Chapter 5

Method of Accounting 1. Generally, a corporation (other than a qualified personal service corporation) must use the accrual method of accounting if its average annual gross receipts exceed $5 million 2. Selection of a corporation's method of accounting is made on its initial tax return by using the chosen method on that tax return 3. Once a corporation has set up its accounting method, the corporation generally must get IRS approval before changing to another method Total Income 1. Income includes: a. Gross receipts or sales b. Rental income collected in advance c. Nonrefundable rent deposits d. Lease cancellation payments e. Royalties collected in advance 2. Income excludes: a. Interest income from municipal bonds

Accrued Expenses Generally, a corporation can deduct accrued expenses in the tax year when: 1. All events that determine the liability have occurred, 2. The amount of the liability can be determined with reasonable accuracy, and 3. Economic performance has taken place with respect to the expense C Corporations Part 3: Form 1120 Bad Debts Corporations: 1. Can take a deduction for bad debts 2. Must be an accrual-basis taxpayer in that the income has already been recorded 3. Must use the direct write-off method 4. Cannot take the bad debt deduction using an allowance method such as aging accounts receivable or a percentage of income

Gross Estate Deductions Gross estate deductions include those expenses associated with the administering of the estate, such as: 1. Funeral expenses 2. Administrative expenses 3. Indebtedness of property in gross estate 4. Claims against estate 5. Medical expenses not on final 1040 tax return (full medical expense amount is deductible)

Adjusted Gross Estate Deductions Adjusted gross estate deductions include: 1. Unified tax credit 2. Charitable bequests 3. Marital deduction Note: A decedent can leave as much as they want to charities and spouse (i.e., unlimited deduction)

Shareholder Control Devices 1. Shareholders may agree to vote their stock in a particular way in order to maximize their effect on corporate policy. 2. Voting Trust—Shareholders turn over their voting rights to a trustee for a period not exceeding 10 years. a. The shareholder receives a voting trust certificate from the trustee, and all dividends received on the stock are paid to the shareholder. b. Upon termination of the trust, the shares are transferred back to the certificate holder. 3. Pooling Agreements—Any two or more shareholders may agree to vote their shares in a given way. a. Such agreements must be in writing and signed by the shareholders. b. A primary difference between pooling agreements and voting trusts is that in a pooling agreement, title to the shares pooled remains with the individual shareholders, while in a voting trust, title to the shares in trust is transferred to the trustee. 4. Proxy—A proxy is authorization to vote for another. a. A general proxy allows the agent to vote the shares only as directed by the shareholder. b. Proxies generally expire after a certain amount of time.

CORPORATIONS PART 1: OVERVIEW Corporations The following entities are taxed as corporations: 1. Businesses formed and referred to under: a. Federal or state law as a corporation b. State law as a joint-stock company/association 2. Insurance companies, certain banks, or foreign businesses 3. Businesses wholly owned by a state or local government 4. Businesses required to be taxed as a corporation by the IRC (Internal Revenue Code), such as certain publicly traded partnerships 5. Businesses that elect to be taxed as a corporation, such as a Limited Liability Company (LLC) 6. S corporations (to be covered in greater detail later) − Some corporations may elect S corporation status 7. Personal Services Corporations a. Activities include personal services (accounting, actuarial science, architecture, consulting, engineering, health, veterinary services, law, and performing arts) b. At least 95% of the corporation's stock is owned (directly or indirectly) by employees, retired employees, an estate of an employee or retiree, and any person who inherited the stock of a shareholder Transfers

Basis Example # 2 Donna organizes the DEF Corporation by transferring the following in a §351 transaction: Transferor Asset Adjusted Basis FMV Subject to Mortgage Consideration Received Donna Building $50,000 $70,000 $80,000 100% Shares of Stock Analysis • Since Donna's basis is $50,000, which is less than the transferred liability of $80,000, Donna recognizes a $30,000 gain − As a result, Donna's basis in the stock is $0 (zero), which is her original basis of $50,000 plus the $30,000 recognized gain less the $80,000 liability assumed by the corporation • As for DEF Corporation, its basis in the stock is $80,000 and it now has the $80,000 liability on its books

