REG - Notes Chapter 3 http://www.cpa-cfa.

org

C Corps, Depreciation, and MACRS

Formation Corporation tax consequences No gain/loss recognized upon formation Basis of property received by corporation is the greater of: - d!usted NB" of the transferor # any gain recognized by the transferor - $ebt assumed by the corporation - %xception: if the NB" is less than the F&" of the asset' the corp uses the F&" as basis to avoid built in losses (hareholder tax consequences No gain/loss recognized )hen contributing property to a corp for stoc* if the follo)ing t)o have been met: - (hareholder has +,- control' and - (hareholder receives no boot .cash or cancellation of debt/ Basis of common stoc* to shareholder Cash 0 the amount shareholder contributed 1roperty 0 d!usted basis .NB"/ - 2he d!usted basis of preoperty is reduced by any cancellation of debt - dd: taxable boot 0 debt exceeds asset3s ad!usted basis 0 to bring stoc* basis to zero (ervices rendered to corp at F&" 4perations Boo* income vs5 taxable income is reconciles on schedule &-6 Cash received in advance of accrual 7 1 income is taxed such as: 8nterest income received in advance 9ental income received in advance 9oyalty income received in advance 2hese create temporary differences (ome 7 1 income items are not includible at taxable income' such as: 8nterest income from municipal or state bonds 1roceeds from life insurance on *ey officers3 lives )here the corporation is the beneficiary 2hese create permanent differences

2rade or business deductions .ordinary and necessary expenses/ $omestic production deduction 0 get a special deduction for *eeping !obs in merica and not outsourcing - :,,; 0 <- deduction - 3,=->,? 0 ;- deduction - :,,?# 0 ?- deduction 2he deduction is a percentage lesser of: @ualified 1roduction ctivities 8ncome .@1 8/' or 2axable income .disregarding the @1 8 deduction/ $omestic 1roduction 7ross 9eceipts Agross receipts derived from production )ithin the B5(C .C47(/ .4ther directly allocable expenses or losses/ .1roper share of other deductions/ D @ualified 1roduction ctivities 8ncome .@1 8/ 1

REG - Notes Chapter 3 http://www.cpa-cfa.org

Bonuses paid by an accrual taxpayer are deductible in the current tax year' provided they are paid )ithin : E months after year end .so if 6:/<6 year end' then pay by </6F/ Bad debts 0 specific charge-off method ccrual basis 0 must use direct )rite off methods Cash basis 0 not allo)ed a tax deduction Business interest expense 8nterest incurred for business purposes are tax deductible 8nterest expense on loans for investments is deductible but limited to net investment income 1repaid interest expense 0 must allocate Charitable contributions is allo)ed a maximum deduction of 6,- of ad!usted taxable income Business losses or causualty losses related to business .its different than the individual/personal casualty loss/ No G6,, deductible No 6,- of 78 reduction

4rganizational expenditures and start up costs Corp can deduct up to GF',,, of organizational expenditures and GF',,, start up costs ny excess costs are amortized over 6+, months 7 1 rule - expense all %xam tric*: carefully loo* at the month the business started5 2hey3ll have the business start in Huly' so you only get to ; months on the excess amortization 2hese cost do not include the cost of raising capital .flotation costs' commissions' under)riter fees/ mortization' $epreciation' and $epletion 1urchased good)ill - 2ax rule: amortize on straight-line basis over 6F years - 7 1 rule: not amortized' test for impairment Iife insurance premiums .expense/ 1remiums paid by Corp on *ey employees' and Corp is beneficiary' not tax deductible %mployee names the beneficiary' it3s a employee benefit' and those premiums are tax deductible Business gifts - G:F is deductible Business meals and entertainment 0 F,- is tax deductible 1enalties and illegal activities are not deductible 2axes (tate' local and federal payroll taxes relating to business are deductible )hen incurred Federal income taxes are not deductible Foreign income taxes may be used as a credit Iobbying and political expenditures are not tax deductible Capital gains and losses Capital losses can only be used to offset capital gains' so no deduction allo)ed Net capital losses can be 2

REG - Notes Chapter 3 http://www.cpa-cfa.org

- Carried bac* < years - Carried for)ard F years Capital gains taxed as ordinary income' no special 6F- rate Net operating loss .same as individuals/ - Carried bac* : years - Carried for)ard :, years

7eneral business credit 8ts generally net income less the greater of: - :F- of regular tax liability above G:F',,, R3-21 corporation taxation summary between temp and permanent differences $ividends received deductions 0 you get to exclude a - of dividends based on o)nership - 4)nership $iv 9ec $eduction .$9$/ , - 6?=,:, - =?+,+, - 6,,6,,9equirements 6st corporation is taxed 4)ned for JF days before or after 2a*e smaller of: - $iv 9ec $eduction - K dividends received' or - $iv 9ec $eduction - K 2axable income before $9$ $9$ does not apply to 1ersonal service corps' personal holding companies' personally taxes ( corps $ividends from affiliated corps that file consolidated returns qualify for 6,,- deduction $epreciation & C9( depreciation rules for machinery and equipment (alvage value is ignored Half year convention 0 applies to personal property places in service or disposed of during a taxable year is treated as being placed or disposed at the midpoint of the year Mid-Quarter convention 0 if more than J,- of depreciable property is placed in service in the last quarter of the year' the mid quarter convention must be used & C9(: real estate .buildings/ (alvage value ignored (ubtract land cost Residential rental property (apartments, rental omes! 0 :=5F year straight line "on-residential real property (office buildin#, ware ouses! 0 <? year straight line Mid mont convention 0 straight line depreciation is computed based on the number of months the property )as in service5 E month is ta*en in the month the property )as placed in service5 E month is ta*en for the month in )hich the property )as disposed5

