Chapter 11 - The Corporate Taxpayer

Chapter11

QuestionsandProblemsforDiscussion

1. Individualswhoperformprofessionalservicesforclients(doctors,attorneys,CPAs,etc.)cannot
avoidliabilityformalpracticebyoperatingasshareholder/employeesofacorporation.These
individualsremainpersonallyresponsiblefortheiractionsandcanbesuedfornegligenceor
misconduct.

2. a. Theshareholdersofapubliclyheldcorporationelectaboardofdirectorstomanagethe
corporationontheirbehalf.Theboardofdirectorsisresponsibleforhiringthecorporateofficers
andotherkeyemployees.Underthiscentralizedstructure,theownersofthebusiness(the
shareholders)donotparticipateinmanagementdecisions.

b. Incontrast,theshareholdersofacloselyheldcorporationusuallyserveastheboardofdirectors
andaretypicallyemployedtomanagethecorporatebusiness.Inthiscase,managementisnot
centralizedbutisretainedbythebusinessowners.

3. a. Equitystockinpubliclyheldcorporationsisahighlyliquidassetthatcanbefreelyboughtorsold
throughestablishedsecuritymarkets.Thesepublicmarketsdeterminethepriceatwhichthe
stockistraded.

b. Equitystockincloselyheldcorporationsisboughtorsoldthroughprivatemarkets.Transfersof
stockmaybeinfrequent,andthestocksvalueisnotdeterminedbythemarketbutbyreference
totheunderlyingvalueofthecorporateassets.Suchstocktypicallyissubjecttobuysell
restrictionsthatpreventtheownersfromtransferringstockunlesstheothershareholdersagree.
Consequently,thestockmaynotbefreelytransferableatall.

4. Thethreefamilycorporationsformabrothersistercontrolledgroup,butnotanaffiliatedgroup.
Consequently,thethreecorporationsareineligibletofileaconsolidatedreturn.

5. AlthoughRPlegallycontrolsQV,its59percentownershipfallsfarshortofthe80percentrequiredto
formanaffiliatedgroup.Consequently,RPandQVareineligibletofileaconsolidatedreturn.

6. Librettomaywanttoisolatetheriskassociatedwiththemusicvideobusinessbyoperatingthe
venturethroughawhollyownedsubsidiary.Thesubsidiarycanhaveauniquemanagement
structureanditsowncorporateofficerswhoaresolelyresponsibleforthesuccessofthe
subsidiarysspecializedbusiness.

7. Thedividendsreceiveddeductionwasenactedtomitigatethedoubletaxthatwouldoccurwhenone
corporationsubjecttofederaltaxdistributesaftertaxincomeasadividendtoasecondcorporation
alsosubjecttofederaltax.Ifthedistributingcorporationisaforeigncorporationnotsubjecttofederal
tax,theproblemofdoubletaxationbytheUnitedStatesgovernmentdoesntarise,andthe
dividendsreceiveddeductionisunnecessary.

8. Congressenactstaxpreferencesasincentivesforallcorporationstoengageincertainbehaviors.
WhileCongresswantstheseincentivestoworkonamacroeconomiclevel,itdoesnotwantanyone
corporationtobenefittoomuchfrompreferences.Consequently,theAMTpenalizesoverindulgence
inpreferencesatthemicroeconomiclevel.

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9. Becausethe20percentAMTrateissomuchlessthanthe34or35percentregularcorporatetax
rate,AMTImustbesignificantlygreaterthantaxableincomebeforeacorporationowesanAMT.
Evidently,CorporationVroutinelyhasinsignificantAMTadjustmentsandpreferences,butnot
enoughtotriggertheAMT.

10. Acorporationismerelyaforminwhichpeople(owners,employees,suppliers,customers)
participateinabusinessactivity.Anytaxleviedontheactivitynecessarilyreducestheaftertax
valueoftheactivitytosomegroupofparticipants.

