Business Taxation: Unit 12: C Corporations In General
Basic Concepts
1. Perpetual life and limited liability: A C Corporation enjoys perpetual life and limited liability. 2. Double taxation: Earnings of a C Corporation may be taxed twice: first at the corp. level and again at the shareholder level if they are distributed as dividends. Shareholders of a C Corporation cannot deduct corporate losses. 3. Shareholder meetings: A corporation must maintain a list of all its shareholders, and generally must conduct at least one shareholder meeting per year. 4.Organization: A C Corporation must file a charter, issue stock, and be overseen by a board of directors. 5. Number of shareholders: A C corporation may have a single owner-shareholder or an unlimited number of shareholders. 6. Articles of incorporation: A corporation's existence starts when articles of incorporation are filed with the state office that handles incorporations (usually the Secretary of State), along with any required filing fees. 7. Liquidation: If a C corporation liquidates, it will recognize gain or loss on the sale or distribution of its assets. Corporate shareholders then recognize gain or loss on the surrender of their stock to the corporation. 8. Stock: A C corporation may sell common and/or preferred stock with different voting rights. 9. Tax-free fringe benefits: A C corporation's shareholder-employee can receive tax-free employee fringe benefits that are deductible by the corporation as a business expense.
Accumulated Earnings Tax
> A corporation is allowed to accumulate a reasonable portion of its earnings for possible expansion or other bona fide business reasons. However, a corporation may be subject to the accumulated earnings tax if it does not distribute enough of its profits to shareholders. This tax was instituted to prevent corporations from hoarding income in order to avoid income tax on distributions for its shareholders. > Note: The accumulated earnings tax is levied at a rate of 20% of the excess amount accumulated. It is ot automatically applied; it is assessed only after audit. A corporation would have the opportunity to try to justify the amount of its accumulated earnings during an IRS examination. > If the accumulated earnings tax applies, interest is also assessed from the date the corporate return was originally due, without extensions. >>>An accumulations of $250,000 or less is generally considered reasonable for most businesses. However, for personal service corporations, the limit is $150,000. "Reasonable needs" of the business include the following: -Specific, definite, and feasible plans for use of the earnings accumulation in the business. Specific examples include: 1. the expansion of the company to a new area or a new facility. 2. Acquiring another business through the purchase of stock or assets. 3. Providing for reasonable estimates of product liability losses. >>The amount necessary to redeem the corporation's stock included in a deceased shareholder's gross estate, if the amount does not exceed the reasonably anticipated total estate and inheritance taxes and funeral and administration expenses incurred by the shareholder's estate.
Contributions of Capital to a Corporation
> A corporation is initially formed by a transfer of money, property, or services by prospective shareholders in exchange for stock in the corporation. A transfer of assets may also take place when a business that previously operated as a partnership or sold proprietorship opts to become a corporation. > Contributions to the capital of a corporation are generally not taxable transactions to the corporation, whether or not they are made by the shareholders. The shareholder's basis in the stock is the amount of cash contributed.
Filing Requirements for C Corporations
> A domestic corporation in existence for any part of a tax year (including corporations in bankruptcy) must file an income tax return, regardless of its taxable income or activity. A C corporation file Form 1120, U.S. corporation Income Tax Return. There are some specialized forms for other types of corporations, such as foreign corporations, which must file Form 1120-F. Tax-exempt organizations organized as corporations file Form 990 rather than Form 1120. > A corporation must continue to file tax returns even if there is no business activity or profits. However, it does not have to file after it has formally dissolved. >>A corporation must generally file by the fifteenth day of the fourth month after the end of its tax year. Thus, a calendar-year corporation must typically file its tax return by April 15 of the following year.
Example: 351 Exchange
> Barney transfer property with a basis of $100,000 to a corporation in exchange for stock with a fair market value of $300,000. This represents only 75% of each class of stock of the corporation. The other 25% was already issued to other persons. Barney must recognize a taxable gain of $200,000 on the transaction, because the transfer does not qualify for section 351 nonrecognition treatment. Instead, it is treated as a sale.
Accounting Methods for Corporations: Know for Exam
> Like other entities, C corporations may generally use any permissible accounting method for keeping track of income and expenses. A corporation generally chooses its accounting method when it files its first tax return. > The "nonaccrual experience method" is a method of accounting for bad debts. If a corporation uses the accrual method of accounting and qualifies to use the nonaccrual experience method for bad debts, it is not required to accrue service-related income that it expects to be uncollectible. >>Accrual-method corporations are not required to maintain accruals for certain amounts from the performance of services that, on the basis of their experience, will not be collected if: -The services are in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting (i.e. personal service corporations);or -The corporation's average annual gross receipts for the three prior tax years do not exceed $25 million. >>>This provision does not apply if the corporation charges interest on late payments, or if it charges customers any penalty for failure to pay an amount timely. Further, a corporation cannot use this method for amounts owed from activities such as lending money, selling goods, or acquiring receivables.
C Corporations
> Most major companies are organized as C corporations, which are taxed under subchapter C of the Internal Revenue Code. A C Corporation can own property in its own name and it can be sued directly. The shareholders who own stock in a corporation do not own its individual assets. Individual shareholders are protected from legal liability, except in very unusual circumstances. >>The IRS requires certain businesses to be taxed as corporations. The following businesses formed after 1996 are automatically treated as corporations: -A business formed under a federal or state law that refers to it as a corporation -A business formed under a state law that refers to it as a joint-stock company -Insurance companies -Certain banks -A business owned by a state or local government -A business specifically required to be taxed as a corporation by the IRC (for example, certain publicity-traded partnerships) -Certain foreign businesses -Any other business that elects to be taxed as a corporation and files Form 8832, Entity Classification Election
Contributions of Capital to a Corporation: More information: Know for Exam!!
