1

I. C Corporation Formation A. Corporation Tax Consequences 1. General rule no gain or loss recognized on issuing stock in exchange for property: a. Formation - Issuance of common stock b. Reacquisition - Purchase of treasury stock. c. Resale - Sale of treasury stock 2. Basis of property (corporation receives) the greater of : a. Adjusted basis (NBV) + gain recognized by transferor b. Debt assumed by corporation B. Shareholder Tax Consequences 1. No Gain or Loss Recognized exchange property (not service) for stock, no gain or loss if following meet: a. 80% Control after the transaction, transferor own at least 80% of the stock b. No Boot Involved (received) following items are treated as boots: (1) Cash withdrawn & (2) Receipt of debt securities c. Boot Excess of debt cancelled over asset NBV, Gain recognized on it

2
2. Basis of Common Stock (to shareholder) a. Cash - Amount contributed b. Property - Adjusted basis (NBV) (1) Stock = asset NBV debt released (2) Stock = 0, when asset NBV < debt released. Gain recognized on excess of debt over NBV c. Services - Fair Market Value (taxable) II. C. Corporation Operations A. Book Income vs. Taxable Income (Schedule M1) Corporation tax return form 1120. M-1 reconcile taxable income with net income B. Corporate Taxable Income/Loss Items 1. Gross Income a. Cash received in advance of accrual GAAP income is taxed (temporary difference between GAAP & Tax): (1) Interest income received in advance. (2) Rental income received in advance. (Nonrefundable rent deposits and lease cancellation payments are rental income when received.) (3) Royalty income received in advance.

3 b. Some GAAP income items are not

includible as income (permanent difference): (1) Interest income from municipal or state obligations/bonds. (2) Proceeds from life insurance on the life of an officer ("key person" policy) where the corporation is the beneficiary. (so the insurance premium is not deductible) (3) Federal income tax not deductible on tax return. 2. Trade or Business Deductions (ordinary and necessary expenses) a. Domestic Production Deduction (1) Limitation: The deduction may not exceed 50% of the W-2 wages paid by the corporation for the year. (2) Deduction 9% the lesser of: (a). Qualified production activities income (QPAI) (b). Taxable income (disregarding the QPAI deduction) (3) D. P. G. R. Defined gross receipts within the United States from:

4
(a). Manufactured (b). Produced (c). Grown (d). Extracted (e). Constructed (f). Engineering services (g). Architectural services (4) Calculating QPAI Domestic production gross receipts <Cost of goods sold> <Other directly allocable expenses or losses> <Proper share of other deductions> Qualified production activities income b. Executive Compensation

(1) Public corp. Deduction for Top 4s compensation maximum = $1,000,000, unless based upon qualifying commissions or a performance based plan of the company. (2) Entertainment Deduction for officers, directors, and 10%-or-greater

5 owners limit to the extent included in the individual's gross income. c.

Bonus Accruals (nonshareholder/employees) (1) Incurred (2) Paid within 2&1/2 months d. Bad Debts - Specific Charge-Off Method (1) Accrual Basis = Deduct when specific A/R written off (2) Cash Basis not allowed deduction e. Business Interest Expense (1) Interest incurred & paid or accrued on general business loan deductible. (2) Interest on investment loan deduction Limit to net investment income (3) Prepaid interest proportionate for the interest periods only incurred portion can be deducted. f. Business Losses or Casualty Losses Related to Business 100% deductible( no 100 reduce & no 10%limit) (1) Partially Destroyed the lesser of:

6 (a). The decline in value, or

(b). NBV before destroyed (2) Fully Destroyed (NBV) the adjusted basis of the property. g. Organizational Expenditures and Start-up Costs (1) Deductible Costs (a). Deduction is allowed for $5,000 of organizational expenditures & $5,000 of start-up costs (b). Each amount is reduced by the amount of each costs exceeds $50,000, respectively. (c). Any excess over $5000 of organizational expenditures or start-up costs are amortized over 180 months (beginning with the month in which the active trade or business begins. Caution: month business started) (2) Included Costs (a). Total start-up costs: Advertising Travel Consultant

7
(b). Organizational costs: Aattorney fees, State incorporation fee Accounting fees (3) Excluded Costs (a). Issuing & selling the stock, (b). Commissions, (c). Underwriter's fees, (d). Costs incurred in the transfer of assets to a corporation. h. Amortization for intangibles acquired after 08/10/1993 15 years S-L beginning with the month acquired. i. Depreciation, j. Depletion k. Life Insurance Premiums (expense) (1) Corporation Named as Beneficiary (key person) not deductible Premiums paid by the corporation for life insurance policies on key employees (2) Insured Employee Named as Beneficiary (fringe benefit) Premiums are deductible as an employee benefit.

