Download Parent-subsidiary

Specific Rules Applicable to
Corporations
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Capital Gains and Losses
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No alternative taxes
Simplified netting of gains and losses
Capital gains taxed at regular rates
Capital losses only offset capital gains;
carry-back 3 years, carry-forward 5 years
(all become STCL)
Calculation of Taxable Income

Revenues – Deductions – NOL & Dividends
Received Deduction.
Specific Rules Applicable to
Corporations
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Net Operating Losses
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Calculation is usually simple: Revenues –
Deductions
Dividends Received Deduction
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Based on % ownership
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Less than 20% ownership
20% - 79.99%
80+
70% deduction
80
100
Limited to 80/70% taxable income unless
corporation has or generates an NOL.
Generally carry back 2 years and carry
forward 20 years with an election to carry
forward.
Specific Rules Applicable to
Corporations
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Charitable Contributions
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Limited to 10% of taxable income before
contributions and special deductions
(dividends received deduction, NOL &
Capital Loss Carry-back)
Carry-forward unused amounts for 5 years.
Accrual basis corporations must pay
authorized contributions within 2 ½
months of the succeeding tax year.
Computation of Tax
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Graduated Rates
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For most mid sized C corporations the rate is
34 %
Corporations have an alternative minimum
tax.
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Structure is similar to individuals except for:
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ACE adjustment
No itemized deductions
Exemption is $ 40,000
AMT rate is 20%
Computation of Tax--Continued
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Penalty Taxes
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Accumulated Earnings Tax (Rare)
Personal Holding Company Tax
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Relates to closely held corporations with
passive (investment) income
Rate coincides with the highest individual
rate.
Controlled Groups
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Two types:
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Brother-sister
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Parent-subsidiary (more common)
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5 or fewer individuals, estates or trusts own at
least 80% of the voting power or value of all
classes of stock of each corporation.
Shareholders commonly own more than 50% of
the total voting power or value of all classes of
common stock, (identical interest)
A common parent owns at least 80% of the stock
of at least one subsidiary corporation.
At least 80% of the stock of each other member is
owned by the other members of the controlled
group.,
Review handout on controlled groups
Controlled Groups--Continued
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Combined Controlled Groups
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Computation of Tax
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Common parent owns at least 80% of at least one
subsidiary corporation and
The common parent corporation is a member of a
group of corporations that constitute a brother-sister
group.
A controlled group must apportion the lower tax
rates among group members as if only one
corporation existed.
Consolidated Returns
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Must be members of an affiliated group (parent/sub)
relationship. Certain corporations are not permitted
to members of the group.
Transfers of Property to a Controlled
Corporation § 351
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No gain or loss if certain conditions are met:
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Property (other than services) is transferred to the
corporation in exchange for stock in the transferee
corporation.
Immediately after the exchange the transferor
shareholders in aggregate control the transferee
corporation by owning at least 80% of the stock.
Gain is recognized for specific transactions:
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If the transferor receives money or property (and
also to the corporation if it transfers appreciated
property)
Character of the gain is determined by the character
of the assets transferred to the transferor.
Transfers of Property to a Controlled
Corporation--Continued
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Basis of stock received by the
transferor:
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Basis of Property transferred to corporation
+ Gain recognized – money received
(including liabilities transferred to
corporation) – FMV of property received =
Basis of stock received.
Basis of Property received by the
transferee corporation:
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Basis of Property = Adjusted basis of
property to transferor + Gain recognized by
transferor
Transfer of Property to a Controlled
Corporation
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Treatment of Liabilities
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Treatment of Gain—Under § 357(a) no
gain or loss is recognized by the
transferee corporation.
Exceptions for:
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Tax Avoidance Arrangements § 357(b)
Total liabilities transferred are in excess
of the basis of the total assets transferred
§ 357 (c)
Earnings & Profits § 312
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Similar in many ways to accrual basis retained
earnings, not defined in the Code.
