Pope Phft2015 Corp PP Stu 03

Chapter 3: The Corporate
Income Tax
Prentice Halls Federal Taxation 2015:
Corporations, Partnerships, Estates and
Trusts
Corporate Tax Year

Can
use calendar or fiscal year.

Tax year must = financial
accounting year.
Tax year must always end on the
last day of a month.
Short tax year corporation begins
or ends business in the middle of
the year.
Copyright 2015 Pearson
Education, Inc.
3-2
Corporate Tax Year

(contd)
Must
request change in
accounting period by filing Form
1128, unless IRS procedures
permit automatic change.
Will have a short period between
end of old period and start of
new.
Form 1128 due 3 months after
close of short period.
Change must not create a
Education, Inc.
3-3
General Rules for Determining

Corporate Tax Liability - Income Tax
(Slide 1)
Gross Income
Minus: Deductions and losses
Taxable Income before special deductions
Minus: Special Deductions
See slide 5
Taxable Income
Times: Corporate tax rates
Regular Tax before credits and other taxes
Minus: Foreign tax credit & possessions tax credit
Regular Tax
Minus: Other tax credits
Plus:
Recapture of previously claimed tax credits
See slide
Income (regular) Tax Liability
6
Education, Inc.
3-4

Corporate Tax Liability Alternative
Minimum Tax (Slide 2)
See slide
Taxable Income before NOL Deduction
4
Plus or Minus: Adjustments to taxable income
Plus: Tax preference items
Minus: Alternative tax NOL deduction
Alternative minimum taxable income
Minus: Statutory exemptions
Tax Base
Times: 20% tax rate and other taxes
Tentative Minimum Tax before credits
Minus: AMT foreign tax credit
Tentative Minimum Tax
Minus: Regular (income) tax
See slide
Alternative Minimum Tax (if greater than zero)
6
Education, Inc.
3-5

Corporate Tax Liability (Slide 3)
See slide
4
See slide
5
Income (regular) Tax Liability

Plus: Alternative minimum tax
Special taxes (if applicable)
Accumulated earnings tax
Personal holding company tax
Total Tax Liability
Minus: Estimated tax payments
Net tax due (or refund)

Education, Inc.
3-6
Calculating Corporate Tax

Liability
Regular
Tax
+ AMT
+
Accum.
Earning
s Tax
= Total
Tax
Liabilit
y

Education, Inc.
3-7
Calculation of Regular Tax

Taxable Income
x rate
Regular tax liability
Foreign Tax Credit ( 27)
Regular tax
General business credits ( 38)
Minimum tax credit ( 53)
Other allowed credits
+ Recapture of previously claimed credits
Regular Income Tax Liability
Education, Inc.
3-8
Sale or Exchanges of
Property
Capital Gains:
Must net all capital gains with
capital losses.
Net capital gains = any net L-T
C/G greater than net S-T C/L.
No capital gain rate differential
for corporations as there is for
individuals.
Education, Inc.
3-9
Sales or Exchanges of
Property
Capital Losses (C/L):

If there is a net C/L, then cannot deduct
currently.
Must first carry back 3 years to offset
capital gains, then can carry forward to
next 5 years. Remaining C/L then expires.
C/L carryback and carryforward treated as
an S-T C/L.
291 Recapture rules may cause some or
all of the gain to be ordinary (e.g., 1250).
Education, Inc.
3-10
Business Expenses
Sec.
162 tax deduction allowed for

ordinary and necessary expenses.
No deduction allowed for bribes,
kickback fines, penalties, certain key
man insurance premiums, or purchase
of tax-exempt securities.
Organizational expenditures generally
must be capitalized and amortized.
248 may deduct the first $5,000 if total
org. exp. < $50,000.
Education, Inc.
3-11
Start-Up Expenses
Start-up expenses ordinary and
necessary business expenses to:
-investigate the creation/acquisition
of a business
-create a new business
-engage in for-profit activities
195 capitalize and amortize
start-up expenses over 180 months.
Education, Inc.
3-12
Accrued Compensation - 2 Month Rule