8 l.
Business Gifts deduction maximum up to $25 per recipient per year. m. Business Meals and Entertainment deductible 50% n. Penalties and Illegal Activities Not Deductible o. Taxes deductible: (1) State Tax (2) Local Tax (3) Payroll Tax (4) Federal income not deductible p. Lobbying and Political Expenditures (1) Lobbying for Federal & State legislation not deductible (2) Political contributions are not deductible (3) Direct-type lobbying expenses in connection with local governmental lobbying are deductible. q. Capital Gains and Losses (1) No $3,000 Capital Losses Deduction allowed differ from individual tax.

9
Capital losses deduction only allowed up to Capital Gains. (2) Capital Loss Carryover 3 back 5 forward, but only as short-term capital losses and are applied only against capital gains.(differ from individual which no carry back, forward forever) (3) Capital Gains Tax Calculation Same rate as ordinary income, differ from individual which special Capital gains rates apply r. Net Operating Losses NOL Carry back 2, forward 20 same as individual (1) NOL Carry back claiming form 1120X (Amended Corporate Income Tax Return) must be filed within three years of the due date (including extensions) of the return for the loss year. (2) An election to forgo carry back must be made on the tax return for the year of loss without special form to file. (3) NOL calculation points:

10 (a). No charitable contribution

deduction is allowed in calculating the NOL. (b). The dividends received deduction (DRD) is allowed to be deducted before calculating the NOL. Inventory Valuation Methods (2) Requirement: (a). Accrual basis of accounting for purchases and sales with inventory is a must. (b). A change in inventory method is considered a change in accounting method and must be approved by the IRS. (c). Valuation method must be consistent same method used on valuing opening and closing inventory. (3) Basic Valuation Methods (a). Cost Method: = DL + DM + OH Disc + Frt-in, no prime cost (no OH)& no direct cost (no fixed OH). (b). Lower of Cost or Market Method Inventories are valued at the lower of

s.

11
cost (per above) or market, which, for normal goods is generally the current bid price at the date of inventory (c). Rolling-Average Method: Not be allowed when inventories are held for long periods of time in some circumstances or when costs tend to fluctuate significantly (unless the taxpayer regularly re-computes costs and makes certain adjustments) (d). Retail Method: approximate the cost or the market of items in inventory by subtracting the mark-up percentage to retail from the retail price (3) Common Inventory Identification Methods (Cost-Flow Assumptions) (a). FIFO (First-in, First-out) Method most commonly used method. (b). LIFO (Last-in, First-out) Method: LIFO must be elected by the taxpayer in the first year it is used, and must be used for its financial statement purposes too. Significant adjustments to inventory valuations may be required to use LIFO.

12
(c). Specific Identification Method (4) Uniform Capitalization Rules (DL+DM+MOH) if subject to the uniform capitalization rules, other methods may not allowed to be used. (5) Unsalable or Unusable Goods deemed as unsalable or unusable, expected selling price ("bona fide selling price") within 30 days minus the costs to dispose of them. t. General Business Credit (1) Included Credits: (a). Investment credit; (b). Work opportunity credit; (c). Alcohol fuels credit; (d). Increased research credit (generally 20% of the increase in qualified research expenditures over the base amount for the year); (e). Low-income housing credit; (f). Small employer pension plan start-up costs credit; (g). Alternate motor vehicle credit;

13
(h). Worker retention credit (allowed for each qualified worker for the first year of eligibility - lesser of $1 ,000 or 6.2% of qualified wages per qualified worker in 2011); and (i). Other infrequent credits. Formula: total credit limit = "net income tax" the greater of: (a) 25% (regular tax -$25,000), or (b) "Tentative minimum tax" for the year. Unused Credit Carryover carried back one year and forward twenty years Special deduction: Charitable Contributions Deduction limitation 10% adjusted taxable income Carry over not deducted contribution carried forward 5 years. Time limit Accrual must be paid within 2&1/2 months after the tax year end Adjusted taxable income = Gross income business deductions, but not including:

(2)

(3)

u.

