. What is Stefon and Josh's basis in Bills Corporation? Stefon:
Adj Basis of Property Transferred: $1,600,000 + Gain Recognized $0 -Boot Received -$0 -Adj for Loss Property -$0_____ Basis of Stock Received $1,600,000
Josh and Stefon form Bills Corporation. Josh transfers land (basis of $1,680,000 and fair market value of $1,700,000); Stefon invests cash ($1,600,000). They each receive 300 shares in Bills Corporation worth $1,600,000, but Josh also receives $100,000 in cash from Bills. What is Stefon and Josh's basis in Bills Corporation? Josh:
Adj Basis of Property Transferred: $1,680,000 + Gain Recognized $20,000 -Boot Received -$100,000 -Adj for Loss Property -$0_____ Basis of Stock Received $1,600,000 *Gain Realized = FMV of Stock (1,600) + Boot (100) - Basis of Transfer (1,680) = 20,000
Alicia exchanges stock in Green Corporation (basis of $60,000 and fair market value of $100,000) for stock in Purple Corporation (fair market value of $100,000). If the exchange is not pursuant to a reorganization,
Alicia's realized gain of $40,000 is recognized for Federal income tax purposes.
Section 291 Recapture
Applies to corporations that sell Section 1250 property. It may require additional recapture of depreciation deductions.
Section 1250 Recapture
Applies to real property, specifically buildings and structural components. The recapture rules for Section 1250 property generally result in a portion of the gain being treated as ordinary income, but the remainder may qualify for long-term capital gains treatment.
Section 1245 Recapture
Applies to tangible personal property used in a trade or business. Any gain on the sale of Section 1245 property is treated as ordinary income up to the amount of depreciation deductions previously claimed.
Addison holds a debt instrument from Hibiscus with a principal value of $10,000 and a maturity date of December 31, 2022. In connection with the merger of Hibiscus and Tea, Addison exchanges Hibiscus debt for a $10,000 Tea note that also matures on December 31, 2022. Even though the Tea notes do not have a term remaining of more than five years, they qualify for tax-free reorganization treatment because they have the same term as the Hibiscus security.
Assume, instead, that in exchange for the $10,000 debt instrument, Addison receives a note from Tea with a $15,000 principal value. Addison recognizes a $5,000 capital gain on the exchange. The basis in the Tea bond is $15,000 ($10,000 original basis + $5,000 gain recognized).
Estimated payment structure
Corporations are generally required to make estimated tax payments throughout the year if they expect to owe $500 or more in tax when they file their annual return. Estimated payments are made using Form 1120-W, and they are typically due on the 15th day of the 4th, 6th, 9th, and 12th months of the corporation's tax year.
In 2023, Mrs. Greer, a widow, wants to give $34,000 to Jean without incurring any gift tax liability. She knows that the law permits her to give up to $17,000 each year per person without any tax consequences (the annual exclusion). With this limitation in mind, the following steps are taken: a gift by Mrs. Greer to Jean of $17,000 (nontaxable because of the $17,000 annual exclusion), a gift by Mrs. Greer to Ben of $17,000 (also nontaxable), and a gift by Ben to Jean of $17,000 (nontaxable because of Ben's annual exclusion). Considering only the form of what Mrs. Greer and Ben have done, all appears well from a tax standpoint. In substance, however, what has happened?
By collapsing the steps involving Ben, Mrs. Greer has made a gift of $34,000 to Jean and, therefore, has not avoided the Federal gift tax.
Determine tax treatment of distributions
Dividends: If the distribution is considered a dividend, it is typically taxable to the recipient as ordinary income. The corporation may have to withhold and remit taxes on dividends to the IRS. Return of Capital: If the distribution is a return of capital, it is generally not immediately taxable to the recipient. Instead, it reduces the recipient's basis in their shares. When the recipient eventually sells their shares, the return of capital reduces their gain (or increases their loss) for tax purposes.
c-corp tax consequences
Double Taxation: C-corporations are subject to corporate income tax. Shareholders are then taxed on dividends received, leading to double taxation. Limited Liability: Shareholders have limited personal liability for business debts. Flexibility in Ownership: Allows for various classes of stock and a larger number of shareholders.
