©2011 Pearson Education, Inc. Publishing As Prentice Hall

©2011 Pearson Education, Inc.
Publishing as Prentice Hall 3-1

THE CORPORATE
INCOME TAX (1 of 2)
 Corporate elections
 Computing corporation’s taxable
income
 Computing a corporation’s income
tax liability
©2011 Pearson Education, Inc. Publishing as Prentice Hall 3-2

THE CORPORATE
INCOME TAX (2 of 2)
 Controlled groups of corporations
 Tax planning considerations
 Compliance and procedural
considerations
 Financial statement implications

Corporate Elections
Tax Year (1 of 2)
 New corp elects tax year by filing

return
 First return may be for short-period
 Some corporations restricted
S-corporation uses calendar year
Affiliated group member must be same
as parent
PSCs usually calendar year
Corporate Elections
Tax Year (2 of 2)
 Changing the tax year

Usually
requires IRS approval
Automatic approval if
Annualizes short-period income
Keeps books based on new year
Short period does not have a NOL
No change in accounting period for 48 mo
No interest in flow-through entities
Not a specialized corporation
Corporate Elections
Accounting Methods
 Accrual
GAAP: generally required for C corps
 Cash
Qualified PSC, or C corp w/ gross
receipts < $5M
Inventories cannot be significant
 Ifinventories significant, must use accrual
method for sales, COGS, inventories, accts.
rec., & accts. pay. (the hybrid method)
Family farm w/ gross receipts < $25M
Computing a Corporation’s
Taxable Income
 Salesand exchanges of property
 Business expenses
 Special deductions
 Exceptions for closely held
corporations

Sales and Exchanges of Property
Capital Gains and Losses
 Net capital gain taxed at ordinary

income rates
 Net capital losses cannot offset
ordinary income
 Net capital losses
Carryback 3 years and forward 5 years
Carryovers classified as short-term
Expired losses are lost forever
Sales and Exchanges of Property
§291 Tax Benefit Recapture Rule
 §1250 property sold at a gain

Amount of depreciation in excess of
straight line is characterized as ordinary
income plus
An additional 20% of all depreciation
characterized as ordinary income under
§291
 No §1250 recapture under MACRS
Business Expenses
 General rule
 Organizational expenditures
 Start-up expenditures
 Limitations on deductions for accrued
compensation
 Charitable contributions

General Rule
 Allordinary and necessary expenses

reasonable in amount
 No deductions for
Interest on loans to buy tax exempts
Illegal bribes or kickbacks
Fines or penalties
Insurance premiums if corp is beneficiary

Organizational Expenditures
(1 of 2)
 Expenses incident to creating corp

E.g.,legal, accounting, temporary
director fees, state incorporation fees
 §248 election deemed to be made
Noneed to filed election w/ 1st return
May expense first $5K of org costs
$5K reduced $ for $ when org costs >
$50K
Organizational Expenditures
(2 of 2)
 Amortize remainder over 180 months

 Expenditures must be incurred before
end of first year of business
 May elect to capitalize and not
amortize
Election irrevocable

Start-up Expenditures
(1 of 3)
 Non-organizational
 Ordinary and necessary expenses
 Paid or incurred BEFORE the actual
start of business operations

(2 of 3)
 Examples of include expenses to:

Investigate creation or acquisition of an
active trade or business
Create an active trade or business
Conduct an activity engaged in for
profit or production of income before
business operations begin

(3 of 3)
 Election to expense first $5K of org costs

$5K reduced $ for $ when org costs > $50K
Remainder amortized over 180 months
Election must be made by due date for filing
tax return for first year of operation or
ownership
Election deemed to be made w/ 1st return
May elect to capitalize with no amortization
Limitation on Deductions for Accrued
Compensation
 Accrued bonuses/compensation must

be paid within 2-1/2 months after
close of tax year
Ifpaid after 2-1/2 months, payment
deemed deferred compensation and is
deductible in year paid

Charitable Contributions
(1 of 4)
 Timing of deduction
Deducted in the year paid
Accrual basis corps may elect to include
payment made w/in 2-1/2 months
following the end of tax year
Board of directors must have authorized
contribution during year it was accrued
 Must meet substantiation
requirements to deduct contribution
(2 of 4)
 Donated money
Deduction equals amount donated
 Non-cash property
Amount USUALLY equal to FMV of
property donated
Ordinary income property
Deduction limited to FMV less Ord Inc or
STCG that would have been recognized if
property were sold (includes recapture)
(3 of 4)
 Non-cash property (continued)

