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Chapter 15
Corporate Taxation
“Corporations don’t pay taxes, they collect
them.”
-- Paul H. O’Neill
McGraw-Hill Education
Copyright © 2015 by the McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or
distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website in whole or part.
LO #1 Corporate Formation and
Filing Requirements
• Corporations are legal entities formed
under the laws of a state.
• Corporations can use the cash-basis of
accounting if average gross receipts <=
$5 million or if inventory is not a material
factor.
15-2
LO #1 Corporate Formation and
Filing Requirements
• Corporations are not limited to a
calendar year fiscal year. They can
choose any fiscal year in their first year
of operation.
• Corporations file a Form 1120.
• Tax returns are due 2.5 months after the
fiscal year-end
– Can obtain an automatic 6-month extension
using Form 7004.
15-3
LO #1 Corporate Formation and Filing
Requirements – Concept Check 15-1
1. A corporation can use either the cash or
accrual method of accounting. True or False?
False
2. Corporate tax returns are due ________ if no
extension is requested.
2.5 months after the end of the fiscal year
3. The tax year of a corporation must end on
December 31. True or False?
False
15-4
LO # 2 - Basis
• On formation of a corporation,
transferors are exchanging cash and/or
property for stock.
• Generally, on corporate formation, no
gain is recognized by the transerors if,
immediately after the transfer, the
transferors control 80% or more of the
corporation.
15-5
LO # 2 - Basis
• Two cases in which gain may be
recognized by the transferor(s):
– 1. If shareholder contributes an asset
subject to a liability and the relief of liability
is greater than basis then the gain
recognized will be equal to the excess.
– 2. Cash or other property received (boot)
triggers gain equal to the lesser of the boot
received or the gain
15-6
LO # 2 - Basis
• Basis of the contributed property to the
corporation (inside basis)
– Equal to the basis in the hands of the
shareholder plus any gain recognized by
the shareholder
15-7
LO # 2 - Basis
• Basis of the stock to the shareholder
(outside basis)
– Equal to the basis of the property
contributed, plus any gain recognized,
minus any boot received (boot includes any
relief of liability).
• Unless shareholder increases or
decreases his or her proportionate
ownership, outside basis generally does
not change.
15-8
LO # 2 – Basis
Concept Check 15-2
1. When forming a corporation, if the transferors control
at least 80% of the corporate entity, then the
formation will generally be tax free. True or False?
True
2. The basis to the corporation of property received is
equal to _______________.
Shareholder basis plus gain recognized by shareholder.
3. Arturo contributed land with a fair value of $100,000
and basis of $40,000 to a newly-formed corporation in
exchange for 90% of the stock. Arturo’s basis in the
stock is ______________.
$40,000
15-9
LO #3 – Taxable Income & Tax
Liability
• Determination of taxable income
generally follows the rules associated
with a trade or business (Chapter 6).
– For corporations, the notion of AGI does
not exist.
15-10
LO #3 – Taxable Income & Tax
Liability
• Capital gains and losses are netted
together.
• Net capital losses are not permitted.
– If a corporation has a net capital loss, it can
carry it back three years and then forward
five years.
• Only offsets net capital gains in the carryback or
carryforward periods.
• Net capital gains are included in income
and are taxed at ordinary rates.
15-11
LO #3 – Taxable Income & Tax
Liability
• Charitable contributions are limited to
10% of taxable income before charitable
contributions, DRD, and carrybacks.
– Excess is carried forward five years.
• Contribution amount for “ordinary
income property,” such as inventory, is
limited to basis.
15-12
LO #3 – Taxable Income & Tax
Liability
• Corporations receive a Dividends
Received Deduction (DRD) for dividends
from other domestic corporations.
– DRD is 70% if ownership is < 20%
– DRD is 80% if ownership => 20% or < 80%
– DRD is 100% ownership => 80%
• DRD may be limited.
15-13
LO #3 – Taxable Income & Tax
Liability
• Organizational expenses and start-up
expenses can be amortized and
deducted over 180 months
– Corporation must make affirmative election.
– Some org expenses and/or startup
expenses may be immediately deductible.
15-14
LO #3 – Taxable Income & Tax
Liability
• Taxable income is subject to tax rates of
up to 35%.