Calculate E&P
E&P = Taxable Income + Nontaxable Income - Deductible Expenses - Non-Deductible Expenses Taxable Income: Start with the corporation's taxable income, which is based on its financial statements but adjusted for tax purposes. Nontaxable Income: Include any income that is exempt from federal income tax, such as tax-exempt interest on municipal bonds. Deductible Expenses: Subtract any expenses that are deductible for tax purposes, such as business expenses, depreciation, and interest payments. Non-Deductible Expenses: Add back any expenses that are not deductible for tax purposes, such as fines and penalties.
Equity considerations
Equity, then, is not what appears fair or unfair to any one taxpayer or group of taxpayers. It is, instead, what the tax law recognizes. The concept of equity appears in tax provisions that alleviate the effect of multiple taxation and postpone the recognition of gain when the taxpayer lacks the ability or wherewithal to pay the tax. Equity also helps mitigate the effect of the application of the annual accounting period concept and helps taxpayers cope with the eroding result of inflation. One measure of equity is whether a tax is progressive (e.g., the Federal income tax on individuals) or regressive (e.g., a gasoline excise tax). The determination is made by calculating the percentage of a taxpayer's income that is used to pay a tax.
Ed, Fran, and Gabriella each invest $25,000 for all the stock of Brown Corporation. Brown obtains creditor financing of $100,000. Brown is subsequently sued due to an accident involving one of its delivery trucks. The court awards a judgment of $2,500,000 to the plaintiff. The award exceeds Brown's insurance coverage by $1,500,000.
Even if the judgment results in Brown's bankruptcy, the shareholders will have no personal liability for the unpaid corporate debts.
onica, a calendar year taxpayer, is a participant in an H.R. 10 (Keogh) retirement plan (see Appendix C for a definition of a Keogh plan). Under the plan, Monica contributes 20% of her net self-employment income, and this amount is deductible for Federal income tax purposes. On April 9, 2023, Monica determines that her net self-employment income for calendar year 2022 was $80,000. Consequently, she contributes $16,000 (20% × $80,000) to the plan.
Even though the $16,000 contribution is made in 2023, the law permits Monica to claim this contribution as a deduction in the 2022 tax year. Requiring Monica to make the contribution by December 31, 2022, to obtain the deduction for that year would force her to arrive at an accurate determination of net self-employment income before her income tax return must be prepared and filed.
C-Corporations:
While C-corporations don't benefit from the QBI deduction, they have a flat corporate tax rate. Depending on the specific circumstances of a business, it may still make sense to opt for a C-corporation, especially if you plan to reinvest profits or go public in the future.
Basis in property acquired via gift
FMV Greater Than Donor's Basis: If the FMV of the property at the time of the gift is greater than the donor's adjusted basis, your basis is typically the same as the donor's adjusted basis. You inherit the donor's potential capital gains tax liability. Donor's Basis Higher Than FMV: If the FMV of the property is less than the donor's adjusted basis at the time of the gift, your basis is generally the FMV of the property when you received it. This could result in a potential capital loss when you sell the property.
Depreciable Assets:
For depreciable assets like machinery or equipment, the basis may need to be adjusted for depreciation over time, which affects the depreciation deductions you can claim on your taxes.
During 2020, Gabby Corporation, a calendar year C corporation, has net short-term capital gains of $15,000, net long-term capital losses of $105,000, and taxable income from other sources of $460,000. Prior years' transactions included the following: 2016 net short-term capital gains $40,000 2017 net long-term capital gains 18,000 2018 net short-term capital gains 25,000 2019 net long-term capital gains 20,000
Gabby's 2020 net capital loss: ($90,000) Gabby's 2020 capital loss deduction: $0 Of the 90,000 loss how much can be taken back? $63,000
Jack exchanges property with a basis of $60,000 and fair market value of $100,000 for 70% of the stock of Gray Corporation. The other 30% of the stock is owned by Jane, who acquired it several years ago. The fair market value of Jack's stock is $100,000.