Corporate Taxes Filings 1. A corporation must file its income tax return by: a. The 15th day of the 4th month after year end, which for a calendar year-end corporations is March 15th b. The 15th day of the 4th month after short period ends for new corporation filing a shortperiod return c. The 15th day of the 4th month after the date that a corporation dissolved 2. An S corporation must file its income tax return by: - The 15th day of the 3rd month after year end, which for a calendar year-end S corporation is March 15th. The same 15th day 3rd month rule applies for short-period returns and dissolutions.

BUSINESS STRUCTURES: CORPORATIONS Federal Subchapter S Revision Act 1. Corporations are divided into two categories: a. Subchapter S b. Subchapter C—all corporations not Subchapter S corporations 2. Main distinction is tax treatment Advantages of Corporate Structure 1. Shareholders have limited liability for corporate debts 2. Continuous life (perpetual) until dissolved—not terminated by death of shareholder 3. Shares can be purchased, sold, and assigned freely

Corporations 1. Domestic—does business in state of incorporation 2. Foreign—does business in any state except the one in which it is incorporated 3. C Corporations—formed under state corporation law and taxed as corporation for federal tax purposes Statutory Close Corporations 1. Also called closely held or closed 2. 50 or fewer shareholders 3. 2/3rds of shares of each stock must approve status 4. Articles and shares must state status 5. May function without BOD (board of directors) and shareholder meetings

Taxable Estate Calculation Gross Estate Less: Gross Estate Deductions Adjusted Gross Estate Less: Adjusted Gross Estate Deductions Taxable Estate

Gross Estate Tax Calculation Taxable Estate Add: Post‐'76 Adjusted Taxable Gifts Tentative Tax Base Times: Uniform Tax Rates Tentative Estate Tax Less: Gift Taxes Paid and Transfer Credits Gross Estate Tax

Form 990-N Small exempt organizations 1. Those whose gross receipts are less than or equal to $50,000 2. Required to electronically file Form 990-N (e-postcard) Tax Rates The tax rate for an exempt organization depends on whether it is organized as: 1. A corporation, then it uses the corporate tax rates, or 2. A trust, then it uses the trust tax rates

Income Exempt from UBI Tax There are some income that is exempt from the UBI tax: 1. Amounts under $1,000 2. Games of chance—bingo 3. Sales of merchandise received as gifts 4. Interest and dividends 5. Income derived from renting real property, and 6. Activities of volunteers—church rummage sale

S Corporations 1. Classified as corporation, taxed as a partnership 2. Maximum of 100 shareholders 3. Only one class of stock 4. Eligible owners—individuals, estates, trusts, and tax-exempt entities 5. Nonresident aliens, corporations, foreign trusts may not be shareholders Business Structures: Corporations 2 Corporations—Promoters Prior to formation of corporation, promoters may act on behalf of corporation 1. Not agents 2. Contracts bind promoters 3. BOD may adopt or reject contracts made by promoter 4. Promoter remains liable unless granted a novation

Incorporation 1. Corporations are regulated by state laws that usually allow their formation for the purpose of carrying on lawful activity 2. Incorporators—sign the articles of incorporation Articles of Incorporation 1. The articles of incorporation must contain certain mandatory provisions: a. The name of the corporation b. Corporate purpose c. Capital stock authorized d. Location of the principal office e. Number of directors f. The name and address of the registered agent for service of process g. Capital structure and a duration 2. After the articles of incorporation are signed and acknowledged by the persons named as directors, the document, accompanied by the appropriate fee, must be filed with the designated state office Bylaws The bylaws are the rules and regulations that govern the internal management of a corporation.