Accrued
compensation must be
paid within 2 months of the
end of the year, or the taxpayer
cannot deduct until the year the
amounts were actually paid.
Should be considered as an
accounting method planning
project.
Education, Inc.
3-13
Charitable Contributions Generally
170 a deduction is permitted for a

contribution made to a bona fide charity
or a state or local government or political
subdivision thereof (e.g., public schools).
A bona fide charity usually means a
charitable organization as defined by
501(c)(3).
The taxpayer (TP) must have a
charitable intent to make the
contribution (e.g., a benevolent and
disinterested motivation).
Education, Inc.
3-14
Charitable Contributions Generally

If
the taxpayer has a different motivation

to contribute other than charitable, it may
still be possible to deduct the amounts
under 162.
Generally, a charitable contribution can
only be deducted when paid, not when
pledged.
Exception: Can deduct the year when
accrued if:
a) BOD authorizes the contribution; AND
b) TP pays within 3 months of the EOY.
Education, Inc.
3-15
Example
ABC corporation, as part of a marketing
campaign, promises to contribute $1
for every unit sold to a local charity.
They cannot deduct the contribution
under 170 since their motive for
making the donation is to promote a
product rather than disinterested
generosity. However, they may be
able to deduct the contribution as a
marketing expense under 162.
Education, Inc.
3-16
Contributions of Property
GR:
Amount of deduction = FMV

Exceptions:
1. Ordinary income property
2. Capital gain property

Education, Inc.
3-17
Contributions of Ordinary Income

(OI) Property
OI Property = inventory,
investment property held < 1 yr,
and property with depreciation
recapture.
Deduction = FMV less short-term
C/G or OI amounts.

Education, Inc.
3-18
Exceptions on Valuation for

Inventory
Exception for certain inventory taxpayers
can deduct cost + markup (ltd to cost)
for inventory donations as long as:
1. donation used for the care of the ill,
needy, or infants
2. not transferred to charity in exchange
for money/property/services
3. donor receives statement from charity

Education, Inc.
3-19
Contributions of Capital Gain

Property
Capital
Gain Property property

that has a built-in gain but is not
subject to depreciation recapture
(e.g., raw land).
Deduction = FMV of the property.
Exception the charity does not
use donated tangible personal
property in a way that is related
to their tax-exempt purpose.
Education, Inc.
3-20
Example Donation of
Equipment
TP contributes a forklift to the
Salvation Army for use in their
warehouse. The forklift has an
original cost of $10,000 and
$4,000 of depreciation has been
taken. The FMV of the equipment
is $ 9,000.
Answer?
Education, Inc.
3-21
Example Donation of Inventory

TP is a retailer and donates 1,000
blankets to the Red Cross for use
in a disaster relief area. The
blankets retail for $20 each but
have a cost of $5 each. What is
the amount of the charitable
deduction?

Education, Inc.
3-22
Example Donation of Capital

Gain Property
ABC Corporation has a tract of land that it
had acquired many years ago with the
intention of building a warehouse on it.
Now, the TP has no use for the land in the
near future. ABC contributes the land to
the YMCA for the site of their new location.
The original cost of the land was $50,000
and its fair market value is $125,000.
What is the charitable deduction?
Education, Inc.
3-23
Substantiating Charitable
Deductions
Contrib. > $500 TP must attach
description of the property to the
tax return.
Contrib. > $5,000 TP must obtain
a qualified appraisal and attach
description and an appraisal
summary to tax return.
Contrib. > $500,000 TP must
attach qualified appraisal to tax
return.

Education, Inc.
3-24
Limitations on Deductions
Maximum
total deduction permitted in

any given year is 10% of adjusted
taxable income (ATI)
ATI = taxable income WITHOUT the
effects of:
1. Charitable contribution deduction
2. NOL carryback
3. C/L carryback
4. Dividends Received Deduction
(DRD)
5. US Production Activities Deduction
(USPAD)
Education, Inc.
3-25
Limitations on Deductions
(contd)
The
taxpayer can deduct up to 10%

of ATI.
Contributions >10% can be carried
forward to the next 5 years.
If carryforward is not used up at the
end of the 5 years, it expires and is
permanently non-deductible.
Must first deduct current year
contributions and then can use
carryovers.
Education, Inc.
3-26
Special Deductions
US Production Activities
Deduction (USPAD)
2. Dividends-Received
Deduction (DRD)
3. Net Operating Losses
(NOLs)
4. Sequencing of the
Deductions
1.