ApplicationProblems

1. AlphaistheparentcorporationofanaffiliatedgroupconsistingofAlphaandBeta.

2. Grommet,Staple,andBinderareeligibletofileaconsolidatedreturn.

3. a. CorporationPs CorporationTs
SeparateReturn SeparateReturn
Ordinaryoperatingincome(loss) $500,000 $(200,000)
Capitalgain 0 6,000
Section1231gain(loss) (1,000) 5,000
Capitalloss(deductibletoextentof
capitalandSection1231gain 0 0
Taxableincome(NOL) $499,000 $(189,000)

b. Consolidated
Return
Ordinaryoperatingincome $300,000
Capitalgain 6,000
NetSection1231gain 4,000
Deductiblecapitalloss (8,300)
Taxableincome $301,700

4. NapaCorporationsdividendsreceiveddeductionis$158,500.
KLPdividend$55,000 70% $38,500
Gammadividend$120,000 100% 120,000
$158,500

5. GHJsdividendsreceiveddeductionis$76,750.
BPdividend$17,300 70% $12,110
MNdividend$80,800 80% 64,640
$76,750
GHJisnotentitledtoadividendsreceiveddeductionfortheABdividendbecauseABisaforeign
corporation.

6. BecauseCamcohadanNOLforitsfirstyear,itcouldnotdeductanyofits$5,000contributionbut
couldonlycarrythecontributionforwardtoitssecondyear.Inthesecondyear,Camcoscharitable

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contributiondeductionislimitedto10percentoftaxableincomeaftertheNOLcarryforward
deduction.Consequently,Camcoisallowedan$11,860charitablecontributiondeduction($10,000
currentyearcontribution+$1,860carryforward),anditstaxableincomeis$106,740.
Incomefromoperations $210,600
NOLcarryforwarddeduction (92,000)
Taxableincomebeforecharitablecontribution 118,600
Charitablecontributiondeduction (11,860)
Taxableincome $106,740

7. a. The$100,000charitablecontributionhasanaftertaxcostof$66,000($100,000$34,000tax
savingsfromcurrentdeductionat34percent).

b. Figcandeduct$49,000ofthecontributionthisyearand$51,000asacontributioncarryforward
nextyear.Theaftertaxcostofthecontributionis$66,988.
Contribution $(100,000)
Currenttaxsavings($49,00034%) 16,660
Taxsavingsnextyear
([$51,00034%] .943discountfactor 16,352
$(66,988
)

c. Figcandeduct$19,000ofthecontributionthisyearand$13,000ineachofthenextfiveyears.
Theremaining$16,000contributioncarryforwardexpires.Theaftertaxcostofthecontributionis
$71,235.
Contribution $(100,000)
Currenttaxsavings($19,00039%) 7,410
NPVoffuturetaxsavings
([$13,00039%] 4.212discountfactor) 21,355
$(71,235
)

8. a. Domesticproductionactivitiesdeduction=$12,000($200,000*6%)
2007taxableincome=$438,000($450,000$12,000)
2007taxliability=$148,920

b. $153,000

c. Potentialtaxsavings=$4,080.Thistaxsavingsmaybeinsufficienttocausethecompanyto
shiftfutureproductionactivitiesfromCanadatotheU.S.,unlessothercostfactorsalsofavor
domesticproduction.

9. a. NetincomefromU.S.productionactivity $429,000
U.S.productionactivitiesdeduction
($429,000 3%) (12,870)
NetincomefromCanadianproductionactivity 343,000
Investmentincome 39,400
Hallickstaxableincome $798,530

b. NetincomefromU.S.productionactivity $429,000
NetlossfromCanadianproductionactivity (112,700)
Investmentincome 39,400
Taxableincomebeforededuction $355,700

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U.S.productionactivitiesdeduction
($355,700 3%) (10,671)
Hallickstaxableincome $345,029