Dissociation 1. Partnership at will = no definite duration 2. Liability continues even after dissociation 3. Deceased partner dissociates from partnership 4. Partnership does not always dissolve 5. Continuing partners can purchase partner's interest or the business will dissolve

Joint Ventures A joint venture is a special form of partnership that is formed for only one transaction or series of transactions, rather than for a general purpose.

Relations With Third Parties 1. Authority to Bind Partnership a. For the purpose of conducting partnership business, every partner is an agent for the partnership and for every other partner b. The act of a partner committed within the scope of the partner's actual or apparent authority, therefore, will bind the partnership 2. Partnership Liability Partners are jointly and severally liable for contracts and all actions in tort or fraud against any partnership member where the partnership is not a limited liability partnership

Limited Liability Companies 1. A limited liability company (LLC) is a hybrid of corporate and partnership law a. LLCs must be created in accordance with the applicable state statute b. An LLC is a company formed by one or more members c. Owners in LLCs usually are referred to as members d. Members are equivalent to partners in a general partnership e. They manage the company unless expressly agreed otherwise 2. Individual Owners—A single individual may form an LLC 3. Manager—The manager is the equivalent of the president of a corporation A manager does not have to be a member in the LLC 4. Liability Shield—There are no restrictions on members of LLCs like restrictions on limited partners Members may be involved fully in the business and not lose the liability shield

Partnership Agreement 1. Names and addresses of all the partners 2. Date the partnership becomes effective 3. Nature, purpose, and scope of partnership activity 4. Procedure for admission of new partners 5. Computation of interest on partnership capital 6. Computation of profits and the proportionate share of profits and losses attributable to each partner 7. Powers and duties of the partners 8. Dissolution procedures and rights 9. Procedure for distribution of surplus, including the disposition of the firm name and goodwill

Relations Among Partners 1. Fiduciary a. Duty of loyalty and the duty of care b. The standard of care imposed by RUPA is that of gross negligence 2. Mandatory Rule Agreement cannot change certain requirements under RUPA

Example #2 Assume the corporation has income of $75,000, with a loss of $25,000. • Now, its taxable income is $50,000 before the DRD. After claiming the DRD of $32,500 ($50,000 × 65%), its taxable income is $17,500. • Because the corporation will not have an NOL after applying a full DRD, its allowable DRD is limited to 65% of its taxable income, or $11,375 ($17,500 × 65%).

S Corporations 1. An S corporation is an eligible domestic corporation that avoids double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation 2. On their tax returns, the S corporation's shareholders include their share of the corporation's separately stated items of income, deduction, loss, and credit, and their share of nonseparately stated income or loss

FEDERAL TAXATION OF ENTITIES: TAX-EXEMPT ORGANIZATIONS Tax-Exempt Organizations 1. An organization may qualify for exemption from federal income tax if it is organized and operated exclusively for one or more of the following purposes: a. Religious b. Charitable c. Scientific d. Testing for public safety e. Literary f. Educational g. Fostering national or international amateur sports competition (but only if none of its activities involve providing athletic facilities or equipment), or h. The prevention of cruelty to children or animals

2. Qualifying organizations include: a. Nonprofit old-age homes b. Parent-teacher associations c. Charitable hospitals or other charitable organizations d. Alumni associations e. Schools f. Chapters of the Red Cross g. Boys or Girls Clubs h. Churches

Accumulated Adjustments Account (AAA) 1. The accumulated adjustments account (AAA) of the S corporation generally reflects the accumulated undistributed net income of the corporation for the corporation's post-1982 years 2. S corporations with accumulated earnings and profits (E&P) must maintain the AAA to determine the tax effect of distributions during S years and the post-termination transition period