Education, Inc.
3-27
US Production Activities
Deduction (USPAD) - 199
Calculation:
9% times lessor of:

a) Qualified Prod. Activities Income
OR b) taxable income before USPAD
Limitation:
USPAD cant exceed 50% of

W-2 wages allocable to qualifying USPA

Education, Inc.
3-28
Qualified Production Activities

Income (QPAI)
QPAI =
Domestic Production Gross
Receipts
- COGS allocable to DPGR
- Direct deductions, expenses, and
losses allocable to DPGR
- Indirect deductions, expenses, and
losses ratably allocated to DPGR
= QPAI

Education, Inc.
3-29
Domestic Prod. Gross Receipts (DPGR)
Consists of the following:

1. Lease, rental, sale of a) qualified
production property mfg in the
US; b) qualified film production;
c) electricity, natural gas, or
water produced in the US.
2. Construction in US.
3. Engineering/architectural svcs
performed in the US for US
projects.
Education, Inc.
3-30
Dividends Received Deduction

(DRD)
DRD
permits a TP to exclude
some or all of dividends received
on stock it owns in another
company.
Without DRD, there could be up
to three layers of tax on the same
dollar of dividends (investment
company, TP, and then TPs
shareholder).
Education, Inc.
3-31
DRD - Generally
TP
may deduct dividends

received from stock it owns in
another company as follows:
Ownership %
DRD
< 20%
70%
Btw 20% and 80%
80%
>80% (affiliated group) 100%
Education, Inc.
3-32
Limitations on the DRD

If
<20% owned, then DRD is

limited to lessor of:
1. 70% of dividends received; OR
2. 70% of TI excluding
a.
b.
c.
d.
NOLSs
C/L carrybacks
DRD
USPAD

Education, Inc.
3-33

(contd)
If
>20% owned, then DRD is

limited to lessor of:
1. 80% of dividends received; OR
2. 80% of TI excluding
a.
b.
c.
d.
NOLSs
C/L carrybacks
DRD
USPAD

Education, Inc.
3-34

(contd)
NOTE: If eligible for both the 70%
and 80% limitation, then first
calculate the 80% limitation and
reduce taxable income before
computing the 70% limitation.

Education, Inc.
3-35
Exception to DRD
limitation
No
taxable income limitation on

the DRD if the DRD creates or
increases an NOL for the year.
Note that low TI could cause the
TP to permanently lose DRD
deductions (TP may be better off
finding a way of pushing itself
into an NOL).
Education, Inc.
3-36
Affiliated Groups
A
group of corporations are affiliated

if a parent company owns at least
80% stock (voting and value) of one
or more subsidiaries, and that any
other corporation is owned at least
80% by other group members.
The DRD = 100% and is not subject
to a taxable income limitation.
The 100% DRD is taken before the
80%/70% DRD.
Education, Inc.
3-37
Other DRD Issues

No
DRD for dividends received

from foreign corporations since it
is not taxable by the US to begin
with.
No DRD for debt-financed stock.
Prevents TP from taking an
interest deduction but avoiding
recognition of dividend income.
Education, Inc.
3-38
Other DRD Issues (contd)

No
DRD for stock held for 45 days

or less. Testing period begins 45
days before a stock becomes exdividend and runs 91 days.
Prevents TP from taking a DRD
and then getting a capital loss if
selling ex-dividend.
Ex-dividend means purchaser is
not entitled to a previously
declared dividend.
Education, Inc.
3-39
Net Operating Losses

(NOL)
Deductions
> Income = NOL

Do not include any NOL
carryforward or carrybacks in
calculating CY NOL.
Do include DRDs in calculating CY
NOL.
No USPAD if there is a CY NOL
because no TI.
Education, Inc.
3-40
Carrybacks and
Carryforwards
NOL
carries back 2 years and carries

forward 20 years.
Any unused NOLs expire after 20 years
and expired amounts become
permanently non-deductible.
TP can elect to forgo carryback and
just carryforward. May want to do this
to avoid having to amend state and
local returns, losing credits or higher
future marginal rates than in the past.
Education, Inc.
3-41
Obtaining a Quick Refund