– Tax rate schedule is progressive, but the
benefit of lower rates for lower income is
recaptured as taxable income increases.
15-15
LO #3 – Taxable Income & Tax
Liability
• Corporations must make estimated
payments
– Payment is lesser of 100% of tax due for
the year or 100% of the tax for the prior
year.
– Due on 15th day of fourth, sixth, ninth, and
twelfth months of fiscal year.
– Underpayment penalty applies if payments
are not sufficient.
15-16
LO #3 – Taxable Income & Tax
Liability
• If a corporation has a net operating loss,
it can be carried back two years and
then carried forward 20.
– Corporations can make an irrevocable
affirmative election to carry the NOL only
forward.
15-17
LO #3 – Taxable Income & Tax
Liability – Concept Check 15-3
1. Corporations follow the same tax rules for
capital gains as do individuals. True or
False?
False
2. The tax liability of a corporation with taxable
income of $520,000 is ___________.
$176,800
15-18
LO #3 – Taxable Income & Tax
Liability – Concept Check 15-3
3. A corporation reported taxable income
of $390,000 before charitable
contributions. The corporation made
charitable contributions of $50,000. Its
permitted deduction for charitable
contributions in the current tax year is
________.
$39,000
15-19
LO #3 – Taxable Income & Tax
Liability – Concept Check 15-3
4. Organizational expenses are automatically
deductible over 180 months. True or False?
False
5. Corporate net operating losses from 2012
can be carried back ____ years and forward
____ years.
2 years, 20 years
15-20
LO #4 – Transactions with
Shareholders
• Corporations have earnings and profits
(E&P). It is similar, but not identical, to
retained earnings
– E&P is based on tax law, not accounting
rules
• Distributions of cash or property from
E&P are dividends
– Taxable to shareholders
– Not deductible by the corporation
15-21
LO #4 – Transactions with
Shareholders
• Distributions in excess of E&P
– Nontaxable to shareholder to the extent of
shareholder basis in the stock
– A capital gain to the extent the distribution
exceeds basis.
15-22
LO #4 – Transactions with
Shareholders
• Distribution of property with FMV in
excess of basis
– Corporation reports gain (write-up to FMV)
– Amount of distribution to shareholder is
based on FMV.
15-23
LO #4 – Transactions with
Shareholders
• Distributions in full liquidation
– Corporation records all assets and liabilities
at FMV and records gain or loss
– Shareholder reports capital gain or loss
equal to the FMV of the distribution
compared to stock basis.
15-24
LO #4 – Transactions with
Shareholders – Concept Check 15-4
1. Dividends are always taxable to a shareholder. True
or False?
True
2. If a corporation pays a dividend in property, the
stockholder will have a dividend equal to the
corporate basis in the property. True or False?
False
3. A corporation has earnings and profits of $10,000
and makes a cash distribution to its sole shareholder
in the amount of $11,000. The amount of taxable
dividend to the shareholder is ______________.
$10,000
15-25
LO #5 – Schedules L, M-1 and M-3
• Schedules L, M-1, and M-2 are all on
page 5 of the Form 1120.
– Small corporations are not required to
complete these schedules.
• Schedule L is a beginning and ending
balance sheet reported in accordance
with the financial accounting method of
the corporation.
15-26
LO #5 – Schedules L, M-1 and M-3
• Schedule M-1 is a reconciliation from
book income to taxable income (not the
other way around).
• Schedule M-1 sets forth all book/tax
differences for the year, whether
permanent or temporary.
15-27
LO #5 – Schedules L, M-1 and M-3
• Some items that are a positive
adjustment (added back) from book
income to taxable income:
– Income tax expense per books
– Excess capital losses
– Disallowed current year charitable
contribution
– Book depreciation in excess of tax
depreciation
– 50% of travel and entertainment expense
15-28
LO #5 – Schedules L, M-1 and M-3
• Some items that are a negative
adjustment (subtracted) from book
income to taxable income:
– Life insurance proceeds
– Tax exempt interest
– Tax depreciation in excess of book
depreciation
– Charitable contributions in excess of 10%
limit in prior year
15-29
LO #5 – Schedules L, M-1 and M-3
• Schedule M-3 is a comprehensive
book/tax reconciliation for large
corporations.