Jack recognizes a taxable gain of $40,000 on the transfer because he does not control the corporation after his transfer, and his transaction cannot be integrated with Jane's for purposes of the control requirement.
Judicial (U.S. District & U.S. Tax Courts)
Hear really complex tax cases, very rare we see a tax case to the supreme courts. Choose us district- you have jury peers. In this court you pay the taxes and sue to get your money back. tax court- the judge makes the decision. You keep your taxes and then pay after the decision is made on the initial decision until the tax court makes a decision.
Legislative (congress)
How tax bill becomes tax law; starts in congress with the house ways and means committee and it ends up at the president's desk and he can choose to sign it
On December 28, 2023, Peach Company, a calendar year, accrual basis taxpayer, authorizes a $5,000 donation to the Atlanta Symphony Association (a qualified charitable organization). The donation is made on April 12, 2024. If Peach Company is a corporation and the December 28, 2023 authorization was made by its board of directors, Peach may claim the $5,000 donation as a deduction for calendar year 2023.
However, if Peach Company is a partnership, the contribution can be deducted only in 2024.
Brown, a closely held C corporation that is not a PSC, has $300,000 of passive activity losses from a rental activity, $200,000 of net active income, and $100,000 of portfolio income. The corporation may offset $200,000 of the $300,000 passive activity loss against the $200,000 net active income but may not offset the remainder against the $100,000 of portfolio income.
If Brown is a PSC, then none of the $300,000 of passive activity losses is deductible in the current year.
In 2023, Eagle Corporation, a calendar year C corporation, has ($1,000,000) of adjusted taxable income, $40,000 of business interest income, zero floor plan financing interest, and $100,000 of business interest expense. Eagle's business interest deduction limitation is $40,000 [$40,000 (business interest income) + $0 (30% × adjusted taxable income amount, but not less than zero)]. As a result, Eagle's current-year deduction for business interest is limited to $40,000, and the disallowed amount of $60,000 ($100,000 − $40,000) is carried forward to next year and treated as business interest in that year.
If Eagle satisfies the small business exception (i.e., had average gross receipts for the prior three-year period of $29,000,000 or less), the limitation on business interest does not apply and the entire $100,000 of business interest is deductible in the current year.
Cost recovery considerations
When you dispose of a depreciable asset (e.g., machinery, equipment, real estate) that you've been depreciating for tax purposes, you need to account for any remaining basis in the asset. This remaining basis may be subject to recapture rules (discussed later) or may result in a capital gain or loss. If you've fully depreciated the asset for tax purposes (its basis is reduced to zero), any proceeds from its disposition are typically treated as ordinary income.
Return to the facts of The Big Picture. Assume that the proposed transaction involving Emily and Ethan qualifies under § 351, but Emily decides to receive some corporate debt along with the stock.
If she receives Transformation stock worth $1,900,000 and Transformation debt of $100,000 in exchange for the property transferred, Emily realizes gain of $1,600,000 [$2,000,000 (value of consideration received) − $400,000 (basis in the transferred property)]. However, because the transaction qualifies under § 351, she recognizes only $100,000 of gain—the $100,000 of Transformation debt is treated as boot. Emily defers the remaining realized gain of $1,500,000.
Assume the same facts as in Example 4, except that Robin is a corporation. None of the $7,500 long-term capital loss incurred in 2023 can be deducted in that year. Robin Corporation may, however, carry back the loss to 2020, 2021, and 2022 (in this order) and offset it against any capital gains recognized in these years.
If the carryback does not exhaust the loss, it may be carried forward to 2024, 2025, 2026, 2027, and 2028 (in this order). The long-term capital loss is treated as short term in any carryover year.
