The American College: HS 321 Income Taxation

1
The American College HS 321Income Taxation

• Class 11 Chapters 18 and 19
• Taxation of Corporations and Shareholders
  Distributions to Corporations and Shareholders

2
Objectives

• Describe the characteristics and
  advantages/disadvantages of the corporate form of
  business and the formation of an S corporation.

3
Objectives

• Describe the requirements for incorporating a
  business under the nonrecognition provisions of
  the Code, and explain the respective roles of
  debt and equity in the corporate structure.

4
Objectives

• Describe how a corporation determines
• taxable income or loss
• issues associated with deductions for salaries,
  charitable deductions, and dividends received
• the purposes of the accumulated-earnings and
  personal-holding-company taxes
• dividend distributions

5
Objectives

• Explain the tax implications of
• corporate distributions to stockholders
• treatment of stock redemptions
• attribution rules
• requirements for Section 303 stock redemptions

6
Non-Tax Benefits for Shareholders
7
Non-Tax Benefits for Shareholders

• 1 Limited liability
• 2 Centralized management
• 3 Continuity after a shareholders death
• 4 Ease of transferability of stock

8
Non-Tax Benefits for Shareholders

• Limited liability
• Not as significant in professional corporations
  as in business corporations
• Professionals corporate liability is limited to
  investment.
• Greatest exposure is personal.

9
Non-Tax Benefits for Shareholders

• Ease of transferability of stock
• Most state laws do not permit transfer of shares
  of professional corporations other than to the
  corporation or person licensed to practice.

10
Non-Tax Benefits for Shareholders

• Ease of transferability of stock
• Many closely held corporations wish to prevent
  transfer to outsiders.
• Often form agreements restricting the transfer of
  stock.

11
Quiz Questions
12
Short Quiz 1

• Limited liability means that it is only the
  officers of a corporation who are liable for the
  debts of the corporation.
• True
• False

13
Short Quiz 1

• A corporation is not legally dissolved on the
  death, disability, incapacity, or withdrawal of
  any of its owners.
• True
• False

14
IRS Concerns/Tax Issues
15
IRS Concerns/Tax Issues

• Check-the-Box regulations
• Owners can choose tax status by organizing entity
  as corporate or a noncorporate entity under state
  law.
• Owners that do not incorporate can elect
  partnership tax status.

16
IRS Concerns/Tax Issues

• Corporation is a separate taxable entity for
  federal income tax purposes.
• Corporation must file a tax return and pay
  federal tax on its taxable income.

17
IRS Concerns/Tax Issues Continued
18
IRS Concerns/Tax Issues

• Income kept within the corporation may have less
  of a tax burden than it would be for a
  proprietorship, partnership, or LLC.
• Dividends are taxed to shareholder.

19
IRS Concerns/Tax Issues

• Dividends are not deductible in determining
  corporations taxable income.
• Concept of double taxation
• Business expenses are deductible.

20
IRS Concerns/Tax Issues

• Shareholders who are employed prefer salary
  rather than dividends.
• Payments of salary are not double taxed.
• Salary payments are only for services rendered.

21
IRS Concerns/Tax Issues

• Shareholders who are employed prefer salary
  rather than dividends
• If salary is deemed in excess of services, the
  excess is disallowed as deduction to corporation
• Deemed as dividend to shareholder

22
IRS Concerns/Tax Issues

• Corporations can avoid double taxation by
  retaining income and accumulating it rather than
  paying it our in dividends.
• Tax laws impose limitations.
• The accumulated-earnings tax

23
Quiz Questions
24
Short Quiz 2

• One tax advantage of corporate status is the tax
  treatment of dividends paid to individual
  shareholders.
• True
• False

25
Short Quiz 2

• The tax advantages of corporate status include
  the ability to deduct the cost of certain
  nontaxable fringe benefits for employees.
• True
• False

26
Accumulated-Earnings Tax and AMT
27
Accumulated-Earnings Tax

• Minimum accumulated earnings credit
• 150,000 for personal-service corporations
• 250,000 for other corporations
• If excess accumulation occurs (above credit),
  entity must show that accumulation is for
  reasonable business needs.

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Accumulated-Earnings Tax

• Reasonable business needs
• Reinvestment of accumulation in capital equipment
• Working capital needs
• Funds to retire existing debt
• If not justified, the accumulated-earnings tax
  will apply.

29
Accumulated-Earnings Tax

• Historically, high penalty tax designed to force
  corporation to pay dividends.
• Penalty is currently equivalent to tax imposed
  on qualifying dividends 15.

30
Corporate AlternativeMinimum Tax
31
Corporate AlternativeMinimum Tax (A.M.T.)

• Corporation takes advantage of too many tax
  preferences in a given year.
• Select tax preferences are added to tax base for
  the year to reach A.M.T. base.
• Subject to a 20 tax rate.