(1)
(2) (3)

(4)

14
(a). Any charitable contribution deduction; (b). The dividends received deduction; (c). Any net operating loss carry back; (d). Any capital loss carry back; or (e). U.S. production activities deduction. Dividends received deduction (1) Percentage of Dividends Received Deduction is based on the stock ownership ; (a). 70% for < 20% ownership (unrelated ) (b). 80% for 20% to < 80% (large investment) (c). 100% for 80% or more (consolidate) (2) Amount = percentage x Qualified Dividend (a). Maximum Deduction limit to the percentage x Taxable income before DRD, When No NOL exist or be created. (b). When NOL exist or be created, Deduction will not limit

15 (3) Owned at least 45days before or after

the dividend income. III. Depreciation The Modified Accelerated Cost Recovery System (MACRS) is used for the majority of depreciation expense for taxation. A. MACRS - Property Other than Real Estate 1. Types of Property ADR (Asset Depreciation Range) Class ADR midpoint Description 3-y 4 years No automobiles 200% 5-y 4 < ADR < 10 Automobiles, light 200% trucks, computers, typewriters, copiers, & duplicating equipment. 7-y 10 ADR < 16 Office furniture & 200% fixtures, equipment, property with no ADR midpoint not classified elsewhere, & railroad track.

16
10-y 200% 15-y 150% 16 ADR < 20 20 ADR < 25 Sewage treatment plants, telephone distribution plants, and comparable equipment use for the two-way exchange of voice &data communications. Other than real property with an ADR midpoint of 27.5 years and more, including sewer pipes.

20-y 150%

25 years

2. MACRS Depreciation Rules (1987 and

beyond)

a. MACRS Modified Accelerated Cost

Recovery System. For 3-,5-,7-, and 10-year MACRS property (other than real property) placed in service after January 1, 1987

17 b. Calculation MACRS: depreciation =

declining balance 1 / years of class 200% (or 150%) 3. Salvage Value No salvage value under the method. 4. Half-year Convention In general, depreciation for the year the proper was placed in use or disposed is treated as it is placed or disposed at midpoint of the year. 5. Mid-quarter Convention If more than 40% of depreciable property is placed in service in the last quarter of the year, the mid-quarter convention must be used. B. MACRS - Real Estate (salvage value ignored/ subtract land cost) 1. Residential Rental Property (27.5-year straightline) include apartments and duplex rental homes. 2. Non-residential Real Property (39-year straight-line) include office buildings and warehouses. Tenant improvements to the interior qualify for depreciation over 15years. 3. Mid-month Convention Straight-line depreciation & One half for first and last month.

18
C. Expense Deduction in Lieu of Depreciation (179) 1. Depreciable property allowed to expense in the year acquired 2. Expense deduction limit $250,000.00 (139,000.00 for 2012) 3. Limit reduced dollar for dollar when property exceeds $800,000(560,000.00 for 2012) 4. No deduction if it could have net loss. 5. Vehicles Qualify for the full Section 179 Deduction a. Section 179 limits the cost of a sport utility vehicle (SUV) that may be expensed to $25,000. b. Nature of vehicle for the purpose: not likely to be used for personal purposes, including the following vehicles: (1) Heavy non-SUV vehicles with a cargo area at least six feet in interior length (this area must not be easily accessible from the passenger area.) To give an example, many pickups with full-sized cargo beds will qualify (although some "extended cab" pickups may have beds that are too small to qualify).

19
(2) Vehicles that can seat nine-plus passengers behind the driver's seat (i.e.: Hotel / Airport shuttle vans, etc.). (3) Vehicles with: (1) a fully-enclosed driver's compartment / cargo area, (2) no seating at all behind the driver's seat, and (3) no body section protruding more than 30 inches ahead of the leading edge of the windshield. In other words, a classic cargo van. D. Straight-line in Lieu of Accelerated Depreciation Election S-L regular or longer period available for election. IV. Depletion Exhaustible natural resources: timber, oil, gas or mineral. The two methods of depletion are (i) cost depletion and (ii) percentage depletion. A. Cost Depletion (GAAP) Under cost depletion, the remaining basis of the property is divided by the remaining number of recoverable units (tons of ore, barrels of oil) to arrive at the unit depletion rate. The deduction for depletion is the depletion unit rate multiplied by the number of units sold for the