> the basis of property contributed to a corporation's capital by anyone other than a shareholder is zero. Example: The city of Phoenix, Arizona gives Ales Motors Corp. a plot of land as an enticement to locate its new manufacturing facility there. Ales Motors accounts for the property as a contribution to capital. The land has zero basis since the property was contributed by a non-shareholder.
Late Filing Penalties
>A penalty for late filing is assessed at 5% of any unpaid tax for each month the return is late, up to a maximum of 25% of the unpaid tax on the return. The late filing penalty is reduced by any late payment penalty for the same period. > In 2019, the minimum late filing penalty for Form 1120 has increased. If filed more than 60 days late, is $435 or the amount of tax owed, whichever is smaller. >The penalty for late payment of corporation income tax is one-half of 1% of the unpaid tax for each month that the tax is not paid, up to a maximum of 25% of the unpaid tax.
Corporate refunds and Ammendments
>Corporations may use Form 1139, Corporate Application for Tentative Refund, or Form 1120X, Amended U.S. Corporation Income Tax Return, to apply for a refund of overpaid tax. >Generally, the corporation must file Form 1139 within 12 months of the end of the tax year in which an NOL, net capital loss, unused credit, or claim of right adjustment arose. If a corporation does not file Form 1139, it must file Form 1120X to apply for a refund. Form 1120X must be filed within 3 years of the due date, including extensions, for filing the return for a year in which it sustains a loss. >>If a corporation accidently overpays its estimated tax, it may use Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax, to obtain a quick refund of its estimated tax payments. Form 4466 must be filed before the corporation file its tax return. Form 4466 may be used if a corporations overpayment is at least 10% of its anticipated tax liability and at least $500.
Section 351: Nontaxable corporate transfers: KNOW FOR EXAM!
>If a taxpayer transfer property to a corporation in exchange for stock, and immediately afterward, the taxpayer controls the corporation, the exchange may not be taxable. This rule applies both to individuals and to entities that transfer property to a corporation. It also applies whether the corporation is being formed or is already in operation. The effect is to allow the investing shareholder to contribute assets to a corporation without immediate tax consequences, and to defer recognition of taxable gain until the stock received is later disposed. This nonrecognition rule does not apply in the following situations: -The corporation is an investment company. -The taxpayer transfers the property in a bankruptcy proceeding in exchange for stock that is used to pay creditors. -the stock is received in exchange for the corporations debt (other than a security, such as a bond) or for interest on the corporation's debt (including a security) that accrued while the taxpayer held the debt. >>In order to be considered "in control" of a corporation immediately after a section 351 exchange, the transferors must own at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock.
Example: 351 Exchange w/ Provided Services
>This nonrecognition rule does not apply to services that are rendered in exchange for stock. The value of stock received for services is income to the recipient. >>Example: Charles is an architect. During the year, he transfers drafting equipment worth $35,000 and provides architectural design services valued at $4,000 to a corp. in exchange for stock valued at $39,000. Immediately after the exchange, Charles owns 85% of the outstanding stock. No gain is recognized on the exchange of the equipment. However, Charles must recognize ordinary income of $4,000 as payment for professional services he rendered to the corporation.
Corporate Taxation
>Unlike a sole proprietorship, partnership or an S corporation, a C corporation is not a pass-through entity. A C corporation pays tax on its earnings and can accumulate income. >C corporation may pay a lower tax rate on profits and even defer taxes on profits, but the disadvantage is that the earnings of a C Corporation may be taxed twice. >Corporate income is taxed when it is earned by the corporation, and then may be tax again when it is distributed to shareholders as dividends. A corporation does not receive a tax deduction for the distribution of dividends to its shareholders. >A C corporation's income does not retain its character when it is distributed to shareholders. >>It is distributed merely as a dividend. This also applies if the corporation earns tax-exempt income. For example, a C Corporation may earn tax-exempt income from investing in municipal bonds. If this income is used to make distributions to shareholders, its tax-exempt character is lost, and the distributions will be taxable dividends to the shareholders.
E-filing mandate for C Corporations
Electronic filing is mandatory for C Corporations with $10 million or more in assets and/or at least 250 or more returns of any type (in 2019), including information returns such as Form W-2 or Forms 1099. >>>Example: Kemmler Pharmaceuticals is a domestic C Corporation. In 2019, Kemmler has $4 million in assets. Kemmler has 70 employees and will file 70 Form W-2 forms for the year. Kemmler also has 200 independent contractors that will receive a Form 1099-MISC from the company. for the purposes of the e-file mandate, Kemmler Pharmaceuticals is required to e-file their corporate return, because they have reached the 250 "return limit"
Corporate Refunds: Example
Example: Assurance Holdings, Inc. is a C Corporation that reports its income and loss using the cash method. Assurance Holdings made regular estimated payments throughout the year based on its current-year tax liability. On December 1, 2019, Assurance holdings suffers a financial loss when a fire destroys its main office building. After this catastrophic event, Assurance Holdings expects to have a net operating loss for the year. The corporation files Form 4466 on December 15, 2019, to obtain a quick refund of its overpaid estimated tax.
Contributions of Capital to a Corporation: Example
Example: Evie purchases 75 shares of Rock Cola, Inc. stock. she is not a professional stockbroker or dealer. She purchases the stock through her online brokerage account, spending $6,525 to acquire the shares. Her basis in the shares is her cost ($6,525 total or $87 per share). Rock cola does not recognize income from this transaction, and it is not a taxable event to either party. Later, when Evie sells the shares, she may have to recognize a taxable gain or loss. While Evie owns the share, they are treated as a capital asset in her hands.