%xpense deduction in leiu of depreciation .section 6=?/ %ach tax year' a tax payer may deduct a fixed amount of depreciation .machinery and property/5 2he limit for :,,; is G6,+',,, on ne) or used property that is acquired during the year 3

REG - Notes Chapter 3 http://www.cpa-cfa.org

2he max amount is reduced dollar for dollar by the amount of property palce in service during the year that exceeds GJ<,',,, in :,,; 2he deduction is not permitted )hen a net loss exists or if it )ould create a net loss (B"3s: limit the cost of sport utility vehicle .(B"/ that may be expensed under section 6=? to G:F',,, $epletion 7 1 is cost depletion calculation .9< 0 :+/ - $epletion .non 7 1/ - 2he deduction is limited to F,- of taxable income - llo)able percentages range from F--::- depending on the mineral being extracted

mortization 8ntangibles such as good)ill' licences' franchises' and trademar*s are amortized (I over 6F years Business start up costs and organization costs 0 F',,, is expensed and excess is amortized (I over 6+, months .explained earlier/ (ummary of (ection 6:<6' 6:JF' and 6:F, assets (ection 6:<6 0 depreciable personal and real property used in taxpayers trade or business and held over 6 year (pecial capital gain treatment on net gains from sales' exchanges of certain non-capital assets ll 6:<6 losses are treated as ordinary income (ection 6:JF .machinery and equipment' gains only/ 0 personal business property assets used in trade or business for over a year .autos/ Bpon a sale of a 6:JF asset all accumulated depreciation is recaptured as ordinary income ny remaining gain is a capital gain under section 6:<6 (ection 6:F, .buildings' gains only/ 0 real business property used in trade or business for over 6 year .)arehouse/ 9ecaptures deprecation in excess of straight line 2axation of a C Corporation Filing requirements 0 6Fth day of the third month after tax year end' so 6:/<6 yr end' file by </6F %stimated payments of corporate tax Iarge corporations 0 must pay 6,,- of tax as sho)n on the current year tax return Not large corporations .less than a G6 million in taxable income in the past < years/ - 6,,- of tax as sho)n on the current year tax return - 6,,- of tax as sho)n on the previous years tax return n affiliated group of corporations may elect to be taxed a single unit' thereby eliminating intercompany gains/losses n affiliated group means that a common parent o)ns: - +,- or more of the voting po)er of all outstanding stoc*' and - +,- or more of the value of all outstanding stoc* of each corporation lternative minimum tax d!ustments 0 add or subtract items to income 0 I8% Long term contracts 0 difference bet)een completed contract and percentage of completion Installment sale dealer 0 difference bet)een full accrual and installment sales Excess $epreciation over J, yr-(I for real property' 6F,- $$B for personal property using normal life 4

REG - Notes Chapter 3 http://www.cpa-cfa.org

1references 0 add items to increase income 0 111 Percentage depletion 0 excess percentage depletion over the ad!usted basis of the property Private activity .tax exempt interest income/ Pre 3+= C9( excess depreciation over (I d!usted Current %arnings 0 increase or decrease 0 &8N$ Muni interest income .tax exempt interest income/ Increase C(" life insurance Non (/I depreciation .excess over (I/ Div 9ec deduction 0 )hen you have under :,- o)nership %xemption Formula 0 the exemption amount is GJ,',,, less :F- of &28 in excess of G6F,',,,5 s a result' the exemption is completely phaseout for &28 over G<6,',,, J,',,, 0 A.&inimum taxable income 0 G6F,',,,/ K :F-C D %xemption allo)ed 2he tax rate on the &28 is a flat :,Foreign tax credit is allo)ed &inimum tax credit .&2C/ &2 can be used as a credit against future regular tax Can be carried for)ard forever 2he accumulated earnings tax is imposed on regular C corps )hose accumulated .retained/ earnings are in excess of G:F,',,, is improperly retained 6F- additional tax if found guilty 1ersonal holding company tax 0 corps set up by rich people to channel their investment income to corporate tax rates .6F-:F-/ instead of paying their higher individual rate 1ersonal holding company 0 corps more than F,- o)ned by F or less individuals and having ;,- of ad!usted gross income consisting of: Net rent Interest that is taxable .non taxable is excluded/ Royalties .not mineral' oil' gas or copyright royalties/ Dividends from an unrelated domestic corp 1ersonal holding companies are taxed an additional 6F- on net income not distributed Corporate distributions $ividends defined 0 earnings and profits .%L1/ $urrent %&' .by year end/ D taxable dividend (ccumulated %&' .dist5 date/ D taxable dividend Return of $apital .No %L1/ D tax free and reduced basis of common stoc* $apital )ain *istribution .No %L1/No Basis/ D taxable income as capital gain &atching cash dividends to source Current earnings and profit 0 allocated on a pro rata basis to each distribution ccumulated earnings and profits 0 applied in chronological order' beginning )ith the earliest distribution (toc* dividends 0 not taxable 5

