ACCT 642-01 Test #1

tax form for a partnership

Form 1065, reports the results of the partnerships business activities. most income and expense items are aggregated in computing the ordinary business income (loss) of the partnership on Form 1065.

Tax form for c corporation

Form 1120, computes tax on the taxable income reported on Form 1120 using the rate schedule applicable to corporations

Tax form for s corporation

1120S

Rules for (C corporation): Dividends Received Deduction

70%, 80% or 100% of dividends received depending on percentage of ownership by corporate shareholders. -DRD cannot exceed the taxable income limitation, equal to the corporations taxable income multiplied by the percentage that corresponds with the deduction percentage. -less than 20% ownership, 70% deduction percentage -20% or more (but less than 80%), 80% deduction percentage -80% or more, 100% deduction percentage. of taxable income.

AMT Adjustments listed

Depreciation of post-1986 real property Depreciation of post-1986 personal property Pollution control facilities Mining exploration and development costs Circulation expenditures Completed contract method Adjusted gain or loss Passive activity loss alternative minimum tax NOL deduction (negative) Loss limitation adjusted current earnings adjustment domestic production activities deduction

DPAD

Domestic Production Activities Deduction, a special deduction that is available for organizations with domestic production activities, including those in manufacturing, film production, construction, print media, engineering and power generation. Form 8903

DPGR

Domestic Production Gross Receipts

MPGE

Manufactured, produced, grown or extracted

Rules for (C corporation): Depreciation recapture for 1250 Property

recapture is limited to the excess of accelerated depreciation over straight line depreciation. corporations have more depreciation recapture on the disposition of 1250 property than individuals. under the section 291, a corporations will have additional ordinary income equal to 20% of the excess of the amount of depreciation recapture that would arise if the property was 1245 property over the amount of depreciation recapture computed under 1250

purpose of dividends received deduction

to mitigate multiple taxations of corporate income. -the DRD alleviates the inequity in double taxable by causing only some or non of the dividend income to be taxable to the recipient corporation

sole proprietorships and general partnerships face the danger of

unlimited liability

taxation of withdrawals/distributions from entity: sole proprietorships

withdrawals by owner are not subject to separate tax

AMTI tax preference items (all positive)

Percentage depletion in excess of adjusted basis accelerated depreciation pre-1987 real property Intangible drilling cost Private activity bond interest income

What code sections impose the AMT?

Sections 55-59

the "whys" of tax law: Political Considerations

Special Interest Legislation Political Expediency: certain provisions in the tax law can be explained on the basis of the political climate at the time of enactment.

sole proprietorship

a non table entity separator from the individual who owns the proprietorship

revenue neutrality

any changes neither increase nor decrease the net revenues under the prior rule

Rules for (C corporation): Charitable Contribution

both corporate and individual taxpayers may deduct charitable contributions if the recipient is a qualified charitable organization. generally only allowed in the year the contribution was made. however, an accrual basis corporation may claim the deduction in the year preceding payment if the contribution is authorized by the BOD by the end of that year and it is paid on or before the due date of the corporations tax returns.

taxation of withdrawals/distributions from entity: C corporations

character of entity income and expense not retained at shareholder level. instead, distributions to shareholders are generally taxes as dividend income. Preferential rates (0%/15%/20%) apply to qualified dividends

taxation of entity income: C corporations

corporate income tax applies. Marginal tax rates range from 15% to 39%.

CGS

cost of goods sold

taxation of withdrawals/distributions from entity: partnerships

distributions to partners are generally not subject to separate tax

taxation of withdrawals/distributions from entity: S corporations

distributions to shareholders are generally not subject to separate tax

partnership

not subject to a federal income tax.

Economic considerations: Encouragement of certain industries

1. Agriculture: base for a well balanced economy. can elect to expense rather than capitalize certain expenditures for soil and water conservation and fertilizers. 2. Natural Resources: permits the use of percentage depletion on the extraction and sale of oil and gas and specified mineral deposits. write offs of certain exploration costs. 3. Railroad and Banking 4. Manufacturing: the "domestic product activities deduction" stimulates the creation of jobs.

Rules for (C corporation): Organizational expenses

- a corporation may elect to amortize organizational expenditures over the 180 month period beginning with the month in which the corporation begins business. -expenditures that do not qualify as organizational expenditures include those connected with issuing or selling shares of stock or other securities or with transferring assets to a corporation. these expenditures reduce the amount of capital raised and are not deductible at all. -to qualify for the election, the expenditure must be incurred before the end of the taxable year in which the corporation begins business. -no separate statement or specific identification of the deducted amount is required.

a corporation is likely to pay an AMT for these reasons

- a high level of investment in assets such as equipment and structures. -low taxable income due to cyclical downturn, strong international competition, a low-margin industry or other factors. -investment at low real interest rates, which increases the company's deductions for depreciation relative to those for interest payments.