Current versus Accumulated E & P § 316
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Distributions to shareholder’s come first from current
E&P
Accumulated E & P represent the total of all prior
years’ undistributed current E & P as of the first day
of the tax year. Distributions are deemed to be made
out of AEP only after current E & P is exhausted.
If total E & P is 0 or negative, distributions reduce
the shareholder’s stock basis.
Distributions in excess of the shareholder’s stock
basis are capital gains.
Distributions of Property
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Tax Consequences to the Shareholder
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The amount distributed equals the FMV of
the property (reduced by any associated
liabilities)
The amount distributed is treated as a
taxable dividend if the corporation has
sufficient E & P
The basis of the distributed property equal
its FMV.
Tax Consequences to Distributing Corporation
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No gain or loss, except gain on distributions
of appreciated property.
Stock Redemptions
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Two possible tax consequences:
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Redemption treated as a taxable dividend to the
extent of E & P
The redemption is treated as an exchange of stock
(Capital gain treatment)
Determining whether a redemption is a
dividend or capital gain:
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§ 302(b)(2) redemption is substantially
disproportionate with respect to the shareholder’s
interest. CG
§ 302(b)(3) complete termination of a shareholder’s
interest. CG
§ 302(b)(4) partial liquidation—CG for non-corporate
shareholder
Review examples 25 & 26 on page 20-23
Corporate Distributions in Complete
Liquidation § 336
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Tax Consequences to the Liquidating Corporation
 Liquidating corporation recognizes gains and losses
on distributions of property and on sales of assets.
 Liquidating subsidiary recognizes neither gain or loss
when it distributes property to its parent corporation.
 Liquidating corporation recognizes no loss when it
distributes property to a related person or if property
was acquired within the last five years in a § 351
transaction.
 Tax attributes disappear
Tax Consequences to Shareholder
 Shareholder generally recognizes capital gain or loss
equal to the difference between the money and/or
property received and the adjusted basis of the
shareholder’s stock.
§§ 332/337: Liquidation of a
Subsidiary Corporation
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Gain or Loss Considerations (Mandatory)
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Neither the parent nor the subsidiary
recognize gain or loss if the parent owns an
80+% subsidiary.
Subsidiary must do either of the following:
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Distribute all of its property to the parent
corporation in complete liquidation within a single
tax year.
Make a series of liquidating distributions resulting
in a complete liquidation over a three year period
that commences with the close of the tax year in
which the first liquidating distribution is made.
Subsidiary recognizes gain on distributions to
minority shareholders.
§§ 332/337: Liquidation of a
Subsidiary Corporation--Continued
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Basis Considerations § 334 (b)(1)
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The basis of the subsidiary’s assets carry
over to the parent corporation and the
parent corporation’s interest in the
subsidiary stock disappears.
Subsidiary tax attributes carry over to
parent.
Schedule M-1, Reconciliation of Book to
Taxable Income
Begin with Net Income per Books
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Additions
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Subtractions
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Federal income tax expense
Excess of capital losses over capital gains
Income subject to tax not recorded on books
Expenses recorded on books, not recorded on return
Income recorded on books and not on return
Expenses deducted on return and not on books
Equals Taxable Income before Special
Deductions, Form 1120 (Page 1, Line 28)
Review Example 14 on Page 20-15.
S Corporation Qualification
Requirements
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Entity
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Must be a domestic corporation
Must not be an ineligible corporation (insurance co.,
financial institution, possessions corp.)
Must not have more than 75 shareholders
Must have only individuals, estate, certain types of
trust & tax exempts as shareholders
Must not have a non-resident alien as a shareholder
Must issue only one class of stock.
If the corporation does not meet any of these
requirements, the election (if made)
terminates.
S Corporation Election Requirements
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Requirements
All shareholders must consent
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File Form 2553
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For current year, during preceding year or within 2 mos.
15 days during the current year.
Elections made after the current year deadline are
consider made for the following year.
IRS has latitude in correcting election deficiencies.
Termination Conditions
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Generally for the entire year if the corporation files a
statement within 2 mos. 15 days., otherwise next
year.