20
year. B. Percentage Depletion (non-GAAP) 1. Depletion deduction = Percentage Gross Income from the property 2. Percentage range from 5% to 22% 3. Mines and other natural deposits The following is a list of the percentage depletion rates for the more common minerals. DEPOSITS Sulphur, uranium, and, if from deposits in the United States, asbestos, lead ore, zinc ore, nickel ore, and mica Gold, silver, copper, iron ore, and certain oil shale, if from deposits in the United States Borax, granite, limestone, marble, mollusk shells, potash, slate, soapstone, and carbon dioxide produced from a well Coal, lignite, and sodium chloride Clay and shale used or sold for use in making sewer pipe or bricks or used or sold for use as sintered or burned lightweight aggregates RATE

22% 15%

14% 10%

7%

21
Clay used or sold for use in making drainage and roofing tile, flower pots, and kindred products, and gravel, sand, and stone (other than stone used or sold for use by a mine owner or operator as dimension or ornamental stone) 5% 4. Deduction limit limit 50% (100% for oil and gas property) of your taxable income from the property before depletion deduction and the domestic production activities deduction 5. No basis limit, so deduction may allowed after cost completely recovered 6. Depletable oil or natural gas Depletable quantity: oil 1,000 barrels. Gas 6,000 cubic feet your depletable oil quantity that you choose to apply. If you claim depletion on both oil and natural gas, you must reduce your depletable oil quantity (1,000 barrels) by the number of barrels you use to figure your depletable natural gas quantity. V. Amortization A. Intangibles 1. S-L 15years. 2. Including: goodwill, licenses, franchises, and trademarks

22 3. Starting on the month of acquisition

B. Others 1. Business start-up expenses or organization costs180ms 2. Research expenses 60ms 3. Pollution-control facilities. VI. Summary of Section 1231, 1245, & 1250 Assets A. Section 1231 assets (loss is ordinary, gain is capital) depreciable property used in the taxpayer's trade or business and held for over twelve months. 1. Capital Gain Treatment A special benefit by allowing capital gain treatment (tax rates of 5% or 15%) on net Section 1231 gains from sales, exchanges, or involuntary conversions of certain "non-capital" assets, subject to Section 1245 and Section 1250 provisions because certain gains for Section 1231 assets fall under Sections 1245 or 1250. 2. Ordinary Loss Treatment Net Section 1231 losses are treated as ordinary losses. a. A capital loss cannot be deducted in excess of capital gains (except for the $3,000 per year allowance for individual taxpayers), and

23
b. A Section 1231 net loss is deducted immediately in full without consideration of capital gains. B. Section 1245 (machinery and equipment) - Gains Only 1. Personal Business Property Section 1245 assets are personal properties used in a trade or business for over twelve months (e.g., autos). 2. Recapture all Accumulated Depreciation Upon the sale of a Section 1245 asset (depreciable personal property): c. The lesser of gain recognized or all accumulated depreciation is recaptured as ordinary income under Section 1245, and d. Any remaining gain is capital gain under Section 1231. C. Section 1250 (buildings) - Gains Only 1. Real Business Property Section 1250 assets are real properties used in a trade or business over twelve months (e.g., a warehouse). 2. Recapture Difference Between Straight-line and Depreciation Taken e. Section 1250, which differs from 1245, only recaptures the portion of depreciation taken on

24
real property (under old assets accelerated Method) in excess of straight line. f. The total amount of the taxable recapture as ordinary income for a corporation subject to the provisions of Section 1250 is equal to the amount of the ordinary income under the general Section 1250 rules (above) plus 20% of the straight-line depreciation that was not recaptured under the general rules. g. The total depreciation recaptured is limited to the recognized gain 3. Straight-line Depreciation Taken -1231 gain treatment. 4. Excess Gain is Section 1231 Gain (capital gain treatment) Sale price (cost S-L depreciation) = Sec. 1231 Gain. Capital gain: taxed at 25% maximum rate. VII. Taxation of a C. Corporation A. Filing Requirements Form 1120 due 2.5 months after year end, (March 15, for year end at Dec. 31) 1. Legal Holiday or Weekend due on the next business day