File
an extension.
Put together a quickie return
based on estimates.
File the quickie return with the IRS.
TPs often use specialty firms to get
their returns processed more quickly.
Prepare the real return and file.
The real return automatically
supersedes the quickie return so no
need to amend S&L returns.
Education, Inc.
3-42
Sequencing Deduction
Calculations
There is an order by which the
TP takes categories of
deductions:
1. All deductions other than

charitable, DRD, NOL, and USPAD.
2. Charitable contributions.
3. DRD.
4. NOL.
5. USPAD.
Education, Inc.
3-43
Controlled Groups Generally

Generally,
there are rules to prevent

controlled groups from artificially
allocating revenue and expenses
among group members in order to
minimize regular taxes and maximize
credits.
Whether a corporation is part of a
controlled group is tested on December
31. Corporation also has to have been
a group member for at least the
year.
Education, Inc.
3-44
Controlled Groups Generally

(contd)
Losses
on sales between
members of a controlled group
are deferred until the asset is
sold outside the group.

Education, Inc.
3-45
Parent-Subsidiary Controlled
Group
Parent
must own at least 80%

voting or value of stock of at least
one other corporation. A
corporation is part of a controlled
group if the parent, subsidiary, or
other members of the controlled
group own 80% (voting or value) of
it.
Very similar to the definition of
affiliated group (DRD).
Education, Inc.
3-46
Example: Parent-Subsidiary
Controlled Group

Education, Inc.
3-47
Brother-Sister Controlled
Group
50%-80% definition of B-S controlled
group:
1. Needs to have 2 or more corporations

2. 5 or fewer individuals, trust, or estates
must meet BOTH conditions:
a. Have in common more than 50% of stock
(voting or value) of each corporation.
b. Own at least 80% of the stock (voting or value)
of each corporation.
Use this definition specifically for 179

expenses and general business tax credits.
Education, Inc.
3-48
B-S Controlled Group

(contd)
50% only definition of B-S
controlled group
1. Needs to have 2 or more
corporations
2. 5 or fewer individuals, trust, or
estates must have in common
more than 50% of stock (voting or
value) of each corporation.
50% only and 50%-80% test used in
determining whether low
Copyrightbracket
2015 Pearson tax
Education, Inc.
3-49
Example: Brother-Sister
Controlled Group

Education, Inc.
3-50
Combined Controlled
Groups
Defined
as three or more
corporations meeting the following
criteria:
1. Each corporation is a member
of a P-S or B-S controlled group.
2. At least one of the corporations
is both the parent of the P-S
group and a member of the B-S
group.
Education, Inc.
3-51
Example: Combined Controlled

Group

Education, Inc.
3-52
Consolidated Returns
Affiliated
groups can file one

combined (consolidated) return.
Criteria:
Common parent must own 80%
stock (voting AND value) of at
least one other corporation.
The group must own 80% stock
(voting AND value) of any of the
other affiliated corporations.
Education, Inc.
3-53
Consolidated Returns
(contd)
Do
not include foreign

corporations, insurance
companies, tax-exempt
organizations, and S corporations
even if they are part of the
affiliated group.
Partnerships are not part of an
affiliated group and therefore
cannot be part of a consolidated
return.
Education, Inc.
3-54
Advantages to Filing a
Consolidated Return
Losses of one member can
offset profits of another
(subject to certain 382 limits).
Capital gains and losses can be
combined across the group.
Intercompany profits and gains
can be deferred until triggered.
Education, Inc.
3-55
Limitations on Utilizing NOLs -

382
One
corporation cannot
acquire another corporation
and utilize the acquirees
outstanding NOLs to offset
the purchasers income.
Chapters 7 and 8 have a
more in-depth discussion of
382.
Education, Inc.
3-56
Disadvantages of Filing a
Consolidated Return
Election
to file a consolidated
return is binding upon
subsequent years unless
granted permission to
discontinue by IRS.
Intercompany losses are
deferred until triggered.
Losses from one member
may affect the deductions
Education, Inc.
3-57
Compliance Issues
Estimated
Payments
Requirements for Filing and
Paying Taxes
Tax Return Schedules