BUSINESS STRUCTURES: PARTNERSHIPS Partnerships 1. Revised Uniform Partnership Act (RUPA): RUPA defines a partnership as an association of two or more persons to carry on a business for profit as co-owners 2. Two or more persons, co-owners 3. General = unlimited liability 4. Agreement may be written or oral (if agreement cannot be completed with 1 year, it must be in writing) 5. If no agreement, share profits and losses equally 6. Does not pay income tax—pass through 7. Generally does not need to file document with state for formation or dissolution 8. If doing business under a fictitious name must file with state 9. Partnership interest is assignable 10. Assignee entitled to receive only profits and capital to which the partner would have been entitled 11. Assignee does not become a partner 12. Not entitled to exercise control 13. Active and inactive partners have right to inspect books

Transfers to a Controlled Corporation (§351) 1. If one or more shareholders transfers money or property to a corporation in exchange for its stock and then controls the corporation, the exchange is usually not taxable a. Property does not include services rendered (FMV (fair market value) of stock for services is ordinary income to the recipient) b. To be in control immediately after the exchange, shareholder(s) must own at least 80% of the: (1) Total combined voting power of ALL classes of stock entitled to vote, AND (2) Outstanding shares of each class of nonvoting stock 2. If a shareholder receives money or property other than stock, gain will be recognized only for the amount of money plus the FMV of the other property received 3. If the corporation assumes liabilities, the exchange is not treated as if money or other property was received unless: a. The liabilities exceed the shareholder's adjusted basis in the property. In this case, gain is recognized up to the difference. b. There is no business reason for the assumption of the liabilities, or the shareholder's main purpose is to avoid federal income tax. In these cases, the liabilities are treated as money received by the shareholder.

Basis Example # 1 David organizes the ABC Corporation by transferring the following assets in a §351 transaction: Transferor Asset Adjusted Basis FMV Subject to Mortgage Consideration Received David Building $50,000 $70,000 $30,000 100% Shares of Stock Analysis • Since David's basis is $50,000, which is greater than the transferred liability of $30,000, no gain is recognized − As a result, David's basis in the stock is $20,000, which is his original basis of $50,000 less the $30,000 liability assumed by the corporation • As for ABC Corporation, its basis in the stock is $50,000, and it now has the $30,000 liability on its books Basis

Defects in Formation 1. The courts adopted several doctrines to deal with defects in the incorporation process: a. De Jure Corporation b. De Facto Corporation c. Corporation by Estoppel 2. De Jure Corporation—Under current common law, any corporation that substantially complies with the mandatory statutory requirements of incorporation is deemed a de jure corporation. Business Structures: Corporations 3 3. De Facto Corporation—If the corporation fails to comply substantially with mandatory requirements, the courts might recognize its existence as de facto. This status forces third parties to perform on corporate contracts and shields shareholders from direct liability. 4. Corporation by Estoppel—In the absence of even a de facto corporation, many courts have protected shareholders from third-party suits. If the third party entered into a contract believing she or he was dealing with a corporation, the courts will not allow the third party to hold shareholders liable on the contract.

Business Judgment Rule 1. Protects corporation directors from personal liability for acts performed in good faith on behalf of the corporation 2. Directors must exercise due care, due diligence, and act in a manner she or he believes to be in best interest of corporation Pierce the Corporate Veil Courts will disregard corporation entity and hold stockholders personally liable: 1. When corporation assets are used for owner's personal purposes 2. When corporation is used to perpetuate a fraud

Form 1120 Basics Form 1120 Total Income Less: Deductions Taxable Income before Net Operating Loss (NOL) and special deductions, usually the Dividends-Received Deduction (DRD) Less: NOL and DRD Various Schedules for information Schedule M-1 Schedule M-2 Schedule M-3

Deductions—an expense that is ordinary if common and accepted and is necessary if appropriate and helpful 1. Charitable contributions that exceed 10% of taxable income for the tax year cannot be deducted but can be carried forward up to 5 years (any excess not used is lost) 2. Capital losses: Corporations can only use capital losses to offset capital gains; excess losses are carried back 3 years and forward 5 years 3. DRD: Corporations may deduct a percentage of certain dividends received during tax year (see separate lecture) 4. Under the TCJA (Tax Cuts and Jobs Act of 2017), the NOL deduction for a tax year is equal to the lesser of (1) the aggregate of the NOL carryovers to such year, plus the NOL carrybacks to such year, OR (2) 80% of taxable income (determined without regard to the deduction) 5. Generally, NOLs can no longer be carried back but are allowed to be carried forward indefinitely