10. a. Allowablerehabcredit=$800,000(20%*$4,000,000)
Aftertaxpurchasepriceofhistoricbuildingis$6,200,000($3,000,000purchaseprice+
$4,000,000rehabcosts$800,000credit)

b. Landovershouldacquirethehistoricbuilding,becauseitsaftertaxcostof$6,200,000isless
thanthe$6,500,000costofthenewbuilding.

c. Ifthecreditcannotbeusedimmediately,itsvalueislessthan$800,000.Dependingonthe
lengthoftimeuntilLandoverexpectstobeprofitable,iftheNPVofthecreditdropsbelow
$500,000,thedecisionwouldchange.

11. a. Bookincome $500,000

Less:DRD (10,500)
Less:excesstaxdepreciation (15,000)
Less:munibondinterest (5,000)
Plus:excesscapitalloss 2,000
Plus:federalincometax 249,000

Taxableincome $720,500

Taxliability $244,970

b. ScheduleM1:

12. a. EFGsnetincomeperbooks $479,900

U.S.productionactivitiesdeduction
($314,800 6%) (18,888)
Taxexemptincome (10,700)
Baddebtexpenseperbooks $3,700
Baddebtdeduction(writeoffs) (4,400)
(700)
Nondeductiblefine 6,000
Bookdepreciationexpense $44,200
MACRSdepreciation (31,000)
13,200

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Capitallosscarryforwarddeduction (8,800)
Amortizationoforganizationalcosts (460)
Federaltaxexpenseperbooks 241,589
EFGstaxableincome $701,141
Taxrate .34
EFGsregulartax $238,388

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b. ScheduleM1:

13. a. CorporationABstaxsavingsis$750($5,000 15%),andCorporationYZstaxsavingsare

$1,750($5,000 35%)

b. Thetaxsavingsofa$5,000credittobothcorporationsis$5,000.

14. a. $45,650($22,250+[39%$60,000])

b. $56,000(35%$160,000)

c. $1,329,400(34%$3,910,000)

d. $5,834,000($5,150,000+[38%$1,800,000])

e. $19,950,000(35%$57,000,000)

15. a. Marginaltaxrate39%;averagetaxrate28.53%

b. Marginaltaxrate35%;averagetaxrate35%.

c. Marginaltaxrate34%;averagetaxrate34%.

d. Marginaltaxrate38%;averagetaxrate34.73%.

e. Marginaltaxrate35%;averagetaxrate35%.

16. MyamoisexemptfromtheAMTonlyfor2005(itsfirsttaxableyear).Myamosfirsttestyearis2006,
andthetestingperiodforthatyearis2005.BecauseMyamos2005grossreceiptsexceeded
$5,000,000,MyamoisnotexemptfromtheAMTfor2006oranysubsequenttaxableyear.

17. NorthupisexemptfromtheAMTfor2002(itsfirsttaxableyear)andfor2003,2004,and2005.
Northupsaverageannualgrossreceiptsforthe2003testingperiodwere$4,282,000,whichisless
thanthe$5,000,000limitforthefirsttestyear.
Northupsaverageannualgrossreceiptsforthe2004and2005testingperiodswere$6,350,000
([$4,282,000+$8,418,000] 2years)and$6,567,333([$4,282,000+$8,418,000+$7,002,000]
3years),whichwerelessthanthe$7,500,000limitforallsubsequenttestyears.

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Northupsaverageannualgrossreceiptsforthe2006testingperiodwere$8,362,667([$8,418,000+
$7,002,000+$9,668,000] 3years).Consequently,NorthupisnotexemptfromtheAMTfor2006
oranysubsequenttaxableyear.