Certain inventory related to exempt
function
Deduction = adjusted basis + 1/2 gain
Similar rule for computer technology
donated for educational purposes
Specialrules pertaining to contributions
of computer equipment, book
inventory, and wholesale food inventory
(4 of 4)
 Max deduction is 10% of “adjusted

taxable income” (ATI)
ATI is taxable income before NOL
carryback, capital loss carryback,
dividend received deduction or
charitable contribution deduction
 Excess carried forward for 5 yrs
Creates a deferred tax asset
Special Deductions
 U.S. Production activities deduction
Other names for the deduction
Domesticproduction activities deduction
Manufacturing deduction
 Dividends-received deduction
 Net operating losses
 Sequencing of the deduction calculations
U.S. Production Activities Deduction
(1 of 3)
 Deduction is lesser of a % times

Qualified production activities income OR
Taxable income before the U.S.
production activities deduction
 Phased-in percentages
6% for 2007-2009
9% for 2010 and thereafter

(2 of 3)
 Qualified production activities income

Domestic production gross receipts from
lease, rental, sale, or exchange, of tangible
property manufactured in the U.S. LESS
Expenses related to qualified income
including CoGS, & indirect allocable
expenses

(3 of 3)
 Deduction limited to 50% of W-2

wages
 Not an expense for financial
accounting
Creates a permanent difference

Dividends Received Deduction
(1 of 3)
 Corpsowning < 20% of a domestic

corporation deduct lesser of
70% of Dividends Received or
70% of taxable income before NOL,
capital loss carryback or DRD
Exception to taxable income limitation
If
70% of dividend received creates an
NOL, then the full DRD is deductible
(2 of 3)
owning  20% and < 80% of a

 Corps
domestic corp
80% deduction instead of 70%
 Corps owning  80% of domestic corp
Member of affiliated group
100% deduction

(3 of 3)
 No deduction is allowed if :
Paying corp is a foreign corp
Stock purchased w/borrowed money
Stock of paying corp held for < 46 days
 Results in a permanent difference
Affectseffective tax rate, but not
deferred taxes
Net Operating Losses
(NOL)
 Deductions exceed gross income for

the year before NOL carrybacks
 NOL may be carried back 2 yrs &
then forward 20 yrs
Corp may elect to forgo carryback &
only carry NOL forward 20 yrs
 Creates a deferred tax asset

Sequencing of the Deduction
Calculations
 Charitablecontributions, DRD, NOL,

and all other deductions must be
taken in the following order
1.All other deductions
2. Charitable contributions
3. DRD
4. NOL
5. U.S. production activities deduction
Exceptions for Closely-Held
Corporations (1 of 3)
 Special
rules apply to shareholders
who own >50% of corp
§1239 sale of depreciable property to
corp causes gain to be ordinary income
to the controlling shareholder
§267 disallows loss on sale of property
by corp to controlling shareholder
Loss may be recovered by shareholder if
later sells prop at a gain
 Special
rules apply to shareholder
who own >50% of corp (continued)
Corporation and shareholder using
different accounting methods
Defers deduction for accrued expenses
owed by accrual-method corp to cash-
method controlling shareholder until
income recognized by cash-method
shareholder
 Loss limitation rules
If5 or fewer s/hs own > 50% of the
stock, the corp’s losses are limited to
amount corp has “at risk”
Losses not currently deductible are carried
over to be used in a later year
May also be subject to passive activity rules
PSCs and closely held corps subject to
passive activity limitation rules
Computing a Corporation’s
Income Tax Liability
 General rules
 Regular income tax formula
 Personal service companies

General Rules
 The tax rates are graduated
 Rate surcharges eliminate benefit of
lower graduated tax rates from
lower income brackets
 Corps with income >$18.33M pay a
flat 35% on all income

Regular Tax Formula
(1 of 3)
Gross Income
- Deductions and Losses
- Special Deductions
=Taxable Income
x Appropriate Rate (or rates)
=Regular Tax Liability before credits