– Total assets of $10 million or more.
15-30
LO #5 – Schedules L, M-1 and M-3 –
Concept Check 15-5
1. Completion of Schedule L is required of all
corporations. True or False?
False
2. Schedule M-1 reconciles book income to taxable
income. True or False?
True
3. A corporation’s depreciation expense is lower on the
financial statements than it is on the tax return.
Would this difference be a negative or positive item
on Schedule M-1?
Negative
15-31
LO #6 – Other Corporate Issues
• Parent-subsidiary group
– A common parent owns, directly or
indirectly, at least 80% of one or more other
corporations.
– Can elect to file a consolidated return.
– If elected, the election is irrevocable for all
future tax years.
15-32
LO #6 – Other Corporate Issues
• Brother-sister group
– Five or fewer persons own two or more
corps
• Total ownership test – group owns at least 80%
of the voting shares
• Common ownership test – group has common,
identical, ownership of at least 50% of share
value
– Must disclose to IRS.
15-33
LO #6 – Other Corporate Issues
• Larger corporations are subject to AMT
– Start with taxable income, add or subtract tax
adjustments, add tax preference items, subtract
exemption amount.
– Preferences similar to individuals
• Additional corporate item is the adjusted current earnings
(ACE) adjustment
– Exemption amount is $40K
• Phased out 25 cents on the dollar for AMT income over
$150K. Exemption is totally phased out for AMT income
of $310K or more.
– AMT rate is 20%
15-34
LO #6 – Other Corporate Issues
Concept Check 15-6
1. To be considered a parent/subsidiary group, the
parent corporation must own, directly or indirectly, at
least ____ percent of the subsidiary corporation.
80%
2. A brother-sister group may exist if ______ or fewer
persons own two or more corporations.
Five
3. For AMT purposes, the corporate exemption amount
is $________.
$40,000
15-35
LO #7 – Subchapter S Corporations
• Subchapter S corporations are “regular”
corporations that affirmatively elect to be
taxed in a manner similar to a
partnership
• File a Form 1120S
• Filing deadlines and extension rules are
the same as Subchapter C corporations
15-36
LO #7 – Subchapter S Corporations
• Must meet four tests to elect Sub S
status:
– Be a domestic corporation
– Have 100 or fewer shareholders
– Have one class of stock
– Have shareholders who are U.S. citizens or
resident aliens.
15-37
LO #7 – Subchapter S Corporations
• Sub S corporations report taxable
income and separately stated items
– Separately stated items are very similar to
those reported by a partnership
• Sub S corporation does not pay tax.
The shareholders do.
15-38
LO #7 – Subchapter S Corporations
• Shareholder basis is determined similar
to a partnership except corporate debt
does not affect shareholder basis.
• Basis increased by:
– Net income
– Separately stated positive items
– Capital contributions
– Loans from the shareholder to the
corporation
15-39
LO #7 – Subchapter S Corporations
• Basis is decreased by:
– Net losses
– Separately stated negative items
– Distributions from the corporation at FMV
• Basis cannot go below zero.
– If negative basis is implied, the amount is
carried forward.
15-40
LO #7 – Subchapter S Corporations
• Subchapter S distributions are not
taxable to shareholders
– Shareholders have already been taxed on
the income
– Similar to a partnership in that income is
taxed and distributions are generally not
taxed.
15-41
LO #7 – Subchapter S Corporations
Concept Check 15-7
1. Corporations with fewer than 100
shareholders are automatically considered
Subchapter S corporations. True or False?
False
2. A Subchapter S corporation is taxed in a
manner similar to a partnership. True or
False?
True
3. Subchapter S corporations file a Form
______.
1120S
15-42
LO #7 – Subchapter S Corporations
Concept Check 15-7
4. Alyssa is a shareholder in a Subchapter S
corporation and has a basis of $1,000 in her
stock. The corporation gives her a $200 cash
dividend. Is this dividend taxable or not
taxable to Alyssa?
Not taxable
5. Similar to a partnership, shareholders of a
Subchapter S corporation increase the basis
of their stock by their share of corporate
debts. True or False?
False
15-43