18. Perkinstaxableincome $100,000

AMTadjustments 45,000
AMTtaxpreference 22,000
AMTIbeforeexemption $167,000
Exemption
($40,000[25% $17,000excessAMTI]) (35,750)
$131,250
AMTrate .20
Tentativeminimumtax $26,250
Regulartax (22,250)
AMT $4,000

19. Raisestaxableincome $3,590,000

AMTadjustments 980,000
AMTtaxpreferences 315,000
AMTIbeforeexemption $4,885,000
Exemption 0
$4,885,000
AMTrate .20
Tentativeminimumtax $977,000
Regulartax (1,220,600)
AMT 0

20. GrandstaxableincomebeforeNOLdeduction $1,250,000

AMTadjustments 0
AMTtaxpreferences 0
AMTIbeforeNOLdeductionandexemption $1,250,000
Exemption 0
$1,250,000
NOLdeduction(90%AMTIbeforededuction) (1,125,000)
$125,000
AMTrate .20
Tentativeminimumtax $25,000
Regulartax* 0
AMT $25,000
*GrandhasnotaxableincomeaftertheNOLdeduction

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21. a.

b. Regulartaxableincome $6,965,000
AMTpreferences&adjustments 2,000,000
AMTI $8,965,000
Rate 20%
Tentativeminimumtax $1,793,000
Regulartax $2,368,100
AMT $0
Finaltaxdue $2,368,100

22.
Year1 Year2 Year3
MinimumTaxCredit $40,000 $0 $0
Generated
MinimumTaxCredit $0 $20,000 $20,000
Used
FinalTax $150,000 $130,000 $130,000
Liability
MinimumTaxCredit $40,000 $20,000 $0
Carryforward

23. a. Hallstaxfor2005was$200,000;for2006was$900,000(including$30,000AMT);andfor2007
was$1,820,000(including$320,000AMT).

b. Halls2008AMTI $11,000,000
AMTrate .20
Tentativeminimumtax $2,200,000
Regulartax($9,000,000 34%) $3,060,000
Minimumtaxcredit (350,000)
Halls2008tax $2,710,000

c. Halls2008AMTI $14,800,000
AMTrate .20
Tentativeminimumtax $2,960,000
Regulartax($9,000,000 34%) $3,060,000
Minimumtaxcredit(excessofregular
taxovertentativeminimumtax) (100,000)

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Halls2008tax $2,960,000

24. a. Toavoidanunderpaymentpenalty,NBsrequiredinstallmentpaymentsof2008taxmustequal
orexceed$201,620($50,405perinstallment).Thetotalequals100percentofNBs2008tax.
b. Toavoidanunderpaymentpenalty,NBsrequiredinstallmentpaymentsof2008taxmustequal
orexceed$242,000($60,500perinstallment).Thetotalequals100percentofNBs2007tax.
c. Toavoidanunderpaymentpenalty,NBsrequiredinstallmentpaymentsof2008taxmustequal
orexceed$476,000($119,000perinstallment).Thetotalequals100percentofNBs2008tax
becauseitisineligibletomakeasafeharborestimate.

25. a. Jamestaxonthe$100,000dividendis$15,000($100,00015%).

b. The$100,000dividendconsistsofaftertaxdollars.Consequently,JJhadtoearn$151,515of
beforetaxincometogeneratethe$100,000dividend($151,515[$151,515 34%]),andthe
corporatetaxwithrespecttothedividendis$51,515.Jamesmustrecognizea$151,515
grossedupdividendonwhichhisprecredittaxis$22,727($151,51515%).Becausehe
receivesacreditforthe$51,515corporatetax,hisindividualtaxonthedividendisreducedto
zero.

26. a. TheshareholderswhoownShinestockbeartheincidenceofthecorporatetaxincrease.

b. Inthiscase,Shinesemployeesbeartheincidenceofthecorporatetaxintheformofreduced
compensation(nomoreonsitedaycare).

IssueRecognitionProblems

1. Wouldthefoundationsprofitsfromsalesofanewsletterbeunrelatedbusinessincomesubjectto
thecorporatetax?CanGreentownFoundationundertaketheforprofitnewsletteractivityand
maintainitstaxexemptstatus?

