Chapter 5 - Corporate Tax

Difference between DEPRECIATION EXPENSE for book purposes & tax purposes:

- generally tax depreciation is more accelerated (MACRS) than book depreciation creating initially FAVORABLE differences - as the assets age, book depreciation will exceed tax depreciation, reversing the initially favorable difference, creating UNFAVORABLE differences

Business interest expense deduction is limited to:

-Business Interest Income, plus -30% times the adjusted taxable income MAX DEDUCTION - 30% EBITDA adjusted taxable income is: // without regard to: -any income/deduction which is not properly allocable to trade/business -interest income -interest expense -depreciation, amortization, and depletion -net operating loss carryovers

Dividends Received Deduction:

-Deduction to mitigate more than 2 levels of tax own less than 20% -- 50% own at least 20%-80% ---- 65% own 80% or more -- 100%

What are some common temporary book-tax differences?

-depreciation expense (fav) -gain/loss on disposition of depreciable assets (unfav) -bad debt expense (unfav) -unearned rent revenue (unfav) -deferred compensation (unfav) -warranty expense (unfav) -interest expense (unfav)

What are some common permanent book-tax differences?

-interest income from municipal bonds / tax-exempt income (fav) - fines & penalties & political contributions (unfav) -excess compensation to executives (unfav) -federal income taxes (unfav) -dividends received deduction (fav)

Inventories...

-must generally be accounted for under the accrual method if sales of goods constitute a "material" income-producing factor -average annual gross receipts of $25 million or less over the 3 prior tax years can opt to treat purchases of goods for sale as non-inventory -non-inventory -- cash method / hybrid method

What is the limitation for the Dividends Received Deduction?

1) Dividend x DRD % or 2) DRD modified taxable income x DRD % modified taxable income = taxable income before DRD, NOL, and capital loss carrybacks if full DRD extends or creates NOL, this limit does not apply FAVORABLE, PERMANENT btd

Required annual payment is least of:

1. 100% of tax liability on prior year return 2. 100% of current year tax liability -- but don't know until end of year 3. 100% of estimated current year tax liability using annualized method

What is the order of "special" C Corporate deductions?

1. Charitable Contributions Deduction (CCD) 2. Dividends Received Deduction (DRD) 3. NOL

The charitable contribution deduction is limited to...

10% of taxable income BEFORE deducting -any charitable contribution deduction (CCD) -dividends received deduction (DRD) -capital loss carrybacks (NOL) -carry forward excess contributions for 5 years BTD: year generate carryover -- UNFAVORABLE, TEMPORARY year utilize carryover -- FAVORABLE, TEMPORARY

Corporate returns are due...

3 1/2 months after the close of tax year automatic six month extension for filing

Estimated Payments --

Corporations with a federal income tax liability of $500 or more are required to pay their estimated income tax in four monthly installments due on the 15th day of: 4th month (25% of required annual payment) 6th month (50% of required annual payment) 9th month (75% of required annual payment) 12th month (100% of required annual payment) Corporations may owe a penalty for underpayment

Bad Debt Expense:

Financial reporting: ALLOWANCE METHOD -estimate the amount sales on credit that business will not be able to collect / recognize estimated bad debt expense as sales are recognized Tax purposes: DIRECT WRITE-OFF METHOD - Deductible ONLY when debt actually becomes worthless within the taxable year - Businesses reporting taxable income on the cash method are NOT allowed to deduct bad debt expenses because they do not include receivables in taxable income

temporary book-tax difference:

REVERSE over time such that, over the long-term, corporations recognize the same amount of income or deductions for the items on their income statements as they recognize on their tax returns

UNICAP...

for tax purposes, inventory (purchased or produced) must be accounted for using tax version of "full absorption" rules - include direct and indirect costs associated with inventory - indirect costs are allocated to inventories (not expensed) - exception for "small" businesses (average annual gross receipts < $25 million) - new in 2018

Difference between GAIN OR LOSS for tax & book purposes when company sells/disposes of depreciable property:

generally arises because of depreciation expense, & thus the adjusted basis of the asset is different for tax & book purposes / essentially the reversal of the BTD related to depreciation expense for the asset disposed