Capital gains and losses
If the sales proceeds exceed your adjusted basis, you have a capital gain, which can be classified as either short-term or long-term depending on the holding period. Long-term capital gains often receive more favorable tax rates. If the sales proceeds are less than your adjusted basis, you have a capital loss, which can offset other capital gains and reduce your overall tax liability.
Basis in a bargain purchase
If you acquire property for less than its Fair Market Value (FMV), your initial basis is generally equal to the amount you paid for it. However, the IRS may require you to use the FMV as the basis if it suspects that the transaction was not conducted at arm's length or if there were related-party transactions that did not reflect the true market value.
Stocks and Securities:
If you acquire stocks or securities, your basis typically includes the purchase price plus transaction costs, such as brokerage fees.
Corporate alternative minimum taxes
The corporate alternative minimum tax is designed to ensure that corporations with significant tax preferences pay a minimum amount of tax. Corporations must calculate both their regular tax liability and their AMT liability, then pay the higher of the two. The Tax Cuts and Jobs Act (TCJA) repealed the corporate AMT for tax years beginning after 2017. However, corporations with AMT credit carryforwards may still use them.
TWC Inc., is a clothing retailer that primarily sells t-shirts. In year 20X5, TWC donates t-shirts to a local qualifying charitable entity. The adjusted basis in the t-shirts is $200,000, and they have a fair market value of $250,000. What is TWC's charitable contribution in year 20X5 if it has $5,000,000 of taxable income in the current year?
Lesser of: Adj Basis ($200,000) + ½ of appreciation ($25,000) = $225,000 2x's basis ($200,000) = $400,000 Limited to 10% of taxable income ($5,000,000) = charitable contribution cannot be more than $500,000
s-corp/LLP/LLC nontax consequences
Limited Liability: Owners have limited personal liability. S-Corp Formalities: S-Corps have specific formalities and governance requirements. Operating Agreement (LLC): An LLC should have an operating agreement outlining ownership and management.
MACRS Depreciation
MACRS allows businesses to spread the cost of an asset over its useful life, reducing taxable income and providing a tax benefit over time MACRS typically assigns assets to one of several depreciation periods, such as 3, 5, 7, 15, or 27.5 years, depending on the asset type.
partnership nontax consequences
Multiple Owners: Partnerships are suitable for businesses with multiple owners who want to share responsibilities and decision-making. Limited Liability Partnership (LLP): Some partnerships may choose to operate as LLPs to limit personal liability. Complex Agreement: It's crucial to have a detailed partnership agreement outlining ownership percentages, responsibilities, and dispute resolution procedures.
Calculate U.S. income tax liability
Multiply taxable income by the applicable tax rate
Net operating losses
NOLs occur when business deductions exceed income. NOLs can generally be carried back two years and carried forward 20 years to offset taxable income. The Tax Cuts and Jobs Act (TCJA) limited the NOL deduction to 80% of taxable income for losses arising after 2017.
During the current year, Mallard Corporation donates a parcel of land (a capital asset) to Oakland Community College. Mallard acquired the land five years ago for $60,000, and the fair market value on the date of the contribution is $100,000.
The corporation's charitable contribution deduction (subject to a percentage limitation discussed later) is measured by the asset's fair market value of $100,000, even though the $40,000 appreciation on the land has never been included in income.
1231 Gains / Losses
Net gains from Section 1231 property are taxed as long-term capital gains, while net losses are treated as ordinary losses. This can provide a tax advantage since long-term capital gains generally receive more favorable tax treatment.