AMT adjustments to taxable income (explained)

- a portion of depreciation on property placed in service after 1986. Depreciate allowances for purposes of the AMT are generally much less favorable than for the regular corporate income tax. - when the bases' for depreciable assets are different a basis adjustment is necessary to reflect the difference in the AMT gain or loss and the regular tax gain or loss. -passive activity losses of certain closely help corporations and personal service corporations -the excess of mining exploration and development costs deducted over what would have resulted if the costs had been capitalized and written off over 10 years. -the difference between completed contract and percentage of completion reporting on long term construction contracts, for some contracts reported under the completed contract method. -amortization claimed on certified pollution control facilities. -the difference between installment and total gain, for dealers using the installment method to account for sales. The installment method is not allowed for AMTI purposes. -a portion of the difference between adjusted current earnings and unadjusted AMTI.

Equity considerations: Coping with Inflation

- any wage adjustment for inflation could place the employee in a higher income tax bracket. -overall effect is the erosion of purchasing power. - Congress began to adjust income tax components through indexations based on the rise of the consumer price index in 1984.

the "whys" of tax law: Equity Considerations

-Equity is not what appears to be fair or unfair to any one taxpayer or group of taxpayers. it is what the tax law recognizes. - the concept of equity in tax provisions that alleviate the effect of multiple taxation and postpone the recognition of gain when the taxpayer lacks the ability and wherewithal to pay.

Economic Considerations: Encouragement of Small Businesses

-a shareholder in a small business corporation can obtain an ordinary deduction for any loss recognized on a stock investment. -tax rates applicable to corporations tend to favor small businesses. if a corporations has taxable income above 100000 the benefits of the lower brackets go away.

Equity Considerations: Mitigating the Effect of the Annual Accounting Period Concept

-all taxpayers must report to and settle with the Fed at period intervals otherwise taxpayers would remain uncertain as to what the tax liability was and the gov't would have difficulty judging revenues and budgeting expenditures. -at the close of each year, a taxpayers position becomes complete for that particular year. -annual accounting concept - the effect is to divide each taxpayers life into equal annual intervals for tax purposes. -carryback or carry over procedures help mitigate the effect of limiting a loss or a deduction to the accounting period in which it is realized. - the annual accounting period concept has been modified to apply to situations in which taxpayers may have difficulty accurately assessing their tax position at year end.

Economic considerations: Control of the Economy

-congress has used depreciation write-offs as a means to control the economy -shorter asset lives and accelerated methods should encourage additional instruments in depreciable business property -longer asset lives and the required use of straight line depreciation dampen the tax incentives on capital outlays. -amount of write off allowed when asset is initially acquired

Rules for (C corporation): Domestic Production Activities Deduction

-deduction based on the income from manufacturing operations. - the domestic production activities deduction (DPAD) is 9% of the lower of qualified production activities income or taxable income (computed without DPAP). -for individuals the DPAD cannot exceed 50% of an employers W-2 wages related to qualified production activities income. -if no w-2 wages are paid no DPAD is allowed. -for a sole proprietor the deduction is claimed on the 1040, line 35, page 1. a for 8903 must be attached to support the deduction.

Categories of DPGR

-lease, rental, license, sale, exchange or other disposition of qualified production property -qualified films -production of electricity, natural gas, or potable water. -construction -engineering and architectural services for domestic construction

types of organizational expenditures

-legal services incident to organizations (drafting the corporate charter, bylaws, minutes of the organizational meetings) -necessary accounting services -expenses of temporary directors and of organizational meeting of directors or shareholders -fees paid to the state of incorporation

Limitations Imposed on Charitable Contribution Deductions

-like individuals, corporations are subject to percentage limits on the charitable contribution deduction. in any year, a corporate taxpayers contribution is limited to 10% of taxable income. any contributions in excess of 10% can be carried forward to the 5 succeeding tax years.

Schedule M-1 (SEE NOTES)

-of the Form 1120 is used to reconcile net income as computed for financial accounting purposes with taxable income reported on the corporations income tax return. -Schedule M-1 is required of corporations with less than $10 million in total assets.

Equity Considerations: Wherewithal to Pay Concept

-recognizes the inequity of taxing a transaction when the taxpayer lacks the means with which to pay the tax. -non taxability of like kind exchanges. WARNINGS: -recognized gain is merely postponed and not necessarily avoided. -wtp is suited for situations in which the taxpayers economic status has not changed significantly as a result of the transaction.

the "whys" of tax law: Revenue needs

-the foundation of any tax system has to be the raising of revenue to absorb the cost of government spending. -when enacting legislation congress is often guided by the concept of revenue neutrality.