25
2. Extension (Form 7004) - six months is available by filing Form 7004. 3. Accrual Basis vs. Cash Basis a. Cash basis most individuals, qualified personal service corporations and taxpayers whose average annual gross receipts < $1,000,000 b. Accrual basis (1) Purchases and sales of inventory (and inventories must be maintained); (2) Tax shelters; (3) Certain farming corporations (other farming or tree-raising businesses may generally use the cash basis); and (4) C corporations, trusts with unrelated trade or business income, and partnerships having a C corporation as a partner provided the business has greater than $5 million of average annual gross receipts for the threeyear period ending with the tax year. 4. Statute of Limitations a. Reassess tax: 3 years, 6years for > 25% misstatement.

26 b. Reopen a closed if item is ruled deductible

in a subsequent year after having been taken in a year now closed by the statute of limitations, the IRS will reopen the statute of limitations to disallow the deduction in the previous year. B. Estimated Payments of Corporate Tax 1. Estimated taxes payments due: on the 15th day of the 4th, 6th, 9th, and 12th months of their tax year. 2. Each payment: of the estimated tax. Unequal quarterly payments may be made using the annualized income method. 3. Penalty will be assessed if these payments are not made and the amount owed on the return is $500 or more. 4. Estimated taxes a. Small Corporations are required to pay the lesser of: (1) 100% of the tax shown on the return for the current year, or (2) 100% of the tax shown on the return for the preceding year,

27
(3) Only current year, if no tax for the preceding year or the preceding tax year was less than 12 months. b. Large Corporations Must pay estimated tax for 100% of the tax as shown on the current year return. (a corporation whose taxable income $1 million in any of its three preceding tax years) C. Graduated Tax Rates and Taxable Income 1. No exemptions as individuals have 2. Taxable income graduated tax rates Corporations with taxable income above $18,333,333 will have all income tax at a flat 35%. D. Consolidated Tax Return 1. Requirements: all the corporations in the group: a. must have been members of an affiliated group at some time during the tax year, and b. must file a consent. The act of filing a consolidated return by all the affiliated corporations will satisfy the consent requirement. 2. Affiliated Group Defined An affiliated group means that a common parent directly owns: c. 80% or more of the voting power of all outstanding stock, and

28
d. 80% or more of the value of all outstanding stock 3. Organizations not allowed for consolidated tax return: a. S corporations, b. foreign corporations, c. most real estate investment trusts (REITs), d. some insurance companies e. most exempt organizations. 4. Brother-Sister Corporations Corporations owned by an individual (not a corporation) with 80% or more of the stock of two or more corporations may not file consolidated returns. 5. Advantages of Filing Consolidated Return e. Capital losses of one corporation offset capital gains of another corporation; f. Operating losses of one corporation offset the operating profits of another corporation; g. Dividends received are 100% eliminated in consolidation because they are intercompany dividends; and h. A corporation's NOL carryover may be applied against the income of the consolidated group.

29
6. Disadvantages of Filing Consolidated Return a. The disadvantages of filing a consolidated return include: b. Mandatory compliance with complex regulations; c. In the initial consolidated tax return year, a double counting of inventory can occur if group members had intercompany transactions d. Tax credits may be limited by operating losses of other members; and e. The election to file consolidated returns is binding for future years and may only be terminated by disbanding the group or seeking permission of the Internal Revenue Service. E. Corporate Alternative Minimum Tax 1. AMT = 20% on alternative minimum taxable income (AMTI) an exemption amount. Regular Taxable Income Before NOL Long-term contracts(percentage) Installment sale dealer (full accr.) Exc.depr. (post 1986)( S-L 40years for real, 150% dec bal) Adjustment Items to Income

30
Percentage depletion(over basis) Private activity - issued post '86 Tax-exempt interest income Pre '87 ACRS excess depreciation (over S-L) Municipal interest Tax exempt interest income Increase CSV life insurance Non S/L deprec. (after 1989; excess ADS depr. over S-L) Dividends received deduction (70% under 20% ownership) < A.M.T. NOL Deduction> Minimum Taxable Income < A.M.T. Exemption> = A. M. T. Income 20% Gross Alternative Minimum Tax <Foreign Tax Credit> Tentative A. M. Tax < Regular Tax Liability >