(Acquired Goodwill) when a corporation acquires the ASSETS of another entity (taxable transaction) it allocates part of the price to goodwill...

tax: purchase goodwill = straight line over 15 years (180 months) book: goodwill subject to impairment testing BTD: when tax amort > book impairment expense -- FAVORABLE, temporary difference when tax amort < book impairment expense -- UNFAVORABLE, temporary difference

Regular tax liability...

flat tax rate = 21% blended for corporations with fiscal years beginning before 12/31/17 and ending in 2018 blended rate is used with days

unfavorable book-tax difference:

add back to book income to reach taxable income, because it increases taxable income relative to book income book income (low), tax income (high)

Business Interest Limitation:

does not apply to any taxpayer that with average annual gross receipts of $25 million or less for the prior three taxable years -- BIG COMPANIES ONLY

permanent book-tax difference:

arise from items that are income or deductions during the year for either book or tax purposes but not both NEVER REVERSE

To compute taxable income, most corporations begin with...

book (financial reporting) income and then make adjustments for book-tax differences to reconcile to the tax numbers.

(stock options) Incentive Stock Option // ISO:

book: initial estimated fair value of stock options/requisite service period -- BOOK COMPENSATION EXPENSE (until vesting period) tax: NO DEDUCTION BTD: UNFAVORABLE, PERMANENT

(stock options) Nonqualified Stock Option // NQSO:

book: initial estimated fair value of stock options/requisite service period -- BOOK COMPENSATION EXPENSE (until vesting period) tax: deduction during EXERCISE = fair market value of the stock - exercise price x amount of shares aka BARGAIN ELEMENT BTD: FAVORABLE, TEMPORARY

Charitable Contributions:

capital gain property -- generally fair market value ordinary income property -- generally adjusted basis accrual method corporation -- deduct when accrue if -approved by board of directors before year end -paid within 3 1/2 months after end of year

Compliance...

corporations report taxable income on Form 1120 -small corporations complete schedule M-1 -large corporations complete schedule M-3 BTD: referred to as M adjustments Consolidated tax returns -- affiliated groups essentially treated as one corporation

How do the books calculate dividend deductions?

depends on ownership -If ownership <20% - NO BOOK TAX DIFFERENCE -If ownership is at least 20% but not more than 50%, receiving corporation does not include dividend in income but includes pro-rata share of distributing corporation's income in its income -If ownership > 50%, consolidated financial reporting and intercompany dividends are eliminated for book purposes SO if <20% - passive/fv NO BOOK TAX DIFFERENCE if at least 20%, EQUITY method -- % ownership x net income

For calculating equity method for dividends...

dividend amount = taxable income book income = % ownership x net income

Annualized Income Method:

most popular method of determining estimated tax rules for large corporations -- $1,000,000 of taxable income in prior three years may use prior year liability for first quarter payment only

Net Operating Loss Deduction:

no current benefit from current year loss --- NOL -- UNFAVORABLE NOLs from tax years beginning after 12/31/17 can be carried forward INDEFINITELY; offset is limited to 80% of taxable income NOLs from pre-2018 tax years can be carried back 2 years and forward 20 years BTD: year generate NOL - unfavorable, temporary year utilize NOL - favorable, temporary

Net Capital Losses:

no current deduction for net capital losses (capital losses in excess of capital gains) carry back 3 YEARS and carry forward 5 YEARS unfavorable, temporary BTD in year of net capital loss favorable, temporary book-tax difference in year carryback or carryover is utilized

favorable book-tax difference:

subtract from book income to reach taxable income, it decreases taxable income relative to book income book income (high), tax income (low)

What is the difference for dividends between tax and books?

tax = dividends received included in gross income books = depends on ownership

(Acquired Goodwill) when a corporation acquires the STOCK in a cash taxable transaction...

tax: basis of the assets carries over unchanged book: required to report target corporations' identifiable assets at fair value with any residual value allocated to goodwill / subject to impairment testing BTD: does not arise UNTIL goodwill is written off as impaired for book purposes - UNFAVORABLE, PERMANENT