Shareholder's Basis of Stock The basis of an S corporation shareholder's stock (generally, its cost) is adjusted as follows and, except as noted, in the order listed: 1. Basis is increased by all income (including tax-exempt income) and the excess of the deduction for depletion (other than oil and gas depletion) over the basis of the property 2. Basis is decreased by property distributions (including cash) made by the corporation (excluding dividend distributions and distributions in excess of basis) 3. Basis is decreased by nondeductible expenses and the depletion deduction for any oil and gas property 4. Basis is decreased by all deductible losses and deductions Note that the taxpayer can make an election to deduct items in "4" in the list above before nondeductible items in "3"

Distributions to Shareholders 1. To the extent the balance of the distributions is less than the adjusted basis of the stock, the shareholder has no gain or loss (i.e., tax free) 2. To the extent the balance of the distributions is more than the adjusted basis of the stock, the shareholder has a gain (usually a capital gain) from the sale or exchange of property

Eligibility A corporation may elect to be an S corporation only if it meets all of the following tests: 1. The entity must be a domestic corporation 2. The corporation may not have more than 100 shareholders - All members of a family (including spouses) and their estates may be treated as one shareholder for this test 3. The corporation's shareholders are limited to individuals, estates, certain exempt organizations, or certain trusts - Partnerships and corporations are not permitted to be shareholders 4. The corporation has no nonresident alien shareholders 5. There is only one class of stock (voting and nonvoting common is acceptable but not preferred stock) 6. The entity is not one of the following ineligible corporations: a. A bank/thrift institution that uses the bad debt reserve method b. An insurance company c. Or other various corporate entities 7. The corporation has a permitted tax year 8. An S corporation can have a C corporation or an S corporation subsidiary - An S corporation can elect to treat one or more of its wholly owned eligible subsidiaries as a qualified subchapter S subsidiary (QSub)

Election A corporation that is eligible to elect to be treated as a corporation must use Form 2553 to make an S corporation election and it must satisfy all tests: 1. One of the tests is that each shareholder consents to the election; in other words, all shareholders need to consent 2. For an election filed before the effective date, only shareholders who own stock on the day the election is made need to consent to the election 3. For an election filed on or after the effective date (no more than 2 months and 15 days after the beginning of the tax year the election is to take effect), all shareholders or former shareholders who own stock at any time during the period beginning on the effective date and ending on the day the election is made must consent to the election

DRD Limits 1. DRD is generally limited to the lesser of the applicable percentage (50% or 65%, respectively) multiplied by the taxable income before the DRD or the dividends received 2. If a corporation has an NOL (net operating loss) for a tax year, the dividends-received deduction limit (50% or 65%, respectively) of taxable income does not apply − To determine if a corporation has an NOL, figure the DRD without the 65% (or 50%) of taxable income limit

Example #1 • A corporation loses $25,000 from operations. • It receives $50,000 in dividends from a 20%-owned corporation. • As a result, its taxable income is $25,000 ($50,000 - $25,000) before the DRD. • If it claims the full DRD of $32,500 ($50,000 × 65%) and combines it with the $25,000 loss from operations, it will have an NOL of $7,500 ($50,000 - $32,500 - $25,000). • Therefore, the 65% of taxable income limit does not apply. The corporation can deduct the full $32,500.