32
Corporate AlternativeMinimum Tax (A.M.T.)

• If T.M.T.gt normal corporate tax, must pay excess
  (A.M.T.).
• Current adjusted earnings figure
• 75 of current adjusted earnings are added to
  A.M.T.
• Example death benefit of corporate-owned life
  insurance

33
Corporate AlternativeMinimum Tax (A.M.T.)

• A.M.T. exemption for small businesses
• 1998 or later corporations with gross receipts
  averaging 5m or less for previous 3 years are
  exempt.
• Once initial gross receipts test passed, 3-year
  average increases to 7.5m or less.

34
Section 351 Exchange
35
Section 351 Exchange

• Business property transferred for stock no gain
  or loss if persons who transfer are in control of
  corporation after receiving stock
• Control means 80 or more ownership.

36
Section 351 Exchange

• Stock must be issued in return for property not
  services.

37
S Corporations
38
Advantages of S Election

• Corporate income and deductions are passed
  through to shareholders individual return
• Double taxation of income is avoided.
• Capital gains on corporate property avoids
  corporate level tax.

39
Advantages of S Election

• Corporate penalty taxes are avoided.
• NO corporate A.M.T
• NO accumulated-earnings tax
• NO personal-holding-company tax

40
S Corporation Requirements

• Not all corporations eligible to make subchapter
  S election.
• No more than 100 shareholders
• Have NO nonresident alien shareholders
• No more than one class of stock

41
S Corporation Requirements

• Not all corporations eligible to make subchapter
  S election.
• Corporation must be incorporated in U.S.
• All shareholders must be individuals, estates, or
  certain types of trusts.

42
Quiz Questions
43
Short Quiz 3

• A corporation that elects to be taxed as an S
  corporation will have all income and losses
  passed through to its shareholders in a way
  similar to the partnership form of business.
• True
• False

44
Short Quiz 3

• An S corporation election is a means of allowing
  start-up losses of a company to be deducted on
  the individual returns of its shareholders.
• True
• False

45
Chapter 19
46
General Rules for Taxation of Corporation
Distributions

• A corporate distribution is taxable as a dividend
  to the extent of the corporations current and
  accumulated earnings and profits.

47
General Rules for Taxation of Corporation
Distributions

• Distributions in excess of the corporations
  earnings and profits are treated as a capital
  transaction
• The excess distribution is taxed as a return of
  capital to the extent of the shareholders basis
  in the stock.
• The balance, if any, will be treated as a capital
  gain.

48
Redemptions That Are Taxed as Capital Transactions

• A redemption that is not essentially equivalent
  to a dividend
• A substantially disproportionate redemption
• A complete redemption
• A distribution to a non-corporate shareholder in
  partial liquidation of the distributing
  corporation

49
Substantially Disproportionate Redemptions

• Requirements for a substantially disproportionate
  redemption are that after the redemption the
• Shareholder must own less than half the total
  voting power of the corporation.

50
Substantially Disproportionate Redemptions

• Requirements for a substantially disproportionate
  redemption are that after the redemption the
• Shareholders percentage ownership of voting
  stock and common stock must be less than 80 of
  his or her ownership of voting stock and common
  stock before the redemption.

51
Attribution
52
Attribution of Ownership

• Means that stock owned by one individual or
  entity is considered to be owned by another
  individual or entity for the purpose of
  determining how a particular transaction is taxed.

53
Attribution of Ownership

• For example, the rules governing Family Ownership
  state that stock owned by an individual
  shareholders parents, spouse, children, and
  grandchildren will be attributed to the
  shareholder for purposes of determining the tax
  treatment of a redemption.

54
Reattribution

• Refers to situations in which two or more
  constructive ownership rules would be combined to
  attribute ownership from one shareholder to
  another shareholder not directly related under
  the attribution rules.

55
Reattribution

• Examples A father will be considered to own the
  stock owned by a trust of which his son is the
  sole beneficiary.
• A corporation will be considered to own 50 of
  the stock owned by a partnership in which the
  corporations sole shareholder is a 50 partner.

56
Sec. 303 Redemption

• Provides a relief provision that applies to
  estates in which stock of a closely held
  corporation constitutes a substantial portion of
  total estate assets. It allows distributions in
  redemption of such stock to be treated as made in
  exchange for a capital asset and, therefore,
  eligible for capital-gains treatment, subject to
  certain requirements and limitations.

57
Quiz Questions
58
Short Quiz 4

• A distribution by a corporation can sometimes be
  taxable as a dividend even if the corporation has
  no current or accumulated earnings and profits.
• True
• False

59
Short Quiz 4

• A corporations redemption of its own stock will
  be treated as a capital transaction if the
  distribution is not essentially equivalent to a
  dividend.
• True
• False