Regulation Set 3

Front 1

C Corporation – Formation
Corporation Tax Consequences

Back 1

- No gain or loss recognized when issue stock, buy treasury stock, or reissue stock
- The basis of the property received from the shareholder is the greater of:
1. Adjusted net book value of the shareholder (plus their gain)
2. Debt assumed by the corporation
*Exception – If the adjusted basis exceeds the FMV, the corporation’s basis is limited to the aggregate FMV

Front 2

C Corporation – Formation
Shareholder Tax Consequences

Back 2

- No gain or loss recognized if:
1. Own at least 80% of voting and non-voting stock
2. No boot involved (received) – cash or cancellation of debt (liab > NBV)
- Basis of the CS received will be cash, property (NBV – debt, will add taxable boot back in to bring the stock basis to 0 if NBV < Debt), and services are at FMV and are taxable

Front 3

Computation of Basis to Shareholder

Back 3

Adjusted Basis Property Transferred
+ FMV Services Rendered
+ Gain Recognized
- Cash Received
- Liabilities Assumed by Corporation
- FMV of non-money boot received

Front 4

Domestic Production Deduction – QPAI

Back 4

Domestic Production Gross Receipts
<Cost of Goods Sold>
<Other directly allocable expenses or losses>
<Proper share of other deductions>
= Qualified Production Activities Income
*May deduct a certain % of the lesser of QPAI or taxable income

Front 5

Bad Debts

Back 5

Accrual Basis – Must use direct write off method
Cash Basis – No tax deduction for bad debts

Front 6

Business Interest Expense

Back 6

General Business Interest Ex. – Tax deductible
Interest Expense on Loans for Investment – Limited to net investment income
Prepaid Interest Expense – Must allocate to period when incurred and paid

Front 7

Charitable Contributions

Back 7

10% of Adjusted Taxable Income Limitation
(Taxable income before charitable ded, dividends received ded, NOL carryback, any capital loss carryback, or US production activities deduction)

Front 8

Business Losses or Casualty Losses (Related to Business)

Back 8

Any loss sustained and not compensated by insurance is deductible
Ordinary or capital depending on asset
No $100 reduction or 10% of AGI reduction
Partially destroyed – limited to decline in FMV or old adjusted basis
Fully destroyed – limited to old adjusted basis

Front 9

Organizational Expenses and Start up Costs

Back 9

Can expense $5000 right away (phased out at $50,000) and remainder is amortized over 180 months
Includes legal fees for charter, accounting services, etc.
NOT cost of raising capital (underwriter fees, commissions, etc.)

Front 10

Amortization

Back 10

Goodwill and other intangibles (franchises, trademarks) amortized on straight-line basis over 15 years

Front 11

Life Insurance Premiums

Back 11

If corporation names beneficiary (key person) – not tax deductible
If employee names beneficiary – tax deductible

Front 12

Taxes

Back 12

All state and local taxes and federal payroll taxes may be deducted
Federal income taxes not deductible
Foreign income taxes may be used as a credit

Front 13

Capital Gains and Losses

Back 13

No $3000 deduction for capital losses
Capital loss carryover – 3 years back and 5 years forward
Capital gains are taxed at the same rate as ordinary income (no special rate)

Front 14

Net Operating Losses

Back 14

2 years back and 20 years forward
*No charitable deduction or dividends received deduction allowed before calculating

Front 15

General Business Credit

Back 15

Generally net income tax less the greater of:
1. 25% of the regular tax liability above $25,000
2. "Tentative minimum tax" for the year

Front 16

Dividend Received Deduction

Back 16

- 70% (0-19), 80% (20-79), 100% (80+)
- Must own the investee stock for more than 46 days during the 91 day period before or after
- 1st corporation is taxed
- DRD Limited by the lesser of 70-80% of dividends received or Gross Income after charitable deductions (but not DRD, NOL, or capital loss)
- The taxable income limitation does not apply if after taking into account full DRD there is a NOL
- DRD does not apply to personal service, personal holding, or personally taxed s corporations

Front 17

Depreciation - MACRS property other than real estate (machinery and equipment)

Back 17

- For property placed in service after 1987: 3,5,7, and 10 year use 200% declining balance method, 20 year uses 150
- Salvage value ignored
- Half year convention applies to personal property that is placed in service or disposed of during the year is treated as occuring at the midpoint
- If more than 40% of depreciable property is placed in service in the last quarter of the year, use mid quarter convention

Front 18

Depreciation - MACRS property real estate (buildings)

Back 18

- Residential real property - 27.5 year straight line
- Non-residential - 39 year straight line
- Use mid month convention with one half month for month placed in service and disposed of

Front 19

Depreciation - Expense Deduction in lieu of Depreciation

Back 19

- May deduct a fixed amount of depreciable property (machine and equipment)
- 2007 limit is 125,000 of new or used property acquired during the year
- Reduced $ for $ by the amount it exceeds $500,000
- Not permitted if it would create a loss or one exists
- SUVs limited to $25,000