Education, Inc.
3-58
Estimated Taxes
Must
pay in quarterly installments

25% of the required amount due.
For large corporations, must pay
100% of this years liability although
1st Q may be based on prior year.
Take into account AMT and regular
tax in determining liability.
Payments due 4/15, 6/15, 9/15,
12/15.
Education, Inc.
3-59
Penalties for Underpayment of

ES Tax
6621 imposes penalties on the

deficient amount that was
underpaid each quarter.
The penalty charges run from the
time the amounts should have
been paid until they are actually
paid.
Rate is the short-term federal
rate + 5%.
Use Form 2220 to calculate
Education, Inc.
3-60
Computational Methods for

Estimated Payments
Annualized
Income Method:
1st and 2nd Q based on annualized income for

the first 3 months of the year.
3rd Q based on first 6 months of the year.
4th Q based on first 9 months of the year.
Most helpful for TP who have income that

increases toward the end of the year.
Can only use this method if less than normal
required installment. Will have to recapture
if greater than normal installment.
Education, Inc.
3-61
Computing Estimated Payments

(contd)
Adjusted
seasonal income method

TP can base installments
assuming CY income will be
earned in same pattern as PY.
Can only use this method if less
than normal required
installment. Will have to
recapture if greater than normal
installment.
Education, Inc.
3-62
Estimated Payments Miscellaneous

Any
remaining amounts must

be paid with the filing of the
return or the extension,
whichever comes first.
If the TP does not pay the
liability in full, then penalties
and interest can apply.
Education, Inc.
3-63
Filing Form 1120

Corporate
TP must file a Form

1120 even if there is no
taxable income for the year.
Due date is March 15
assuming calendar year end
and 3/15 does not fall on a
weekend or holiday.
Can file automatic 6-month
extension to 9/15 by filing
Education, Inc.
3-64
Tax Return Schedules

Schedule
L balance sheet.
Schedule M-3 for large corporations
with total assets > $10m reconciles
book and tax.
Shows permanent and temporary
differences.
Schedule
M-2 analysis of
unappropriated R/E (like a retained
earnings statement).
Education, Inc.
3-65
Book-Tax Differences
Arises
when financial accounting

records an item differently than
what is reported for tax.
Permanent
differences income
never recognized or deductions
never taken. Examples:
Meals and entertainment
Tax-exempt interest
Education, Inc.
3-66
Book-Tax Differences
(contd)
Temporary
differences
Income will eventually be
recognized or deductions
taken, but at a different time
than the other system.
Example tax depreciation
that is accelerated.
Education, Inc.
3-67
Tax Provision
Also
known as Federal Income Tax

Expense (FITE or Provision) on
the financial statements.
Financial Accounting may
calculate tax expense differently
than the amount that is actually
due to the IRS.
Differences are associated with
book-tax temporary differences.
Education, Inc.
3-68
Tax Provision (contd)

Broken
down into current and deferred

components.
Current ties into what is actually due to the
IRS that year.
Deferred is associated with book-tax
temporary differences and a state and local
component.
The Deferred component can further be
broken down into Deferred Tax Assets
(DTAs) or Deferred Tax Liabilities (DTLs)
which are part of the balance sheet.
Education, Inc.
3-69
Tax Provision (contd)

Rules
of the Provision are dictated by

ASC 740 issued by FASB.
Major components:
1. Current tax liability (due to IRS) or asset
(refund from IRS)
2. DTA or DTL associated with temporary
differences and carryforwards
3. Reduce DTA by amount TP does not expect
to get based on research and valuation
4. Liability for Uncertain Tax Positions (UTP)

Education, Inc.
3-70
Temporary Differences
Book v. Tax
Acceleration
or delays in
revenue recognition
Expenses deductible earlier
or later for tax purposes
rather than for book.
Differences in tax v. book
basis
Tax carryforwards
Education, Inc.
3-71
Deferred Tax Assets

TP
will realize the tax benefit of an

event some time in the future.
If there is a possibility that the TP
wont get the full benefit, the DTA
must be reduced by a valuation
allowance.
This reduction is only required if
there is a greater than 50% chance
(more likely than not MLTN) the
TP will NOT sustain its tax position.
Education, Inc.
3-72
DTA Example
TP has tax credit carryforward of $1m.
However, the TP is running losses and may
not be able to use all of the credits before
they expire. There is a 48% chance that
some or all of the credits will expire. The
TP needs to reflect the DTA at $750K based
on its analysis.
DTA 1,000,000
Valuation allowance 250,000
Federal income tax exp 750,000
Education, Inc.
3-73
Uncertain Tax Positions

