Corporate Income Tax

Chapter 3: Corporate Income Tax

Corporate income tax rate

What is a corporation?

• Separate taxpaying entity

1. i. flat 21% rate (start of 2018)

            *Previous rates range from 15%-35%

1. ii. must file annual tax returns

            *Note: must file even no income/loss annually

Choosing calendar or Fiscal year

-Corporation tax year should be similar to accounting period employed for financial accounting reasons

1. Calendar Year– 12-month period ending on December 31^st
2. Fiscal Year – 12-month period

                                                *Any month, except December

Short Tax Period

-Not covering full 12-month period

Restriction on Tax Year

Determining Corporate Tax Liability: The General Rule

Corporate and Individual Income

Prior to 2018, no alternative minimum tax for:

1. Income Tax
2. Accumulated earnings tax
3. Personal holding company tax

Corporate Income vs Individual

1. Gross Income

                        -generally similar

1. Deductions

                        -Corp. have ↑ and itemized deductions and exemptions

1. Taxable Income:

                        Gross Income – Deductions

Property Dispositions for Corporations

Organizational and Startup expenses

• Should be capitalized unless:

1. Election to deduct under the ff:
2. Sec. 248 (org)
3. Sec. 195 (startup)
4. Election =automatic

            *Elect out of

1. Deduction or Amortization remainder over 180 mos
2. Less $5000 however reduce if

                                    *exceeds $50000, remainder amortized in 180 mos

Charitable expenses

Limitation (at 10% adjusted taxable income)

      *for taxable income

                no deduction for:

1. Charity donations
2. Cap loss carrybacks
3. Dividend collected deductions

                 Has deduction for

1. nol carryforward

CARES Act

            If there is election

1. 2020-2021 contributions

                                    -no 10% limit

                        BUT..

                        -restricted to 25% on adjusted taxable income over every charitable donation

Donation (Property)

            General Rule : FMV deduction (for LTCG prop)

                        Basic deduction for others:

1. can deduct basis less half excess/ basis

                                                *not exceed 1x ab

                        Deduction limited to basis only if satisfied:

1. IP (intellectual property)
2. Tangible personal property (not related to charity org. purpose)

Dividends received deduction

            DRD in 2018:

1. 50% – own (<20%)
2. 65% – own (20 to <80%)

                        iii. 100% (own 80% or ↑)      

            Limitations:

                        -same percentage (taxable income = DRD)

                        *before DRD, cap loss carryback, after donation deductions, NOL carryover

If 50% and 60% dividends receive, then:

1. 65% is computed 1^ST
2. Less taxable income by 65% DRD, then:

                                                -compute for 50% DRD

Chapter 4 – Non-Liquidating Distribution of Corporations

Types of NLD:

1. Distribution of property or cash

                        *Not used for stock exchange

2. Distribution of stocks of the corporation (dividend stock)
3. Distribution of property or cash (exchange to stock redemption)

Distribution

            Dividents à corp. extent in profit and earning (E&P)

• non-corporate taxpayer ( 20% tax = capl. gain rate)

            Exceeding (E&P)

• capital return
• capital gain

Earning and Profits (E&P)

[1] life insurance proceed, tax exempt interest

[2] plus or minus of (E&P and Tax)

[3] org expense deduction, dividends collected deductions

[4] NOL, charity, cap loss

[5] tax exempt expense, keyman life ins, pol. vontributions, penalties

E&P Distribution

• Made fist out of recent E&P then amassed E&P
• If corporation has +CEP
  • Divided to CEP extend even if:

*aEP is deficit (applies to nimble dividend rule)

• Distribution reduce E&P
  • Not below to zero, and or;
  • Increase deficit
  • AEP end of year = aep prior year +CEP – dividend value

Ordering rules multiple distributions

• ceP = proportionally allocated based on distributions
• aEP = chronological allocation
  • note: same day distribution
• should be allocated using E&P rule

Property Distribution

Non-taxable stock dividends

1. Total amount of basis should be allocated before
2. distribution of new and old shared

                                                and if dividend is different stock class

                                                            *should be allocated as to FMV

2. Holding period is tacked
3. No impact with corp

                        – NO GAIN/LOSS

                        – NO E&P IMPACT

Taxable Dividends

• Only taxable if shareholder proportionate interest
  • Can elect to take prop. or stock
  • Some shareholders receive stock/property
  • Some shareholders receive preferred/ common
  • Distribution on pref. stock
    • Not OF
  • Distribution OF pref. stock convertible

Rules of Attribution

• Own constructively stock by means of:
  • Spouse
  • Child
  • No double attribution in family
  • Grandchild
  • Parent

*not : grandparents, brothers, sisters

Rules of Attribution (Entity)

• Attribute stock by estate to partner proportinally
• Attribute stock by C Corp to SH

*ONLY            if SH owns >50%                     

Susbstantially Disproportionate

1. Vote <50%
2. Voting stock <80%
3. Common Owned <80%

Absolute Termination

1. Use attribution rules, waive if:

            – No interest attained except being creditor

            – IRS file written aggreement notifies any acquired interest

            – 10 years after redemption cant be acquired besides inheritance

                        In 10 years:

• Stock is not acquired by redeemed SH
• No stock is attributable to the stock of redeemed SH
• No tax purpose make it non-applicable

NEED (Not essentially equivalent to dividend)

• Should be meaninful reduction (earnings, liquidation, earnings)
• Circumstances and facts
• Davis case
• No control
• Application of attribution rules
• Lose control = NEED