Filing Requirements 1. Most organizations exempt from income tax under Section 501(a) must file an annual information return (Form 990 or 990-EZ) − Religious groups—churches, religious schools, and missions are exempt from reporting regardless of income 2. Form 990: a. Provides information on the organization's exempt and other activities, finance, governance, and so forth b. Identify substantial contributors and amounts c. Identify managers and highly compensated employees and salaries d. Simple report of gross income and expenses

Exempt Organization Business Income Tax Return (990-T) Exempt organizations with unrelated business income (UBI) must file Form 990-T (Exempt Organization Business Income Tax Return) 1. Must pay tax on unrelated business income 2. Due 15th day of 5th month after year end (May 15) 3. An exempt organization that fails to file a return for 3 consecutive years will lose its taxexempt status

General Partnership 1. An ordinary partnership formed under RUPA or common law and consists only of general partners 2. A general partner has the right to share in the management and profits of the partnership and has unlimited liability to partnership creditors Limited Partnership 1. An arrangement specially created under the Revised Uniform Limited Partnership Act (RULPA) which consists of one or more general partners and one or more limited partners 2. A limited partner is one who contributes capital to the partnership but does not have any authority or voice in the management of the business 3. The limited partner's liability to partnership creditors is limited to the amount of capital contributed

Limited Liability Partnership 1. Limited Liability Partnership (LLP) offers liability protection to general partners 2. An LLP is a general partnership which has made an election to invoke the limited liability protection of the enabling state statute 3. Some states allow most professional partnerships to use LLPs; others allow most operating businesses to use LLP 4. Regulations require specified amounts of malpractice insurance 5. Partners and supervisors of negligent partners retain full unlimited liability for negligence and wrongful acts Classifications 1. Silent Partner—One who has unlimited liability but does not share in the management of the partnership 2. Ostensible or Nominal Partner—One who is not actually a partner, but who may become a partner by estoppel insofar as she or he is held out to appear to be a partner 3. Dormant Partner—One who is a partner with the right to management participation, but who is undisclosed and generally inactive Once disclosed, the dormant partner has the same liability as any other general partner 4. Secret Partner—One who actually participates in the management of the partnership but is undisclosed If the secret partner's connection with the business is disclosed, she or he has unlimited liability

Dividends-Received Deduction (DRD) 1. A corporation is permitted a dividends-received deduction (DRD), which is a percentage of certain dividends received during its tax year 2. The DRD is limited to: a. 50% of the dividends received if the corporation receiving the dividends owns less than 20% b. 65% of the dividends received if the corporation owns 20% or more of the corporation but less than 80% c. 100% of the dividends received if the corporation owns 80% or more up to 100% (affiliated group members)

No DRD Deduction No DRD deduction if dividends are received from: 1. A real estate investment trust (REIT) 2. Corporations exempt from tax under IRC §501 or §521 3. A corporation whose stock or preferred stock was held less than 46 days during the 91-day period beginning 45 days before the stock became ex-dividend (i.e., wash transaction) 4. Any corporation that is under an obligation (such as a short sale) to make related payments with respect to positions in substantially similar or related property

Deductible Business Expenses Other deductible business expenses include but are not limited to: 1. Business travel: 100% deductible 2. Meals at which business is discussed: 50% deductible 3. Business gifts: maximum $25 gift per recipient plus wrapping, taxes, and shipping 4. Expenses such as the cost of a block of tickets for clients at a professional football game are no longer deductible 5. Executive compensation: deductible up to $1 million unless based on performance 6. Casualty losses are fully deductible: no $100 floor or % of AGI as is the case for individual taxpayers 7. MACRS (Modified Accelerated Cost Recovery System) depreciation

Nondeductible Business Expenses There are other business expenses a corporation may incur that are not deductible business expenses, which include: 1. Bribes and kickbacks 2. Political contributions 3. Premiums on key-person life insurance policy 4. Fines and penalties

FEDERAL TAXATION OF ENTITIES: ESTATES AND TRUSTS Estate Tax 1. An estate is created when someone dies 2. Estate files an Estate Tax Return (Form 706) if the gross estate exceeds $11,400,000 currently 3. Form 706 is due 9 months after death (can file a 9‐month extension) 4. If all property is not distributed immediately, or if estate continues as a going concern, Form 1041 must be filed if gross income for the tax year is $600 or more