Matt is the sole shareholder of Rams, Inc. Rams has $500,000 in accumulated earnings and profits (E & P) at the beginning of the current year. Current E&P is at a deficit of $375,000. If Rams pays out a cash distribution to Matt at the end of the current year of $750,000, how much is a taxable dividend to Matt? Assume Matt has a basis in stock of $200,000. (-/+) à Net the two, if positive, start with dividend, then ROC, then CG
Net: $125,000 (dividend) ($500,000 - $375,000) Remaining: $200,000 (return of capital) All Else: $425,000 (capital gain) ($750k - 200k - 125k) If Matt's AGI is $15,000,000, then what is his tax liability from this transaction? $550,000 * 20% = $115,500
Matt is the sole shareholder of Rams, Inc. Rams has $500,000 in accumulated earnings and profits (E & P) at the beginning of the current year. Current E&P is at a deficit of $375,000. If Rams pays out a cash distribution to Matt at the beginning of the current year of $750,000, how much is a taxable dividend to Matt? Assume Matt has a basis in stock of $200,000.
Net: $500,000 (dividend) ($500,000 - $0) Remaining: $200,000 (return of capital) All Else: $50,000 (capital gain) ($750k - 200k - 500k) If Matt's AGI is $15,000,000, then what is his tax liability from this transaction? $550,000 * 20% = $115,500
Tax Structure:
One of the fundamental differences is the tax structure itself. Individuals file their taxes on Form 1040 and are taxed on their personal income. Corporations, on the other hand, are separate legal entities, and their income is taxed at the corporate level, usually on Form 1120 for C-corporations.
Purchase Price:
When you purchase an asset (e.g., real estate, stocks, business assets), your initial basis is generally equal to the purchase price you paid for it. This purchase price includes not only the actual cost but also any associated expenses such as commissions, legal fees, and closing costs.
On 1/1/20X1, Dr. G purchases 10,000 shares of State Inc. for $30/share. Dr. G must also pay a transaction fee of $2,500. On 1/1/20X2, Dr. G purchases an addition 20,000 shares of State Inc. for $40/share, and he must pay a transaction fee of $4,000. On 1/1/20X9, he decides to sell 20,000 shares for $100/share. During the sale, he pays a transaction fee of $1,000 on the sale. What is Dr. G's gain on the sale of these shares?
P1: 10,000 * $30 + 2,500 = $302,500 P2: 20,000 * $40 + 4,000 = $804,000 Basis of Sale: All of P1 ($302,500) ½ of P2 ($402,000) = $704,500 basis Net Sales Price: $20,000 * $100 - 1,000 = $1,999,000 Gain on Sale: $1,294,500
partnership tax consequences
Pass-Through Taxation: Income and losses "pass through" to the partners, who report their share on their individual tax returns (Form 1065 for the partnership). Self-Employment Tax: General partners are subject to self-employment tax on their share of partnership income. Distributive Share: Partners are taxed on their distributive share of partnership income, regardless of whether it is distributed to them.
LLC/LLP tax consequences
Pass-Through Taxation: Income and losses pass through to the owners, who report them on their individual tax returns (Form 1065 for LLCs). Flexibility: LLCs have flexibility in management structure and profit-sharing.
s-corp tax consequences
Pass-Through Taxation: Income and losses pass through to the shareholders, who report them on their individual tax returns (Form 1120-S for the S-Corp). Avoiding Double Taxation: Avoids the double taxation issue of C-corps. Limit on Shareholders: Limited to 100 shareholders, who must be U.S. citizens or residents.
Passive activity losses
Passive activity losses, such as rental losses, may be limited or disallowed if the taxpayer does not meet material participation criteria. Passive losses can generally be carried forward to offset passive income in future years.
Travis and Patrick form Chiefs Corporation. Travis transfers property (basis of $55,000 and fair market value of $90,000) while Patrick transfers land (basis of $2,000 and fair market value of $2,000) and $88,000 of services. Each receives 50% of Chiefs Corporation's stock (total value of $180,000). As a result of these transfers, how much recognized gain or loss does Patrick incur?