Equity considerations: Alleviating the Effect of Multiple taxation

-the same income earned by taxpayers may be subject to taxes imposed by different taxing authorities. - fed tax law allows a taxpayer to claim a deduction for state and local income taxes. the deduction does not neutralize the effect of multiple taxation because the benefit derived depends on the taxpayers Fed income tax rate. for corporate taxpayers for whom triple taxation is possible the law provides a deduction for dividends received from certain domestic corporations -for individual shareholders, the income tax on qualified dividends ranges from 0%-20%. (lower tax rate mitigates the effect of multiple taxation)

the "whys" of tax law: Economic Considerations

-this process involves amending the IRC through tax legislation and emphasizes measures designed to help control the economy.

steps for applying rules for DRD

1. Multiply dividends received by the deduction percentage 2. Multiply the taxable income by the deduction percentage. 3. The deduction is limited to the lesser of Step 1 or Step 2, unless deducting the amount derived in Step 1 results in an NOL. If so, the amount derived in Step 1 is used. This is the NOL rule.

Economic Considerations: Encouragement of Certain Activities

1. Technological: tax law places the inventor in a special position. Patents can qualify as a capital asset and their disposition automatically carries long tern capital gain treatment. 2. Ecological: tax law permits 60 month amortization period for costs incurred in the installation of pollution control facilities. 3. Stimulating the development and rehabilitation of low income rental housing: tax law allows generous tax credits to tax payers incurring such costs. 4. Saving: saving leads to capital formation and this makes funds available to finance home construction and industrial expansion. Tax law provides incentives to encourage saving by giving private retirement plans preferential treatment.

after the initial year, a small corporation exemption applies if these two requirements are met.

1. the corporation must have been qualified as a small corporation exempt from the AMT for all prior years beginning after 1997. 2. Average annual gross receipts for the three-year tax period ending before its current tax year did not exceed $7.5 million ($5 million is the corporation has only one prior year).

How is ordinary business income treated in a partnership?

ordinary business income (loss) and the separately reported items are allocated to the partners according to the partnership's profit and loss agreement.

the "whys" of tax law: Influence of the IRS

IRS has been influential in the passage of much legislations designed to curtail the most flagrant tax avoidance practices.

the "whys" of tax law: Social Considerations

Instead of using loans, grants, and other programs to reach desired goals, congress often uses the IRC to provide incentives and benefits.

Are dividend distributions deductible by a C corporation?

No

QPAI

Qualified Production Activities Income, the excess of domestic production gross receipts over the sum of the COGS and other deductions and a ratable portion of deductions not directly allocable to such receipts. -If QPAI cannot be used in a particular year due to the taxable income limitation it is lost forever.

QPP

Qualified Production Property, includes TPP.

AMT calculation

Repeat definition

the "whys" of tax law

Revenue needs Economic Considerations Social Considerations Equity Considerations Political Considerations Influence of the IRS

tax form for a sole proprietorship

Schedule C or Form 1040, with the net profit and loss from the proprietorship used by the taxpayer to report taxable income

TPP

Tangible Personal Property, does not include real property (land, buildings). Does include automobiles, books, food, clothing, display racks and shelves. Non permanent machinery

Rules for (C corporations): Property Contributions

generally a charitable contribution of property results in a deduction equal to the property's fair market value at the date it is given. a sale of the property to recognize the loss, followed by a charitable contribution of the sale proceeds would produce a much more favorable result. - if the corporation contributes tangible personal property and the charitable organization puts the property to an unrelated use the deduction is limited to the basis of the property. -the deduction for a contribution of ordinary income property is limited to the basis of the property. the deduction for charitable contributions of capital gain property to certain private nonoperating foundations is also limited to the basis of the property. -on certain contributions of inventory by corporations, the amount of the deduction is equal to the less of the (1) sum of the property's basis plus 50 percent of the appreciate on the property of (2) twice the property's basis.

Rules for (C corporation): Depreciation Recapture for 1245 Property

generally equally applicable as1250 to both individual and corporate taxpayers.

taxation of entity income: S corporations

generally no separate income tax. s corporations income and expenses are allocated and reported (Schedule K-1) to shareholders who report these items on their 1040. character of entity income and expenses retained at shareholder level.

S corporations

governed by Subchapter S, generally do not pay federal income and general business income flows through to the shareholders (according to their ownership interest) to be reported on their separate return

C corporations

governed by subchapter C also known as regular corporations, subject to an entity level federal income tax

Net Operating Losses

like the net operating losses of an individual, the NOL of a corporation can be carried back 2 years and forward 20 to offset taxable income for those years. -corporations can elect to forgo the carryback period and just carry forward an NOL. -a corporation does not adjust its tax loss for the year for capital losses, because a corporation is not permitted a deduction for net capital losses.

taxation of entity income: Partnership

no separate entity level income tax. partnerships income and expenses are allocated and reported (Schedule K-1) to partners who report these items on their return 1040.

taxation of entity income: sole proprietorship

no separate entity level income tax. proprietorship income and expense are reported on the owners 1040 (Schedule C).