Partial Liquidation

• Discontinued line of business
• Should be bonafide business contraction
• At corporate level (not essentially equivalent with dividend)
• Only applicable in shareholders who are non-corporate

Redemption Analysis

1. Is redemption present? If yes, use option 2
2. Does redemption applies any categoris for exchange? If no, distribution rules is applied. If yes, sale rules are used, requirements:

• Disproportionate on substantial leve
• Absolute termination
• Not equal to dividend (essentially)
• Liquidation should be partial

Tax Treatment (Redemption)

Chapter 6: Liquidating Distributions of Corporation

Motivator for Liquidation

1. Tax reason (principal motivation)
2. Business reason

Liquidation is conducted if:

1. assets are resulting to losses

            -SH prefer to hold in incorporated form and reduce to personal tax return

                        *limitations:

1. Passive activity
2. At-risk
3. Excess business loss
4. corporate earnings taxed once under the income tax of corporation
5. when earnings are distributed as dividends
6. when SH exchanges stock for gain

    *the act of liquidation = assets held to unincorporated form = avoid double tax

iii. Additionally, may claim 20% reduction for qualified business income

1. Reduce tax rate below effective tax rate on the income of the corporation

Complete Liquidation

–Under Reg. Sec. 1.332-2 (c)

• Distributions under liquidation corp. must redeem all stocks or cancel
• One or more distribution, corporation should be:

1. liquidating status
2. distribution should be under the plan

• Distribution before plan of liqidation = taxed to SH through dividends/ redeemed stocks

Dissolution

• Legal phrase that organization undertaken dissolution
• Cannot happen if corporation retains charter for name of corporation acquired by another
• Corporation can settle for tax reasons without undertaking dissolution

Liquidation

• Reg. 1.332-2(c) – Corporation termination concern and interests
• winding up its activities
• debt payment
• shareholder property distribution

Liquidation General Rules

1. Effect to Shareholders

Amount of Loss or Gain

-Under Sec. 331 (a):

            -liquidation distribution transferred to shareholder = full payment for SH stock

            – if SH acquire liabilities, then:

                        – these liabilities reduce value realized by SH

2. Accounting Method Impact

            -Accounting method, if Accrual:

1. Shareholder acknowledge loss or gain

*Cash method

1. Sharehoder report loss/gain when actual liquidating upon distribution receipt acceptance
2. Stock Acquisition

            -SH may have acquire stock in different time/ amount

                        -SH must compute G/L separately

3. Recognized Gain or Loss Character

            -Corporation stock liquidation (Capital Asset for Shareholder)

                        Two exemptions:

1. Loss recognized by individual SH under sec. 1244

                                                *Where stock is within limits, considered ordinary loss

2. Loss recognized by corp. SH on the subsidiary stock worthlessness

                                                **where stock is considered ordinary loss under sec. 165 (g) (3)

Holding Period of Property and Its basis

            -Under Sec. 334 (a)

                        -Basis of SH’s property received is:

1. FMV on distribution date
2. property distribution upon date of distribution

Liquidation for Shareholder (Non-Subsidiary)

Under Sec. 331 (Shareholder):

• loss/ gain as if traded stock
• liabilities are assume less realized value (not under ZERO)
• Basis adjusted(Property received) = FMV (under Sec. 334 (a))
• After liquidation marks holding period date

Corporation Liquidation

Two Key questions:

1. What is the character and amount of recognized loss/gain?
2. What happens to tax attributies prior to liquidation?

Liquidation for Corporation (Non-Subsidiary)

Under Sec. 336 (Corporation):

• loss/ gain as if sold property (meant for FMV)
• liabilities assumed ≠ fmv property distributed
• Attributes of tax (e.g., carryovers, E&P, NOLS) vanish

Corporation Liquidation limitation related person (Non-subsidiary)

No loss permitted if:

• distribution to related person satisfies:

à 50% of family and shareholder attribution

                                                *Under sec. 267, this includes

1. Sisters
2. Brothers
3. Lineal relatives
4. Ancestors,

• and or;

1. non-pro rata distribution of property loss across shareholder, and or;
2. Sec.351 acquired property/ capt’l contribution are distributed in 5 yrs

Tax Avoidance purpose, Corporation Loss limitation (Non-subsidiary Liquidation)

Tax Avoidance purpose

            -property acquired to take liquidation loss

-determination of loss

                        * basis reduced to FMV (prior to collection on exchange, distb’n, or sale, if:

• Acquired , given that it is:

*w/in 2 years of liquidation plan)

• not if asset is employed in either:

* business or trade

• not if disposed

*on the first 2 years of the existence of corporation

Liquidation (Subsidiary)

Corporate shareholder

            -has 100% vote

            -subsidiary amount of corporation

Under Sec. 332 (Shareholder):

• NO loss/ gain
• basis in assets = carryover (under sec. 334 (b))
• Subsidiary stock basis (recedes)
• After liquidation marks holding period date

Under Sec. 337 (Corporation):

• NO loss/ gain
• Attributes of tax to shareholders + recapture depreciation

Hybrid Liquidation

• Corporate shareholder (and other SH, either individual or corporate) plus 80%

Shareholder:

• 80% + NO loss/ gain acknowledged
• other SH acknowledge loss/gain on sold stock
• basis of asset carryover allocated to 80% plus corp. SH (basis of FMV to another)

Corporation:

• NO loss/ gain acknowledged for allocated Assets + corp. Shareholder
• Asset Gain if allocated to another Shareholder
• No Loss on allocation of any asset to ANY Shareholder