Property Transferred: Yes Stock Received: Yes Control: No control related to person who transferred property does not count if property is immaterial to total transferred. Realized Gain: Travis: $35,000 realized GAIN (90,000 - 55,000) Patrick: $0 realized GAIN ($2,000 - 2,000) Recognized Gain: Travis: $35,000 Patrick: $88,000 (Not really a gain. Ordinary income. Value of services)
Travis and Patrick form Chiefs Corporation. Travis transfers property (basis of $55,000 and fair market value of $90,000) while Patrick transfers land (basis of $8,000 and fair market value of $75,000) and $15,000 of cash. Each receives 50% of Chiefs Corporation's stock (total value of $180,000). As a result of these transfers, how much recognized gain or loss does Patrick incur?
Property Transferred: Yes Stock Received: Yes Control: Yes (100% > 80%) Realized Gain: Travis: $35,000 realized GAIN (90,000 - 105,000) Patrick: $67,000 realized GAIN ($75,000 - 8,000) Recognized Gain: Lesser of Realized Gain & Boot Received No boot received! $0
Describe the tax treatment of dividends for shareholders
Qualified Dividends: Qualified dividends are eligible for lower tax rates, similar to long-term capital gains rates. To qualify for this lower rate, the dividend must meet certain criteria, including being paid by a U.S. corporation or a qualified foreign corporation. Ordinary Dividends: Ordinary dividends are taxed at the shareholder's ordinary income tax rates. These dividends can come from various sources, including domestic and foreign corporations. Dividend Reinvestment: If a shareholder reinvests dividends by purchasing additional shares of the same company, they still need to report the dividends as income in the year they receive them, even though they haven't received cash. Tax Forms: Shareholders typically receive Form 1099-DIV from the corporation, which reports the dividend income received during the tax year.
Sarah transfers property with a basis of $400,000 and fair market value of $1,000,000 to Garden, Inc., and receives 50% of its stock. Tiffany receives the other 50% of the stock for services rendered (worth $1,000,000). Tiffany has ordinary income of $1,000,000 because she contributes only services. She must recognize compensation income for services rendered.
Sarah contributes property, but she receives only 50% of Garden's stock. Because Sarah does not own at least 80% of Garden's stock, she has a taxable gain of $600,000 [$1,000,000 (fair market value of the stock in Garden) − $400,000 (basis in the transferred property)].
Section 179 selection
Section 179 of the Internal Revenue Code allows businesses to deduct the cost of certain qualifying assets as an expense in the year they are placed in service, rather than depreciating them over several years. $1,080,000 of the cost of qualifying assets, subject to a phase-out threshold of $2,700,000.
Section 357
Section 357 outlines rules related to the recognition of gain or loss when a corporation assumes a shareholder's liabilities, and it also specifies the treatment of certain liabilities, such as those related to property subject to a liability or those that exceed the basis of the property. The specific treatment under Section 357 includes the following key provisions: Recognition of gain: When a corporation assumes a shareholder's liabilities, the shareholder may recognize gain to the extent the liabilities exceed their basis in the property transferred. Recognition of loss: Generally, no loss is recognized by the shareholder if the corporation assumes their liabilities. Treatment of certain liabilities: Section 357 provides rules for the treatment of liabilities related to property subject to a liability and liabilities that exceed the basis of the property.
c-corp nontax consequences
Separate Legal Entity: The corporation is a separate legal entity from its owners, which provides protection to shareholders' personal assets. Raising Capital: Easier access to capital through the sale of stocks. Complex Compliance: C-corporations have more complex compliance requirements and administrative burdens.
Return to the facts of The Big Picture. The easiest business entity for Amy to form is a sole proprietorship. She need not create any legal documents for the proprietorship, although she may need to obtain a business license in her county or city (and pay a tax or fee for it), including filing a statement of business purpose.
She should also set up accounting records (e.g., using QuickBooks) and make her accounting and tax record keeping simpler by having a separate bank account and credit card for business purposes (accounts that are not used for personal purchases).
sole propiteriorship nontax consequences
Simple Setup: Easy and cost-effective to establish and operate. Complete Control: The owner has full control over business decisions. Unlimited Liability: The owner has unlimited personal liability for business debts and obligations, which can put personal assets at risk. Limited Capital: May face challenges in raising capital compared to other structures.
sole propiteriorship tax consequences
Simplified Taxation: Income from the business is typically reported on the owner's personal tax return (Form 1040). It's subject to individual income tax rates. Self-Employment Tax: Sole proprietors are responsible for paying self-employment tax, which covers Social Security and Medicare contributions. This tax can be relatively high.