Property Included in Estate 1. Gross estate is cash plus FMV (fair market value) of property at date of death or alternate valuation date (6 months subsequent to death) 2. Gross estate includes: a. FMV of all worldwide property to extent of decedent's beneficial interest b. Certain life insurance proceeds c. Anything payable to estate d. Income in respect to decedent e. Jointly held property, spouse 50/50 split f. Other than the spouses, the property's FMV is included in the decedent's estate to the extent of the % that the decedent contributed to the purchase

Schedule M-1 Schedule M-1 is part of a corporate tax return and reconciles book income to taxable income as follows: 1. Increase book income by: a. Federal income tax expense b. Excess of capital losses over capital gains c. Income items included on tax return but not on the books d. Expenses deducted on the books but not on tax returns 2. Decrease book income by: a. Income reported on books but not on tax return b. Expenses deducted on tax return but not on books

Schedule M-2 Schedule M-2 is part of a corporate tax return and analyzes unappropriated retained earnings per books between beginning and end of the year as follows: 1. Balance at beginning of year a. Plus net income (loss) per books and other increases (itemized) b. Less distributions in cash, stock, property, and other decreases (itemized) 2. Balance at end of year Schedule M-3 Corporations with total assets of $10 million or more are also required to provide a Schedule M-3 with their tax return 1. Schedule M-1 reconciles book income to taxable income 2. Schedule M-3 also reconciles book income to taxable income, except it breaks out the differences into either temporary or deferred differences pertaining to the rules of accounting for income taxes

Possible Taxes at S Corporation Level In a few cases, an S corporation may pay taxes on its income: 1. If an S corporation was previously a C corporation or if the corporation engaged in a tax-free reorganization with a C corporation (see built-in gain tax (the BIG tax) below) 2. If the S corporation has accumulated earnings and profits at the close of its tax year, has passive investment income in excess of 25% of gross receipts, and has taxable income at year-end, the corporation may pay a tax on the excess net passive income 3. The corporation may be liable for the additional tax due to LIFO (last in, first out) recapture if the corporation used the LIFO inventory pricing method for its last tax year as a C corporation or a C corporation transferred LIFO inventory to the corporation in a nonrecognition transaction 4. A corporation with net recognized built-in gain may owe tax on its built-in gains

Separately States K-1 Items 1. The shareholders' pro rata share items include items such as the following: a. Ordinary business income (loss) b. Net rental real estate income c. Interest income d. Dividends e. Royalties f. Charitable contributions g. Section 179 deduction h. Net short-term capital gain or loss Federal Taxation of Entities: S Corporations i. Foreign taxes paid to the government of a foreign country 2. These items as well as other deductible items, credits, and foreign transactions are listed separately on Schedule K and Schedule K-1 of Form 1120S

Termination and Re-Election 1. An S election may be revoked only with the consent of shareholders who hold more than 50% of the number of issued and outstanding shares of stock (including nonvoting stock) at the time revocation is made. a. The revocation may specify an effective revocation date that is on or after the day the revocation is filed b. If no date is specified, the revocation is effective at the start of a tax year, if the revocation is made on or before the 15th day of the 3rd month of that tax year 2. After an S election has been terminated, the corporation (or a successor corporation) can make another election on Form 2553 only with IRS consent for any tax year before the 5th tax year after the 1st tax year in which the termination took effect 3. An election terminates automatically in any of the following cases: a. The corporation no longer meets the eligibility tests to be an S corporation - This kind of termination of an election is effective as of the day the corporation no longer meets the eligibility tests b. The corporation, for each of 3 consecutive tax years: (1) Has accumulated earnings and profits (2) Derives more than 25% of its gross receipts from passive investment income (3) This kind of termination of an election is effective on the 1st day of the 1st tax year beginning after the 3rd consecutive tax year