+ Preferences

75% of the difference (neg. adj. limited to past positive)

$40,000 25% (MTI 150,000)

31
Alternative Minimum Tax Tax due in addition to regular tax

2. Minimum Tax Credit (MTC) a. AMT paid would be future year regular tax credits b. Carry forward: The MTC may be carried forward indefinitely, but no carry back. F. Accumulated Earnings Tax 1. Condition: a. C Corporation: > $250,000. b. Personal service corporations: > $150,000 c. No Accumulated Earnings Tax on personal holding companies (PHCs), tax-exempt corporations, or passive foreign investment corporations. 2. AE Tax rate: a flat 15%. 3. To avoid AET: must be: a. A demonstrated specific, definite, and feasible plan for the use of accumulation (reasonable needs); or b. A need to redeem the corporate stock included in a deceased stockholder's gross estate. 4. Not self-assessed Tax: AE Tax assessed by IRS audit, not self assessed.

32
5. To reduce AE Tax: A dividend paid by the due date of the tax return or hypothetical "consent" dividends may reduce or eliminate the tax. 6. AET Calculation

33 Before: G. Personal Holding Company Tax Tax Shelters Dividends received

TAXABLE INCOME deduction Net operating loss Charity deduction Capital loss carryover

< All Charity > < All Capital Losses> < Taxes> < Dividends Paid> During tax year Within 2&1/2, months Consent dividends

Accumulated Taxable Income Lifetime Credit: 250,000 Business (Reg.corp) Need: or Beg. E&P 150,000 <Corporation (Serv.corp.) needs> <Beg. Excess> Beg. Excess <Remaining Credit> Remaining Credit Current Accumulated Taxable Income 15% Accumulated Earnings Tax

34
1. Definition of Personal Holding Company a. Ownership: > 50% owned by 5 at any time during the last half of the tax year b. AGI: 60% of adjusted ordinary gross income consisting of: (1) Net rent (if less than 50% of ordinary gross income); (2) Interest that is taxable (nontaxable is excluded); (3) Royalties (but not mineral, oil, gas, or copyright royalties) (4) Dividends from an unrelated domestic corporation. 2. Additional Tax Assessed a. Taxed Rate: 15% addition tax on personal holding company net income not distributed. b. Net income not distributed = Taxable income Federal income taxes Net L-T capital gain (net of tax). c. No addition tax if distributed (actual dividends paid or consent dividends). d. No Accum. Earnings Tax. 3. Self-assessed Tax by filing Schedule 1120 PH with 1120.

35
H. Personal Service Corporations: 1. No Graduated Rates, a flat tax rate of 35% 2. Professional service companies: accounting, law, consulting, engineering, architecture, health, and actuarial science. VIII. Corporate Earnings and Profits (E&P) E&P (taxation) Retained Earnings (GAAP): for example, while non-taxable dividends reduce retained earnings, they have no effect on E&P (nonprofit distribution) A. General 1. Required for Corporate Income Tax Return Preparation The calculation of E&P (both the current and prior accumulated amounts) is required in the preparation of the corporate income tax return. 2. Impact on Corporate Distributions and Other Activities a. E&P the ability to pay a dividend, while Retained earnings net financial position, used to evaluate its common stock, b. The calculation of E&P tax impact of corporate distributions, or non-liquidating dividends (note that special rules exist for 20% shareholders).

36 c. E&P is a factor in the determination of

corporate reorganizations, accumulated earnings tax, stock redemptions, partial liquidations, and the tax status of certain S corporations that have previously been C corporations (e.g., passive income limit rules). 3. Start with Corporate Taxable Income E&P is calculated by adjusting the taxable income of the corporation. Any items not in taxable income but may impact ability to pay dividends would be included in E&P. B. Adjustments 1. Positive and Negative Adjustments always positive, always negative, or either positive or negative. 2. Temporary or Permanent presents the corporate Schedule M-1. C. Current Earnings and Profits General Calculation Corporate taxable income: 1. Negative Adjustments (not deductible on tax) a. Federal income tax expense b. Non-deductible penalties, fines, political contributions, etc.