Regular Tax Formula
(2 of 3)
Regular Tax Liability before credits

- Foreign tax credit
- Other Credits
+Credit recapture
=Regular tax liability

Regular Tax Formula
(3 of 3)
Regular Tax Liability

+AMT Liability
+Special Taxes (if any)
- Estimated Payments
=Refund or tax due

Personal Service Corporations
(1 of 2)
 PSCs taxed at a flat 35%

 PSC is defined as a corp that:
Substantially all of the activities involve
services in the following fields:
Health, law, engineering, architecture,
accounting, actuarial science, performing
arts, and consulting

Personal Service Corporations
(2 of 2)
Substantially all stock must be owned

by employees, former employees or
survivors of employees

Controlled Groups
 Why special rules are needed
 What is a controlled group?
 Special rules applying to controlled
groups
 Consolidated tax returns

Why Special Rules are Needed
 Preventshareholders from using
multiple corporations to avoid
having income taxed at 35%
Eachcorporation would be able to take
advantage of lower graduated rates
 Lower graduated rates must be
spread among all corporations in a
controlled group
What Is a Controlled Group?
 Two or more corps owned directly
or indirectly by same shareholder or
group of shareholders
 Types of controlled groups
Parent-subsidiary
Brother-sister
Combined

Parent-Subsidiary Controlled Group
 One corp directly owns at least:

80% of voting power of all classes of
voting stock OR
80% of total value of all classes of
stock of subsidiary corporation

Brother-Sister Controlled Group
 50%-80% definition
Five or fewer individuals, trusts or
estates own:
At least 80% of voting power or at least
80% of value of stock of two or more
corporations AND
> 50% of the voting power or value is held
by identical owners (common ownership)
 50%-only definition is 2nd test above
Combined Controlled Groups
 Threeor more corps which meet the

following criteria:
Each corporation is a member of a
parent-subsidiary or brother-sister
group
At least one is both a parent and a
member of a brother-sister group

Special Rules Applying to
Controlled Groups (1 of 2)
 Benefits allocated among members
5% and 3% surcharge
50%-only test for brother-sister groups
$40,000 AMT exemption amount
The $250,000 minimum accumulated
earnings credit
Special Rules Applying to
Controlled Groups (2 of 2)
 Benefits allocated (continued)
§179 expense amount
50%-80% test for brother-sister groups
50% used for parent-sub test instead of 80%
The $25,000 general business credit limit

50%-80% test for brother-sister groups
No loss on sale of assets between members

Consolidated Tax Returns
 Affiliated
groups
 Advantages of filing a consolidated
return
 Disadvantages of filing a
consolidated return

Affiliated Groups
(1 of 2)
 One or more chains of includible

corps connected through stock
ownership to a common parent
 Common parent directly owns
80% of voting power AND value
of at least one includible corporation

Affiliated Groups
(2 of 2)
 Each corp owned at least 80/80 by

another member of the group
 An affiliated group MAY file a
consolidated return
Capital losses offset capital gains from
other group members
Operating losses reduce operating
income from other group members
Consolidated Return Advantages
 Losses of one member offset gains of

another member
 Capital losses of one member offset
capital gains of another member
 Profits and gains from intercompany
transactions deferred until sale
outside the group
Consolidated Return Disadvantages
 Electionbinding on all subsequent

tax years
Unless IRS grants permission otherwise
 Losses from intercompany
transactions deferred until sale
outside the group
 Additional administrative costs

Tax Planning Considerations
 Compensation planning for
shareholder-employees
 Special election to allocate reduced
tax rate benefits
 Using NOL carryovers and carrybacks

Compensation Planning
 Salary payments
Reduce double taxation if paid to
shareholder-employees
 Fringe benefits
Deducted by corporation and certain
benefits are not be taxable to
shareholder-employee

Allocating Reduced Tax Rate
Benefits
A controlled group may apportion
lower tax rates in any manner to
member corporations
Reduce benefits to members with little
or no income
Increase benefits to members with the
highest income