Pass-Through Entities
Sole proprietorships, partnerships, S-corporations, and eligible LLCs often benefit most from the QBI deduction since it allows owners to deduct a portion of their business income on their individual tax returns. This can result in significant tax savings.
Capital structure considerations
Specific treatment for capital structure considerations involves evaluating the tax consequences of different financing options (equity vs. debt) and understanding how changes in the capital structure may affect the company's overall tax position
Sundra and Patel are equal partners in Canary Enterprises, a calendar year partnership. During the year, Canary Enterprises had $500,000 gross income and $350,000 operating expenses. In addition, the partnership sold land that had been held for investment purposes for a long-term capital gain of $60,000. During the year, Sundra withdrew $40,000 from the partnership, and Patel withdrew $45,000. The partnership's Form 1065 reports ordinary business income of $150,000 ($500,000 income - $350,000 expenses) and long-term capital gain of $60,000 as a separately stated item.
Sundra and Patel each receive a Schedule K-1 reporting ordinary business income of $75,000 and separately stated long-term capital gain of $30,000. Each partner reports ordinary business income of $75,000 and long-term capital gain of $30,000 on his or her own return. Likewise, Sundra and Patel would claim any related deduction for qualified business income on their individual tax returns.
Tom, a sole proprietor, decides to incorporate his business. In exchange for the business's assets (adjusted basis of $60,000 and a fair market value of $100,000), Tom receives all of the stock of Azure Corporation, a newly created corporation.
The Azure stock is worth $100,000.
In 1983, Brad claimed a capital loss of $100,000 for Tan Corporation stock that became worthless during the year. In the absence of any offsetting gains, the capital loss deduction produced no income tax savings for Brad either in 1983 or in future years. Brad instituted a lawsuit against the former officers of Tan Corporation for their misconduct that resulted in the corporation's failure and thereby led to Brad's $100,000 loss. In settlement of the suit, the officers paid $50,000 to Brad in 1986. The IRS argued that the full $50,000 should be taxed as gain to Brad. The Tan stock was written off in 1983 and had a zero basis for tax purposes. The $50,000 recovery that Brad received on the stock was, therefore, all gain.
The IRS's position was logical but not equitable. The court stated that Brad should not be taxed on the recovery of an amount previously deducted unless the deduction produced a tax savings. Because the $100,000 capital loss deduction in 1983 produced no tax benefit, none of the $50,000 received in 1986 resulted in gain.
Business interest expense limitation
The TCJA introduced a limitation on the deduction of business interest expenses. Generally, interest expense deduction is limited to 30% of adjusted taxable income (ATI). Certain small businesses may be exempt from this limitation.
Adam and Beth form a general partnership, AB, to build and manage an apartment building. Adam contributes cash of $200,000, and Beth contributes land (FMV $200,000; adjusted basis $60,000) on which the apartment building will be constructed. The building will cost $1,000,000.
The partnership is considering borrowing $800,000 to construct the building. Adam and Beth would each be legally responsible for the repayment of the loan as well as for other liabilities the venture generates. Alternatively, Adam and Beth are considering borrowing only $200,000 and seeking additional partners to finance the remaining cost of the building. However, new partners may be concerned about being responsible for the loan as well as other debts of the venture that may arise. Adam and Beth are also concerned about sharing management rights and responsibilities with additional general partners.
Determining the basis for shareholders & corporation
The specific treatment for determining basis depends on various factors, including initial contributions, subsequent contributions, distributions, depreciation, and other adjustments as specified by the tax code. The tax code provides specific rules for calculating and adjusting the basis of assets, stock, and other items for both shareholders and the corporation.