37
c. Officer life insurance premiums [corporation is the beneficiary] d. Expenses for production of tax-exempt income (non-taxable income expenses) e. Non-deductible charitable contributions f. Non-deductible capital losses 2. Positive Adjustments (not included in taxable income) a. Refunds of federal income tax paid b. Tax-exempt income c. Refunds of items that were not subject to regular tax under the tax benefit rule d. NOL deductions e. Life insurance proceeds where corporation is the beneficiary f. Dividends received deduction used to calculate regular taxable income g. Carryovers of capital losses that impacted taxable income h. Carryovers of charitable contributions that impacted taxable income i. Non-taxable cancellation of debt not used to reduce basis of property 3. Positive or Negative Adjustments

38
a. Losses and gains that have different effects on taxable income vs. E&P b. Changes in the cash surrender value of certain life insurance policies c. Excess depreciation for E&P over that for regular income tax d. Differences in allowable deductions for organizational and start-up expenses e. Installment income method adjustments f. Completed contract income vs. percentageof-completion income adjustments g. Amortization of intangible drilling costs adjustments h. Section 179 expense per regular tax vs. ratable depreciation on the same property using a five-year life: i. = CURRENT EARNINGS AND PROFITS (E&P) D. Accumulated Earnings and Profits 1. General Calculation the accumulated E&P to carry forward to next year: Accumulated E&P as of the beginning of the year +/Current E&P for the tax year Distributions deemed from current E&P

39
= Distributions from accumulated E&P Accumulated E&P as of the end of the year

2. Classification of Distribution a. current E&P, pro rate basis to each distribution b. accumulated E&P, chronological order, beginning with the earliest distribution IX. Corporate Distributions taxable if classified as dividends. A. Dividends Defined a distribution of property by a corporation out of its earnings and profits (E&P): Current E&P (by Taxable year-end) (Pro rated) dividend Separated not net Accumulated E&P Taxable (distribution date) dividend Return of capital (no Tax free & reduces E&P) basis of common stock Capital gain Taxable income as a distribution (no capital gain E&P/no basis 1. General Netting Rules

40
a. If current E&P is positive and accumulated E&P is negative, distributions are dividends = current E&P only. b. If current E&P is negative and accumulated E&P is positive, the two amounts are netted, and distributions are dividends = net positive. c. If current and accumulated E&P are net negative, distributions are not dividends at all. 2. Preferred vs. Common a. Receiving priority over common b. Taxable income B. Source of Distributions 1. Order of Distribution Allocation a. current E&P first Pro rate b. accumulated E&P. chronological order c. nontaxable return of capital d. capital gain distributions (taxable income) by the shareholder, if any excess remains, it is classified as "excess distributions" C. Constructive Dividends 1. Excessive salaries paid to shareholder employees 2. Excessive rents and royalties

41
3. "Loans" to shareholders where there is no intent to repay 4. Sale of assets below fair market value D. Stock Dividends 1. Definition a distribution by a corporation of its own stock to its shareholders. 2. Generally Not Taxable unless the shareholder has a choice of receiving cash or other property. 3. Determination of Value the value of taxable stock dividend is the fair market value on the distribution date. 4. Allocation of Basis The basis of stock dividend = total old stock basis / # of stock(old + new) E. (Shareholder)Taxable Amount 1. Individual Shareholder a. Cash dividends - amount received b. Property dividends - FMV of property received 2. Corporate Shareholders (subject to the dividends received deduction) a. Cash dividends - amount received b. Property dividends - FMV of property received

42
F. Corporation Paying Dividend - Taxable Amount 1. General Rule not a taxable event. A dividend is a reduction of earnings and profits (retained earnings). 2. Property Dividends distribution of appreciated property, tax as follows: a. Gain recognized as if sold (FMV adjusted basis). Gain added to current E&P. FMV Property < Net Book Value> Corp. Gain Current E&P Pass Key 1. Corporation has no E&P (dividend would not be taxable income) 2. Corporation distributes appreciated property as a dividend 3. Corporation has a recognized gain (on property dividend) 4. Corporate gain increase/creates corporate E&P 5. Dividend to shareholder is now taxable income (to extent of E&P)