(UTP)
The
TP may take certain positions

in its tax return which may or may
not pass IRS scrutiny. FASB may
require the TP to reduce or
eliminate the tax benefit.
The TP cannot recognize the tax
benefit for financial accounting
purposes unless it is more likely
than not the position will be
sustained.
Education, Inc.
3-74
UTP (contd)
If
MLTN threshold is not met, the tax

benefit can later be recognized for
financial accounting purposes if:
1. The position later meets the MLTN

threshold.
2. Position is settled with the IRS/court.
3. Statute of Limitations runs.
MLTN is a cliff. If below 50%, then no tax
benefit is recognized. If above, then
some or all of the tax benefit can be
recognized.
Education, Inc.
3-75
Journal Entries for UTP

Fed. Inc. Tax Exp. (book) 1,000,000
Liab. for unrecog. tax benefits 150,000
Fed. Inc. Taxes Payable (tax) 850,000
To record liability for UTP below MLTN
Liab. For unrecog. tax benefits

Cash (disallowed) 50,000
Fed. Tax Exp. 100,000
150,000
To record settlement with IRS

Education, Inc.
3-76
Balance Sheet
Classification
DTAs
and DTLs must be classified

as current or noncurrent.
Classification depends on
underlying asset, then expected
reversal date.
Current assets and liabilities are
netted to one amount.
Non-current assets and liabilities
are netted to another amount.
Education, Inc.
3-77
Tax Provision Process

ID temporary differences.
2. Prepare roll forward schedules of
temporary differences that
tabulate cumulative differences
and CY changes.
3. Apply statutory rates to
schedules to determine ending
balances of DTAs and DTLs.
4. Adjust DTAs by valuation
allowance.
1.

Education, Inc.
3-78
Tax Provision Process

(contd)
Determine Federal Tax Payable.
7. Determine Federal Tax Expense.
8. Prepare journal entries.
9. Prepare tax provision
reconciliation (walking book
numbers to tax).
10.Prepare tax rate reconciliation
(book to tax).
11.Prepare financial statements.
6.

Education, Inc.
3-79
Accounting Methods
Very
important way of
implementing tax planning
ideas.
Taxpayer requests permission
to change the way it treats
certain expense or revenue
items.
Education, Inc.
3-80
END
Chapter 3
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Education, Inc.
3-81

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Chapter 3: The Corporate

Corporate Tax Year

use calendar or fiscal year.

Corporate Tax Year

General Rules for Determining

General Rules for Determining

General Rules for Determining

Income (regular) Tax Liability

Copyright 2015 Pearson

Calculating Corporate Tax

Copyright 2015 Pearson

Calculation of Regular Tax

Capital Losses (C/L):

162 tax deduction allowed for

Accrued Compensation - 2 Month Rule

Charitable Contributions Generally

170 a deduction is permitted for a

Charitable Contributions Generally

the taxpayer has a different motivation

Amount of deduction = FMV

Copyright 2015 Pearson

Contributions of Ordinary Income

Copyright 2015 Pearson

Exceptions on Valuation for

Copyright 2015 Pearson

Contributions of Capital Gain

Gain Property property

Example Donation of Inventory

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Example Donation of Capital

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total deduction permitted in

taxpayer can deduct up to 10%

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9% times lessor of:

USPAD cant exceed 50% of

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Qualified Production Activities

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Domestic Prod. Gross Receipts (DPGR)

Consists of the following:

Dividends Received Deduction

may deduct dividends

Limitations on the DRD

<20% owned, then DRD is

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Limitations on the DRD

>20% owned, then DRD is

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Limitations on the DRD

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taxable income limitation on

group of corporations are affiliated

Other DRD Issues

DRD for dividends received

Other DRD Issues (contd)

DRD for stock held for 45 days

Net Operating Losses

> Income = NOL

carries back 2 years and carries

Obtaining a Quick Refund

1. All deductions other than

Controlled Groups Generally