Deductions and Credits
The types of deductions and credits available to individuals and corporations differ significantly. For example, individuals may have deductions for mortgage interest, student loan interest, and child tax credits, while corporations may have deductions related to business expenses, depreciation, and research and development credits.
Executive compensation
There are rules and limitations on the deduction of executive compensation, including the $1 million limit on deductible compensation for certain executives. Performance-based compensation may be exempt from this limitation.
In January of the current year, Southwest Sportsman's Corporation established an allowance for uncollectible accounts (bad debt reserve) of $35,000 on its books and increased the allowance by $65,000 during the year. As a result of a client's bankruptcy, SSC decreased the allowance by $25,000 later in the year. The corporation deducted the $100,000 of increases to the allowance on its income statement but was not allowed to deduct that amount on its tax return. On its tax return, the corporation was allowed to deduct the $25,000 actual loss sustained because of its client's bankruptcy.
These amounts must be reported on line 32, Part III as follows: $100,000 book bad debt expense in column (a), $75,000 temporary difference in column (b), and $25,000 tax return bad debt expense in column (d).
Schedules M-1 / M-2 / M-3
These schedules are attached to Form 1120 to reconcile book income (financial accounting income) with taxable income (income subject to taxation). Schedule M-1 identifies differences between book and tax income. Schedule M-2 records changes in the corporation's capital and earnings accounts. Schedule M-3 is required for certain large corporations and provides more detailed information about income and deductions.
Section 351
To qualify for tax-free treatment under Section 351, the transferor(s) must receive stock in exchange for their property, and they must control the corporation immediately after the exchange. Additionally, the property transferred should consist of money, tangible or intangible property, and liabilities. The specific treatment under Section 351 involves the non-recognition of gain or loss at the time of the transfer if the following conditions are met: The transferors receive stock in the corporation. The transferors, collectively, control the corporation immediately after the exchange. The property transferred consists of money, property, and liabilities. Any gain or loss on the transfer is deferred until a later taxable event, such as selling the stock received. For the transaction to qualify as nontaxable under § 351, the property transferors must control the corporation immediately after the exchange. Specifically, the property transferors must own stock possessing 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 number of shares of all other classes of stock.
Return to the facts of The Big Picture. Emily transfers her $2,000,000 of property to Transformation, Inc., and receives 200 shares of stock, and Ethan transfers $48,000,000 of cash for 4,800 shares of stock. In the same transaction, Marco transfers property worth $800,000 (basis of $260,000) and agrees to serve as manager of the corporation for one year (services worth $200,000) for 100 shares of the stock. Emily's, Ethan's, and Marco's transfers qualify under § 351. None of them is taxed on their property transfers. However, Marco has ordinary income of $200,000, the value of the stock received for the services he will render to Transformation, Inc.
Transformation has a basis of $260,000 in the property it acquired from Marco, and it may claim a compensation expense deduction under § 162 for $200,000. Marco's stock basis is $460,000 [$260,000 (basis of property transferred) + $200,000 (income recognized for services rendered)].
Entity Choice Considerations:
When deciding on the appropriate business entity, it's crucial to consider not only the QBI deduction but also other factors like liability protection, governance, and long-term business goals.
Tax Rates:
While both individuals and corporations have progressive tax rates, the tax rates for corporations are typically different from those for individuals. Corporate tax rates may change due to legislative changes and vary based on taxable income levels.
Economic considerations
refer to using tax policies to influence economic growth, stability, and behavior. Examples may include tax credits for businesses that invest in research and development can stimulate innovation and economic growth by incentivizing companies to spend more on research and development activities. Congress has used tax depreciation rules as one means of controlling the economy. Theoretically, shorter asset lives and accelerated methods should encourage additional investments in depreciable business property. On the other hand, longer asset lives and the use of straight-line depreciation should discourage capital outlays. Congress also uses incentives like immediate expensing (§ 179) and bonus depreciation to stimulate the economy when needed.