Front 20

Depletion

Back 20

1. Cost depletion (GAAP) - estimated cost / estimated natural resource = rate x amount sold, extracted, etc.
2. % Depletion - limited to 50% of taxable income, range depends on mineral or substance, may be taken even after costs have been completely recovered and there is no basis

Front 21

Section 1231 Assets

Back 21

- Depreciable personal and real property used in the taxpayer's trade or business and held for over 12 months
- Capital gain treatment on sale, exchange, etc.
- All 1231 losses are ordinary losses

Front 22

Section 1245 Assets

Back 22

- Machinery and equipment
- Personal business property used over 12 months
- Upon sale, all accumulated depreciation is recaptured as ordinary income and any remaining gain is capital gain under section 1231

Front 23

Section 1250 Assets

Back 23

- Buildings
- Real business property used in trade or business over 12 months
- Recapture only portion of depreciation in excess of straight line
- S-L depreciation taken results in overall gain taxed at 25%
- Any excess gain is capital under section 1231

Front 24

C Corporation Estimated Tax Payments

Back 24

- Corporations other than large corporations - required to pay the lesser of 100% of tax shown on return for current year or 100% tax shown on previous year return
- Large corporations - no last year provision

Front 25

Consolidated Tax Returns

Back 25

- An affiliated group may elect to be taxed as a single unit
- The common parent owns 80% or more of voting power and the value of all outstanding stock

Front 26

Corporate AMT Formula

Back 26

Regular Taxable Income
+/- Adustments
+ Preferences
+/- Adusted Current Earnings (ACE)
<AMT NOL Deduction>
Minimum Taxable Income
<AMT Exemption>
= AMT
x 20%
= Gross AMT
<Foreign Tax Credit>
Tenative Minimum Tax
<Regular Tax Liability>
= AMT

Front 27

AMT Adjustments LIE

Back 27

L - Long-Term Contracts (complete contract vs. % completion)
I - Installment Sales
E - Excess depreciation of tangible property placed in service after 1986 over S-L for real property (40 yr life) or 150% declining balance

Front 28

AMT Preferences PPP

Back 28

P - % depletion over basis of property
P - private activity bonds
P - Pre-1987 ACRS depreciation

Front 29

AMT - Adjusted Current Earnings ACE MIND

Back 29

M - Municipal bond interest
I - Increase life insurance cash surrender value
N - Non-straight-line depreciation after 1989 vs. ADS
D - Dividends received deduction (70%)

Front 30

AMT - Calculations

Back 30

- Exemption amount is 40,000 less 25% of AMTI in excess of 150,000
- Tax rate is 20%
- Minimum tax credit (MTC) - may use AMT paid this year as a credit in future years (can carry forward indefinitely)

Front 31

Accumulated Earnings Tax

Back 31

- Imposed on C corporations whose accumulated retained earnings exceed $250,000 if improperly retained instead of distributed as dividends
- Additional tax rate is 15%
- Calculated by taxable income - ALL charity, ALL capital losses, taxes, dividends paid = Accumulated taxable income - remaining credit = current accumulated taxable income x 15% = tax

Front 32

Personal Holding Company NIRD

Back 32

- Corporations more than 50% owned by 5 or fewer individuals and having 60% of adjusted ordinary gross income consisting of:
N - Net rent (if less than 50% ordinary gross income)
I - Interest that is taxable (nontaxable included)
R - Royalties (not mineral oil gas or copyright)
D - Dividends received from unrelated domestic corp.
- Taxed at an additional 15% on personal holding company net income not distributed
- Not subject to accumulated earnings tax

Front 33

Dividends Defined

Back 33

1. Current E&P (by YE) = taxable dividend
2. Accumulated E&P (dist date) = taxable dividend
3. Return of capital = tax free, reduces basis of CS
4. Capital gain distribution (no E&P or basis) = taxable inxome as capital gain

Front 34

Current E&P and Accumulated E&P rules

Back 34

- General rule = not netted
- if both are negative -> not a dividend
- if current is positive and accumulated is negative -> dividends to the extent of current only
- if current is negative and accumulated is positive -> net*
- if dividends are in excess of E&P, current earnings are allocated on pro-rata basis to each distribution and accumulated are applied in chronological order beginning with the earliest

Front 35

Corporation Paying Dividend - Taxable Amount

Back 35

- If a corporation distributes appreciated property, the corporation recognizes gain as if the property had been sold which increases current E&P
- Ex. corporation has no E&P, corporation distributes appreciated property as a dividend, corporation has recognized gain and dividend to shareholder is now taxable income

Front 36

Stock Redemption

Back 36

If sale or exchange, shareholder recognizes G/L. Otherwise dividend to the extent of E&P.
1. Proportional - taxable dividend income (to shareholder ordinary income)
2. Disproportional - sale by shareholder subject to G/L to shareholder
3. Complete buy-out of shareholder - treated as exchange of stock