May specify termination date.
Cannot elect S status again for five years.
S Corporation Operations
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Similar to Partnerships
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Ordinary Income (page 1, Form 1120S & Schedule
K). The residual amount.
Separately stated items
Schedule K-1 for each shareholder
However, the allocations are based on shares owned
on each day of the year.
Other characteristics
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No dividends received or NOL deduction
Special taxes on S corporations that were previously
C corporations
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Built in gains
Excess net passive income
Lifo conversions
Basis Adjustment to S Corporation
Stock § 1367(a)
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Increased by:
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Stock purchases
Capital contributions
Non-separately computed income
Separately stated income items
Depletion in excess of basis
Decreased by
Basis Adjustments to S Corporation
Stock § 1367(a)
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Increased by:
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Stock purchases
Capital contributions
Non-separately computed income
Separately stated income items
Depletion in excess of basis
Decreased by distributions not reported as
income by shareholders (tax free distributions
and return of capital)
Then decreased (but not below zero) by:
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Non-deductible expenses
Non-separately computed loss
Separately stated loss and deduction items
Basis Adjustments for S
Corporations--Continued
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Excess Losses
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Restoration of Basis
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Once the stock basis is zero, any additional basis
reductions from losses or deductions but not
distributions decrease (but not below zero) the
shareholder’s basis in loans made to the S
corporation. Any excess of losses or deductions is
suspended until there is subsequent basis.
If a shareholder’s basis in the loan is reduced by a
loss deduction, subsequent increases restore first the
loan, and then the shareholder’s stock basis.
Passive Activity Losses
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S corporation shareholders are subject to the PAL
rules
Other S Corporation Considerations
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Distributions of Cash and Property
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Assuming the S corporation was not
previously a C with AEP, money and
property distributions are treated as a
return of capital to the shareholder (tax
free, unless they exceed the shareholder’s
basis, then CG)
Tax Year Restrictions
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Generally S corporations use a calendar
year.
S Corporations—Treatment of Fringe
Benefits
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S corporation shareholders who own more than 2% of
the outstanding stock are not eligible for tax-free
corporate employee fringe benefits. These include:
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Group term insurance
Accident and health insurance premiums
Cafeteria plan benefits
Employer provided fringe benefits
Meals and Lodging
Not all fringe benefits are subject to this special
treatment. These include
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Stock Options and Non-qualified deferred comp.
Qualified fringes, dependent care assistance, no-additional
cost fringes
Educational Assistance Programs
§ 721 Formation of a Partnership
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No gain or loss upon either transfer of
property in exchange for a partnership
interest or subsequent transfers of
property by the partners in exchange for a
pro rata increase in their partnership
interests.
Principal Exceptions:
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Sales by partner to partnership or
partnership to partner
Contributions to the partnership of services
Liabilities transferred exceed partner’s basis
§ 722 Basis of a Partnership Interest
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Basis = sum of money contributed +
adjusted basis of other property transferred
to the partnership.
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If a contributing partner renders services
to the partnership in exchange for a
partnership interest , the contributing
partner’s basis = income recognized (FMV)
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§ 752 Basis Adjustments: Includes
partner’s ratable share of partnership
liabilities
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Increase in liabilities increases the basis.
Decrease in liabilities decreases the basis.
§ 731 Basis cannot be negative. Negative
Other Partnership
Formation/Contribution Issues
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Holding Period for Partnership Interest
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Cash and Ordinary Asset Contributions 
Date interest is acquired
Capital and § 1231 Asset Contributions 
generally includes the holding period of the
property
Basis of Partnership Assets
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§ 723 provides for carry-over basis
Holding period includes the period the
property was held by the contributing
partner.
No basis adjustment for gains related to
contributions of negative basis assets.
Other Partnership
Formation/Contribution Issues
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Financial Accounting Considerations
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GAAP basis of accounting does not apply
carryover basis and non-recognition rule.
GAAP approximates approach required by
special allocation rules.
