TAX

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CHAPTER 17

• TAX
• ENTITIES

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Business Entities

• The following are the possible types of business
  entities
• Sole proprietorship Not a separate taxable
  entity
• Partnership Conduit entity (flow-through entity)

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Business Entities

• Possible types of business entities
• Regular corporation Separate taxable entity
• S corporation Conduit entity
• Limited liability company Generally conduit
  entity (i.e., partnership)

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Business Entities
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Business Entities- Tax Considerations
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• Prior to 1997-An entity could be treated as a
  corporation depending on the number of corporate
  characteristics it possesses
• Continuity of life
• Centralized management
• Limited liability
• Free transferability of interests

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• After 1996Check-the-box rules
• Entity can elect to be taxed as corporation or
  partnership regardless of attributes
• Existing entities not affected
• Final Regulations effective 1/1/97
• Allows entities with more than 1 owner to elect
  to be taxed as either a partnership or a
  corporation
• Entities with only 1 owner can elect to be taxed
  as a corporation or a sole proprietorship

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SOLE PROPRIETORSHIP

• Not a separate taxpaying entity
• Income and losses are reported on Schedule C (or
  C-EZ), and the net gain or loss is carried
  forward to front of taxpayers Form 1040.

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C CORPORATION

• Tax paying entity
• Form 1120 (or Form 1120-A) must be filed whether
  the corporation has taxable income or not
• Due date for the return is the 15th day of the
  third month following year-end
• Automatic extension of 6 months can be obtained
  by filing Form 7004
• What is the primary tax disadvantage that C
  Corporations face?

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Similarities between Corporate and Individual Tax
Rules

• The gross income and gains and losses from
  property transactions of a corp. are determined
  in much the same manner as for individuals
• Both individuals and corporations are entitled to
  exclusions from gross income
• e.g., Interest on municipal bonds
• Business deductions of corporations parallel
  those available to individuals
• Corporate deductions are allowed for all ordinary
  and necessary expenses paid or incurred in
  carrying on a trade or business

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Similarities between Corporate and Individual Tax
Rules (contd)

• Corporations usually have the same choices of
  accounting periods as do individuals
• May choose a calendar year or a fiscal year

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Corporate Tax Differences

• The treatment of many items of income and expense
  are similar for corporations and individuals
  however, differences include the following
• Capital gains and losses for corporations
• Long-term capital gains are taxed at the same
  rates as ordinary income
• Net capital losses are not currently deductible
  but are carried back 3 and forward 5 years as
  short-term losses

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Corporate Tax Differences

• Charitable contributions for corporations
• Limitations other special treatment

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Corporate Deductions

• Certain deductions are only available to
  corporations, such as
• Dividends received deduction (DRD)
• Purpose of deduction is to mitigate multiple
  taxation
• Organizational expenditures
• A corporation may elect to amortize
  organizational expenses over a period of 15 years
  or more

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Corporate Tax Rates

• Marginal rates range from 15 to 39
• Personal service corporations are taxed at a flat
  rate of 35

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Partnerships

• Taxation
• Partnerships are flow-through entities
• Thus, tax reporting rather than tax paying
  entities
• Tax return (Form 1065) is due on the 15th day of
  the fourth month following year-end

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Partnerships

• Operations
• Income or loss and separately stated items are
  allocated to the partners based on their
  proportionate share of ownership
• Special allocations of income or expense items
  are allowed as long as they have substantial
  economic effect
• Partners can deduct losses to the extent of their
  basis in the partnership

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Subchapter S Corporations

• Requirements to qualify as a Subchapter S
  corporation
• Be a domestic corporation
• Have no more than 100 shareholders
• Shareholders must be individuals, estates, and
  certain trusts
• No nonresident alien shareholders
• Have only one class of stock outstanding

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Subchapter S Corporations

• S corporation election
• All shareholders must initially consent to the
  election
• To be effective for the current year, election
  must be made either in the prior year or by the
  15th day of the third month of the current year

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Subchapter S Corporations

• S corporation election
• S election can be terminated voluntarily (by
  majority of shareholders) or involuntarily
  (ceases to qualify as an S corporation or has
  excessive investment income)
• If the election is terminated, the corporation
  generally cannot reelect for 5 years

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Subchapter S Corporations

• Operations
• S corporation generally applies the flow-through
  concept (like partnerships), i.e., income is
  taxed only to the owners
• Income or loss and separately stated items are
  allocated to the owners on a per share per day
  basis

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Limited Liability Companies

• An entity that possesses the corporate
  characteristic of limited liability but is
  generally treated as a partnership for Federal
  tax purposes
• Avoids several of the limiting factors associated
  with S corporations (e.g., number of shareholders
  limitation)