Front 37

Corporate Liquidation - Corporation Sells Assets and Distributes Cash to Shareholders

Back 37

- Double taxation - corporation recognizes gain or loss on sale of assets and shareholders recognize gain or loss to extent that cash exceeds adjusted basis of stock

Front 38

Corporate Liquidation - Corporation Distributes Assets to Shareholdres

Back 38

- Double taxation - corporation recognizes G/L as if it sold the assets at FMV and shareholder recognize G/L to extent FMV of assets received exceeds the adjusted basis of stock

Front 39

Types of Tax-Free Reorganizations

Back 39

A. Mergers of Consolidations
B. The acquisition by one corporation of another corporation's stock (stock for stock)
C. The acquisition by one corporation of another corporation's assets (stock for assets)
D. Dividing of the corporation into separate operating corporations
E. Recapitalizations
F. Mere change in identify, form, or place of organization
G. Bankruptcy

Front 40

Corporate Liquidations - Tax-Free Reorganizations

Back 40

- No G/L by parent or sub
- Nontaxable event to corporation and shareholder (unless shareholder receives boot)
- Results in continuation of business in modified form - must continue business of old entity or use a significant portion of their assets
- Must pass control test of 80% voting power and classes of stock

Front 41

Worthless Stock - Section 1244 (small business stock)

Back 41

- When a corporation's stock is sold or becomes worthless, an original stockholder can have an ordinary loss instead of a capital loss up to $50,000

Front 42

Small Business Stock 50% Exclusion of Gain

Back 42

A noncorporate shareholder who holds qualified small business stock for more than 5 years may exclude 50% of the gain on the sale or exchange of stock

Front 43

S Corporation - Eligibility

Back 43

- Must be domestic
- May not file consolidated return with C corp
- May create a qualified S subsidiary
- Eligible shareholders are individuals, estates, or certain trusts (no nonresident aliens)
- limit of 100 shareholders
- only one class of stock (no preferred)

Front 44

S Corporation - Tax on Corporation

Back 44

- General rule is that there is no tax at corporate level, all earnings are passed through to shareholders
3 Exeptions:
1. LIFO recapture tax (C Corps must pay excess of inventory computed on FIFO over LIFO)
2. Built in gains tax
3. Tax on passive investment income (35% on the lesser of net income or excessive passive investment income if the S corp has accumulated C corp E&P and passive investment income exceeds 25% of gross receipts)

Front 45

S Corporation - Built in Gains Tax

Back 45

- Unrealized built in gain occurs when a C corp elects S status and the FMV of the corporate assets exceed the adjusted basis at the election date
- An S corp is exempt from a tax on built in gains if they were never a C corp, the sale or transfer does not occur within 10 years that the S election is made, the S corp can demonstrate that the appreciation occurred after the S election
- Tax is 35% times the lesser of the recognized built in gain for current year or taxable income if it were a C corp

Front 46

Effect of S Corporation Election on Shareholders

Back 46

- Like partnerships, S corps report both separately stated and non-separately stated items of income/loss, shareholders are taxed on these items regardless of whether or not the items have been distributed to them during the year
- Allocations to shareholders made on per-share, per-day basis
- Losses are limited to shareholder's adjusted basis plus direct shareholder loans
- Fringe benefits are deductible for non-shareholder employees (and those that own less than 2%)
- Tax effects of distributions of an S corp with accumulated E&P since inception are computed using AAA (0 at inception) - increased by separately and non-separately stated income and gains and decreased by corporate distributions and expense items and losses (no tax exempt income, non-deductible items, etc)

Front 47

Shareholder Basis in S Corp

Back 47

Initial basis
+ Income items
+ Additional shareholder investments in stock
- Distributions to shareholders
- Loss or expense items
= Ending Basis
* Can deduct losses but limited to: basis + direct loans - distributions

Front 48

Taxability of Distributions to Shareholders - S Corporation with No C Corporation E&P

Back 48

- To the extent of basis in stock - not subject to tax and treated as a return of capital
- In excess of basis of stock - taxed as long term capital gain

Front 49

Taxability of Distributions to Shareholders - S Corporation with C Corporation E&P

Back 49

1. To the extent of AAA - not subject to tax, reduces basis in stock
2. To the extent of C corporation E&P - taxed as dividend, does not reduce basis in stock
3. To the extent of basis in stock - not subject to tax, reduces basis in stock
4. In excess of basis in stock - taxed as L-T capital gain
*Distributions may not reduce AAA below 0 but can be negative from S corp losses

Front 50

How to Terminate S Status

Back 50

- Holders of a maority of the corporation's stock consent to a voluntary revocation
- Corporation fails to meet eligibility requirements
- More than 25% of gross receipts come from passive investment income for 3 consecutive years and the corporation had C corp E&P at the end of each year
- Once revoked, a new election cannot be made for 5 years