Organization and Syndication Fees
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Organization expenses include legal and
accounting fees incident to organizing the
partnership. Amortize over 60 months
Syndication fees are expenses incurred to
promote and market partnership interests.
No amortization.
Partnership Operations
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Partnership Schedule K
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Partnership ordinary income/loss, Page 1,
Line 22 form 1065 (the residual amount)
Separately Stated Items
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Rental income, capital gains/losses, § 1231
gains/losses, contributions, § 179 deduction, tax
exempt interest.
Schedule K-1 shows individual partner’s
share. schedule K =  (schedule K-1)
Individual partner’s share of ordinary
income/loss is determined by the
partnership agreement.
Partnership Operations--Allocations
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Special Allocations § 704
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Partners have latitude to decide how income,
deductions, losses and credits are to be allocated
among the partners.
Special allocations must show “substantial economic
effect” (i.e. similar to GAAP accounting).
Particularly important in allocation of depreciation
deductions and gain/loss for contributed property.
Allocation of Partnership Income, Deductions,
Losses and Credits
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If any partner’s interest in the partnership changes
during the year, all partners must determine their
distributive share of income, deductions, losses &
credits.
Calculation of Partner’s Basis § 705
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Initial basis
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+ Partner’s subsequent contributions
+ Debt increase
 Taxable income items
 Exempt income items
 Excess of depletion over adjusted basis
- Partner’s distributions and withdrawals
- Debt decrease
 Non-deductible items charged to the capital
account
 Special depletion deduction for oil and gas wells
 Loss items
The basis of a partner’s interest can never be
negative.
Limitations on Losses and
Restoration of Basis
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§ 704 (d) limits the deductibility of losses to
the partner’s adjusted basis in his or her
partnership interest as determined at the end
of the partnership tax year. All positive and
negative adjustments are made before the
limitation is considered.
Any unused losses and deductions carry over
indefinitely and are allowed in subsequent
years when the partner again has a positive
basis.
Passive activity losses are determined at the
partnership level buy applied at the partner
level.
Transactions between a Partner and
a Partnership
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§ 707(b) disallows losses and recognizes
ordinary income in certain situations:
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Losses are disallowed:
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On sales or exchanges between a partner and the
partnership if the partner owns more than a 50%
interest in the partnership. Review example 47.
On sales or exchanges between two partnerships
in which the same partners own more than a 50%
interest.
Gains are treated as ordinary income if the
partner owns more than a 50% interest in
the partnership and if the exchanged asset
is not a capital asset in the transferee’s
hands. Review Example 48
Guaranteed Payments and
Partnership Distributions
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Guaranteed Payments
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Partnership deducts fixed payments for salary and
interest to arrive at ordinary income.
Partner includes such payments in gross income in
the year received. Guaranteed payments are subject
to SE tax. Review example 40 on page 20-34
Partnership Distributions
 Non Liquidating Distributions
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Generally no gain or loss to partner of
partnership.
Partner recognizes gain if the amount of money
received exceeds the partner’s basis.
Property is assigned basis after considering the
cash distribution.
Sale of a Partnership Interest
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Liquidating Distributions
 Generally results in capital gain or loss.
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§ 741 Gain or Loss = Amount Realized (including
share of liabilities) less Adjusted Basis in Partnership
(including liabilities)
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§ 751 Ordinary Income Treatment for “Hot
Assets”
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Ordinary income rather than capital gain treatment may
result if a partnership has unrealized receivables or
inventory items when a partnership interest is sold.
 Unrealized receivables = 0 basis A/R, §§ 1245, 1250
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recapture
Inventory = Inventory + Other ordinary assets
Partnerships—Other Issues
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Optional Basis Adjustments § 754
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Generally occurs when a partnership
interest is sold or terminated.
Results because the sale price or
distribution amount is greater than the
partnership basis.
If elected, the partnership adjusts the tax
basis in its assets to reflect the difference
Tax Year Restrictions—generally a calendar
year.
Cash method of accounting is generally
available.