2. CanTKaccrueanddeductthe$375originalissuediscountasinterestexpenseoverthefiveyear
lifeofthebonds?

3. CanBanderadeductthe$16,800feeasanordinaryandnecessarybusinessexpense?Isthe
consultingfeeconsideredpartofBanderasnondeductibledividendpayment?

4. IsM&Mallowedadeductionforacharitablecontributionofitsowncommonstock?Istheamountof
thecontributionequaltothestocksFMVeventhoughM&Mhasnobasisinthestock?

5. CanChemcodeductthe$950,000paymentasacharitablecontribution?WilltheIRSdisallowthe
deductionbecausethepaymentisinlieuofanondeductiblegovernmentfine?

6. IsthedifferencebetweenthegainrealizedusingtheMACRSadjustedbasisandthegainrealized
usingtheAMTadjustedbasisanAMTadjustmentthisyear?IsFerrisentitledtoa$122,000negative
AMTadjustment(excessofgainrealizedforregulartaxpurposesoverAMTgainrealized)thisyear?

7. WillthelimitationontheNOLcarryforwarddeductionforAMTpurposestriggeranAMTliabilityinthe
nextthreeyears?

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8. WillWigginsoweanunderpaymentpenaltybecauseofthesubstantialunpaidtaxliabilitytriggered
bythesaleofthelandinthelastmonthoftheyear?CanWigginsavoidunderpaymentpenaltyonits
firstthreeinstallmentpaymentsbecausethesepaymentswerebasedoncorporateincomeearned
throughthedateofpayment?

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ResearchProblems

1 AccordingtoSection118(a),Connordidnotrecognizeincomeonreceiptofthelandbecause
AugustaCountycontributedthelandtocorporatecapital.AccordingtoSection362(c)(1),Connors
initialbasisinthecontributedlandwaszerobecauseAugustaCountywasnotashareholder.Connor
wasrequiredtocapitalizethe$17,560expenditureforthetitlesearch,survey,andwaterwellstothe
basisoftheland.(SeeReg.Sec.1.263(a)2(c),Wacker,TCMemo1968173,andTidwell,TCMemo
1961162).
Section165(a)andReg.Sec.1.1652allowataxpayertorecognizeanordinarylossonthe
abandonmentofnondepreciablebusinessproperty.Thedollaramountofthelossisthepropertys
adjustedbasis.Therefore,Connorrecognizeda$17,560ordinaryabandonmentlossin2008whenit
renouncedanylegalclaimtotheland.

2. Section170(a)(1)allowsadeductionforcharitablecontributionspaidwithinthetaxableyear.
However,Section170(a)(2)providesthataccrualbasiscorporationscanelecttotakeadeductionin
theyearinwhichtheboardofdirectorsauthorizesacharitablecontributionontheconditionthatthe
contributionispaidonorbeforethefifteenthdayofthethirdmonthfollowingthecloseoftheyear.
BecauseWilkiefailedtotransfertheGydostockbeforeMarch15,2006,itcannotelecttotakethe
deductionin2005butcantakeitonlyin2006.AccordingtoReg.Sec.1.170A1(c)(1),theamountof
acontributionofpropertyisthepropertysFMVatdateofcontribution.Thisamountisnotreduced
underSection170(e)(1)becausethesaleofthestockwouldhaveresultedinlongtermcapitalgainto
Wilkie.Consequently,Wilkiesdeductionequalsthe$100,000FMVofthedonatedshares.

3. AccordingtoSection311(b),ifacorporationdistributespropertytoashareholderasadividendand
theFMVofsuchpropertyexceedsthecorporationsadjustedintheproperty,thedistributing
corporationmustrecognizegainasifsuchpropertyweresoldtotheshareholderatFMV.Becauseof
thisrecognitionrule,EchoValleymustrecognizea$209,000gain($420,000FMV$211,000basis)
onthedistributionoftractD6toBarryandLynetteMajors.Ifitheldthelandasaninvestment,the
gainiscapitalgain.Ifitusedthelandinacorporatebusiness,thegainisaSection1231gain.
AccordingtoSection301(b)and(c),theamountofthecorporatedistributionequalstractD6s
$420,000FMV,andtheMajorsmustrecognizea$420,000dividend(assumingthatEchoValleyhas
sufficientearningsandprofits).AccordingtoSection301(d),thecouplesbasisinthetractisits
$420,000FMV.