43
b. Dividend = FMV of property to the extent of current E&P c. no loss recognized when depreciable property is distributed G. Stock Redemption qualifies for sale or exchange treatment, gain or loss is recognized 1. Proportional- Taxable dividend income (to shareholder-ordinary income) for redeems or cancels the stock pro-rata for all shareholders. 2. Disproportional (substantially disproportionate) - Sale by shareholder subject to taxable capital gain/loss to shareholder percentage of ownership changed after redemption 3. Partial liquidation of corporation (stock held by a non-corporate shareholder) Treated as an exchange of stock, not as a dividend. 4. Complete buy-out of shareholderShareholder's entire interest is redeemed, and the transaction is treated as an exchange of stock. 5. Redemption not essentially equivalent to a dividend - Treated as an exchange of stock. 6. Redemption to pay estate taxes-or expenses Treated as an exchange when the corporation redeems stock that has been included in the

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decedent's gross estate (subject to dollar and time limitations). X. Corporate Liquidation If a corporation is liquidated, the transaction is subject to double taxation (that is, the corporation and the shareholder must generally recognize gain or loss). Note that the corporation generally deducts its liquidation expenses (e.g., filing fees, and professional fees) on its final tax return. Corporation liquidations take two general forms: A. Corporation Sells Assets and Distributes Cash to Shareholders 1. Corporation recognizes gain or loss (as normal) on the sale of the assets, and Sale Price <Property Basis> Taxable Gain/Loss 2. Shareholders recognize gain or loss to extent cash exceeds adjusted basis of stock. Proceeds <Stock Basis> Taxable Gain/Loss B. Corporation Distributes Assets to Shareholders:

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1. Corporation recognizes gain or loss as if it sold the assets for the FMV, and Property FMV <Property Basis> Taxable Gain/Loss 2. Shareholders recognize gain or loss to extent FMV of assets received exceeds the adjusted basis of stock. Property FMV <Stock Basis> Taxable Gain/Loss C. Tax-free Reorganizations 1. Reorganization Defined a. Mergers or consolidations (Type A); b. The acquisition by one corporation of another corporation's stock, stock for stock (Type B); c. The acquisition by one corporation of another corporation's assets, stock for assets (Type C); d. Dividing of the corporation into separate operating corporations (Type D); e. Recapitalizations (Type E); and

46 f. Mere change in identity, form, or place of

organization (Type F). 2. Parent/Subsidiary Liquidation a. No gain or lossby either the parent or the subsidiary when the parent, who owns at least 80%, liquidates its subsidiary. b. Parent assumes the basis of the subsidiary's assets as well as any unused NOL or capital loss or charitable contribution carryovers. 3. Nontaxable Event - reorganizations a. Corporation Nontaxable (1) Nontaxable transaction. (2) All tax attributes remain. b. Shareholder - Nontaxable (1) Nontaxable transaction. (2) Retain his/her original basis on stocks (3) Gain to the extent he/she receives boot (cash) in the reorganization. 4. Continuity of Business nontaxable reorganization requirements the acquiring corporation must: a. continue the business of the old entity (or entities), or

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b. use a significant portion of the old corporation's assets. 5. Control Requirement nontaxable reorganization control test: At least acquired 80% of the total voting power of all classes of stocks, and At least 80% of all other classes of stock. 6. Distinguish Reorganization from Liquidation
Pass Key Liquidation Reorganization Business Activity Complete ceases Continues Corp. Conseq Taxable Nontaxable Sharehold. Conseq. Taxable Nontaxable

D. Worthless Stock - Section 1244 Stock (small

business stock) ordinary loss treatment for worthless stock 1. Qualification a. Must be an original stock holder b. Stock acquired by cash or property, not by stock, securities, or service c. Cash or property for first $1,000,000 of capital stock 2. Maximum Ordinary Loss Deduction

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a. Married-$100,000 b. Single - $50,000 E. Small Business Stock - 50% Exclusion of Gain 1. Qualification a. Must be a non-corporate shareholder (individual or partnership) b. Hold stock for more than 5 years. c. Stock must be: (1) issued after August 10, 1993. (2) Acquired at the original issuance. (3) C corporation only (not an S corporation). (4) Capital < $50 million as of date of stock issuance. (5) Corporations 80% (or more) of assets must be used in qualified trades or businesses. 2. Maximum exclusion - limited to 50% of the greater of: a. 10 times the taxpayer's basis in the stock, or b. $10 million dollars (shareholder by shareholder basis). 3. Taxable Portion Includible portion of the gain is taxed at 28% rate.