Shareholder Schedule K-1 1. In most cases, an S corporation does not pay tax on its income 2. Instead, income, gain, deduction, loss, credit, etc. recognized at the corporate level are passed through to the shareholders 3. Each shareholder includes in his taxable income his pro rata share of each item of income, loss, deduction, or credit that is separately stated by the S corporation, regardless of whether or not a distribution was made to the shareholder 4. A shareholder's distributive share of loss is limited to the shareholder's stock basis in that corporation. a. Losses that exceed a shareholder's basis are disallowed for that year but can be carried forward indefinitely and deducted in a later year, subject to the basis limit for that year b. The adjusted basis of a shareholder in an S corporation is increased by any loans made by the shareholder to the corporation

Taxes 1. The following taxes are deductible: a. State and local taxes b. Real estate taxes c. Payroll (employer's share, not employee's portion) 2. The following taxes are not deductible: − Federal income taxes Organizational Costs 1. A corporation may deduct for the tax year: a. Up to $5,000 of organizational expenditures in the year expended b. The $5,000 deduction is reduced by the amount the total organizational costs exceed $50,000 c. Any remaining nondeducted organizational costs are amortized over 180 months Note: If organizational costs equal or exceed $55,000, the corporation can only amortize these expenditures 2. Organizational costs include attorney fees to draft articles of incorporation, bylaws, organizational and temporary directory meetings costs, and state incorporation fees 3. Organizational costs do not include syndication fees (i.e., cost of issuing and selling stock or securities such as commissions, professional fees, and printing costs)

Start-up Costs 1. A corporation may deduct for the tax year: a. Up to $5,000 of start-up costs in the year of the expenditure b. The $5,000 start-up deduction is reduced by the amount the total start-up costs exceed $50,000 c. Any remaining nondeducted start-up costs are amortized over 180 months C Corporations Part 3: Form 1120 2. Start-up costs include: a. An analysis or survey of potential markets, products, labor supply, transportation, or facilities b. Advertising and promotional costs for the opening of the business c. Employee training costs d. Insurance, license, and permit fees

Shareholders and Directors 1. Shareholders: a. Elect directors and approve removal of directors b. Approve dissolution 2. Directors: a. Set corporate policy b. Elect officers c. May terminate officers d. Declare dividends e. Must comply with articles of incorporation

Stockholder Rights—DIVAP

Corporate Taxes Filing Extension What about a filing extension? 1. The IRS will grant a 6-month extension of time to file a corporation income tax return if Form 7004 is filed, and 2. Any taxes due are paid by the original due date Note: The filing of Form 7004 does not extend the time a corporation has for paying taxes. Estimated Payment Dates 1. A corporation is required to make installment payments if the estimated tax is $500 or more 2. Installment payments are due by the 15th day of the 4th, 6th, 9th, and 12th months of the corporation's tax year a. In the case of calendar year-end corporations, payments are due by April 15th, June 15th, September 15th, and December 15th b. If any due date falls on a Saturday, Sunday, or legal holiday, the installment is due on the next regular business day

Underpayment Penalty 1. Corporations, like individuals, are subject to an underpayment penalty unless they paid estimate taxes of: a. 100% of last year's taxes and last year's tax was not zero or for less than 12 months, or b. 100% of this year's taxes 2. In the case of a Large C Corporation, it: Corporate Tax Filings and Underpayment Penalties 2 a. Can base only its first required installment on the prior year's tax, and b. Must base estimated payments on 100% of its current year's tax to avoid penalty Note: A Large Corporation is one with $1 million or more of taxable income in any of its 3 preceding tax years. 3. Given that S corporations usually do not pay taxes (because the shareholders do), see Instructions for Form 1120S for estimated taxes for an S corporation 4. The underpayment penalty: a. Is figured separately for each installment due date b. May apply to a corporation even if a refund is due when its return is filed c. Is figured for the period of underpayment rate determined under §6621; however, the penalty will not be imposed if the failure to pay on time was due to a reasonable cause d. Is not deductible