4. Underthegeneralcomputationalrule,Prewerisentitledtoa$112,000dividendsreceiveddeduction
(70%$160,000)withrespecttoitsTKSdividend.However,Section246(b)(1)limitstheDRDto70
percentofPrewerstaxableincomebeforetheDRD.Thissubparagraphspecifiesthattaxable
incomeiscomputedwithoutregardtoanyNOLdeductionfortheyear.Consequently,PrewersDRD
andtaxableincomearecomputedasfollows.
Dividendincome $160,000
Operatingloss (43,500)
TaxableincomebeforeDRDorNOLdeduction $116,500
.70
LimitedDRD $81,550
TaxableincomebeforeDRDorNOLdeduction $116,500
DRD (81,550)
NOLdeduction (31,300)
Taxableincome $3,650

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TaxPlanningCases

1. a. An$80,000deductionisworth$27,200($80,000 34%)toTMMCorporation.Becausethe
corporationsprecredittaxon$500,000incomeis$170,000,itcanuseitsentirecredit($80,000
50%)tosave$40,000intax.Therefore,TMMshouldelectthecredit.

b. TMMsprecredittaxon$70,000incomeis$12,500.Thecorporationcanreduceitscurrentyear
taxtozerobyelectingthecredit.Ifthecorporationdeductsthe$80,000costoftheprogram,it
hasa$10,000netoperatingloss,whichitcancarrybackorforwardasadeductionagainstpast
orfutureincome.Inthiscase,TMMhasnocurrentyeartaxplusavaluableNOLdeduction.
Therefore,TMMshoulddeducttheprogramscost.

2. A&Zsbeforetaxandaftertaxcostofthenondeductibledividendpaymentsonthepreferredstock
wouldbe$28,000(5.6%$500,000).Thecorporationsaftertaxcostofthedebtwouldbe$29,700
($45,000beforetaxcost[9%$500,000]$15,300taxsavingsfrom$45,000interestdeduction).
Consequently,thepreferredstockoptionminimizesA&Zsaftertaxcostofnewcapital.

3. Thecostofthe$129,300AMTpaymentinNPVtermsis$20,688.
2006AMTpayment $(129,300)
NPVof2009minimumtaxcredit
($129,300 .840discountfactorat6%) 108,612
NPV $(20,688
)

4. a. Becauseinterestfromthebondsisexemptfromregulartax,aftertaxcashflowequalsthe
$400,000beforetaxinterestreceived.

b. BecauseoftheDRD,only$120,000ofthedividendistaxed($400,000$280,000DRD[70%
$400,000]).Consequently,aftertaxcashflowis$359,200($400,000dividendreceived$40,800
regulartax[34%regularrate$120,000]).

c. ThetaxexemptinterestisincludedinbookincomeandalsoinACE.WingosACEadjustment
increasesby$300,000(75%$400,000),anditsAMTincreasesby$60,000(20%AMTrate
$300,000).Consequently,aftertaxcashflowis$340,000($400,000interestreceived$60,000
AMT).

d. Wingosregulartaxwithrespecttothedividendis$40,800(seetheanswertob.).Theentire
dividendisincludedinbookincomeandalsoinACE.WingosACEadjustmentincreasesby
$210,000(75%$280,000DRD),anditsAMTincreasesby$42,000(20%AMTrate
$210,000).Consequently,aftertaxcashflowis$317,200($400,000dividendreceived$40,800
regulartax$42,000AMT).

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