REG - Notes Chapter 3 http://www.cpa-cfa.org

Corp paying dividend 2he payment of the dividend does not create a taxable event 1roperty dividends recognizes a gain as if the property had been sold .F&" 0 ad!usted basis/ (toc* redemption/buybac* 1roportional buybac* 0 taxable dividend income .to shareholder 0 ordinary income/ $isproportional .only shares from certain stoc*holders )ere bought bac*/ 0 sale by shareholder is sub!ect to capital g/l to shareholder Corporate liquidation 0 corp and shareholder recognize g/l .double taxation/5 2)o types of corporate liquidations Corp sells assets and distributes cash to shareholders - 2he corp recognizes a g/l on the sale of the assets' and - (hareholders recognize a g/l to the extent the cash exceeds ad!usted basis Corp distributes assets to shareholders - Corp recognizes g/l as if it sold the assets for the F&" .F&"-basis D g/l/ - (hareholder recognizes g/l to extent F&" of assets received exceed the ad!usted basis in the stoc* 9e-organizations are a tax free event Because it results in the continuation of a business in a modified form5 8n order to meet the Mcontinuity requirementN the acquiring corporation must continue the business of the old entity or use a significant portion of the old corporations assets Oorthless stoc* 0 (ection 6:JJ stoc* .small business stoc*/ n original stoc*holder can be treated as having an ordinary loss .fully tax deductible/' instead of a capital loss Bp to ( GF,',,, .&FH G6,,',,,/ ny loss in excess of this amount )ould be a capital loss' )hich )ould offset capital gains and then a maximum G<',,, per year )ould be deductible (mall Business stoc* non corporate shareholder' )ho holds qualified small business stoc* for more than F years' may exclude F,- of the gain on the sale or exchange of the stoc*

Small Business Corps S Corps

%ligible ( Corp (hareholders &ust be an individual' estate or certain type of trust .no corps or 1/( not allo)ed/ &ay not be a non-resident alien Iimit of 6,, shareholders 4nly one class of stoc* allo)ed5 $ifferences among common stoc* voting rights are allo)ed5 .no preferred/ 8f you elect to be an ( corp by &arch 6F' then it ta*es effect for the )hole year ( corps must adopt a calendar year' unless there is valid business purpose 1ass-through entity' no tax at the corporate level %xception: 2axed at corporate level if both conditions exist: - C corp elects ( corp status' and - F&" of the corporate assets exceeds the ad! basis of on the election date 1ass through income/losses to shareholder P-6 6

REG - Notes Chapter 3 http://www.cpa-cfa.org

Ii*e 1/(' ( corps report both separately and non-separately stated items of income and/or loss llocations to shareholders are made on a per share' per day basis Iosses are limited to a shareholders ad! basis in ( corp stoc* # direct shareholder loans to the corp - in a 1/(' liabilities increase basis Computing shareholder basis in ( corp stoc* 8nitial basis # 8ncome L additional investment into the stoc* - $istribution L losses D %nding basis n ( corp shareholder is permitted to deduct .on their personal income tax return their pro rate share of the ( corp loss based on the follo)ing limitation: Ioss limitation D Basis # direct shareholder loans 0 distributions 2axability of distributions to shareholders ( Corp )ith no C Corp %L1 $istribution 2reatment 2o extent of basis in stoc* return of capital 8n excess of basis of stoc* capital gain distribution ( Corp )ith C Corp %L1 $istribution 2o extent of 2o extent of C corp %L1 2o extent of basis in stoc* 8n excess of basis of stoc* 2reatment (-corp profits .already taxed/ old C corp div return of capital capital gain distribution

2ax 9esult not taxable' reduce basis in stoc* taxed as (2 ot I2 capital gain 2ax 9esult not taxable' reduce basis in stoc* taxed as div' no basis reduction not taxable' reduce basis in stoc* taxed as (2 ot I2 capital gain

D ccumulated d!ustments ccount D the cumulative amount of ( corp income or loss .li*e 9/%/ 2erminating the ( selection Qolders of the ma!ority of the corporations stoc* consent to a voluntary revocation 2he corporation fails to meet any or all of the eligibility requirements .lets a foreigner be a shareholder/ &ore than :F- of the corp3s gross receipts come from passive investments for < consecutive years and the corporation had C corp earnings and profits at the end of each year 4nce an ( corp election is terminated or revo*ed' a ne) election cannot be made for F years unless the 89( agrees other)ise5