Using NOL Carryovers and
Carrybacks
 Two options
Carryback to 2nd previous year, then 1st
previous year, then forward
Forgo the carrybacks and carry forward
 Examine marginal tax rates in prior
years and expected marginal tax
rates in future years to maximize tax
benefit
Compliance and Procedural
Considerations Estimated Taxes
 Estimated taxes required if corp owes
>$500 for current year.
 Pay in four installments
Each installment 25% of annual liability
 Underpayment of estimated tax penalty
Small corps exempt from penalty if
Pay in lesser of 100% of prior or current
year’s tax liability
Compliance and Procedural
Considerations Filing Requirements
 Return is required each year regardless
of income
 Use form 1120
 Use form 1120A if gross receipts, total
income & total assets each < $500K
 Large corps (assets>$10M) must fill
out more detailed schedule M-3
Financial Statement Implications
 ASC 740 - Income Taxes (SFAS 109)
 Temporary differences
 Deferred tax assets and the valuation
allowance
 ASC 740 - Uncertain Tax Positions
(FIN 48)
 Balance sheet classification
 Tax provision process
ASC 740 - Income Taxes
Scope
 Establishes
principles of accounting
for current and deferred taxes
Arising from temporary differences

Principles
 Addresses
financial statement
consequences of
Rev, exp, gains/losses recognized in
different years for tax and financial
statement purposes
Events affecting book/tax differences in
bases of assets and liabilities
Loss & credit carrybacks or carryforwards
Objectives
 Recognize current yr taxes payable or

refundable
 Recognize deferred tax liabilities and
assets for future tax consequences of
events on fin stmts or tax return

Temporary Differences
(1 of 2)
 Deferred tax liabilities occur when

Rev/gains recognized earlier for book
than tax
Exp/losses deducted earlier for tax than
book
Tax basis of asset < book basis
Tax basis of liability > book basis

Temporary Differences
(2 of 2)
 Deferred tax assets occur when

Rev/gains recognized earlier for tax than
book
Exp/losses deducted earlier for book than
tax
Tax basis of asset > book basis
Tax basis of liability < book basis
Loss/credit carryforwards exist
Deferred Tax Assets and the
Valuation Allowance
 Deferred tax asset
Firm will realize tax benefit of event in
the future
Valuation allowance used for portion
of benefit not likely to be realized
Use “more likely than not” standard

ASC 740 - Uncertain Tax Positions
Formerly FIN 48
 Two-step to account for uncertain tax

positions
Determine if position exceeds “more
likely than not” (>50%) probability of
being sustained on its merits by IRS
If not, corp cannot recognize tax benefit
 Records liability for unrecognized tax benefits
If yes, measure amount of benefit
Balance Sheet Classification
 Classify as current or noncurrent
 If related to another asset or liability
use classification of related asset/liab
 Net current assets and liabilities
 Net noncurrent assets and liabilities

Tax Provision Process
(1 of 3)
1. Identify temporary differences and

tax carryforwards
2. Prepare “roll forward” schedules
3. Apply appropriate tax rates in roll
forward schedules to determine
deferred tax asset/liability balances
4. Adjust deferred tax assets by
valuation allowance if necessary
(2 of 3)
5. Adjust income tax expense for

uncertain tax positions under FIN 48
6. Determine current federal income
taxes payable (current tax expense)
7. Determine total federal income tax
expense (benefit)

(3 of 3)
8. Prepare and record tax journal

entries
9. Prepare tax provision reconciliation
10. Prepare tax rate reconciliation
11. Prepare financial statements

Comments or questions about PowerPoint Slides?
Contact Dr. Richard Newmark at
University of Northern Colorado’s
Kenneth W. Monfort College of Business
richard.newmark@PhDuh.com

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Publishing as Prentice Hall 3-1

©2011 Pearson Education, Inc. Publishing as Prentice Hall 3-2

©2011 Pearson Education, Inc. Publishing as Prentice Hall 3-3

 New corp elects tax year by filing

 Changing the tax year

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 Net capital gain taxed at ordinary

 §1250 property sold at a gain

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 Allordinary and necessary expenses

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 Expenses incident to creating corp

 Amortize remainder over 180 months

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©2011 Pearson Education, Inc. Publishing as Prentice Hall 3-14

 Examples of include expenses to:

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 Election to expense first $5K of org costs

 Accrued bonuses/compensation must

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 Non-cash property (continued)

 Max deduction is 10% of “adjusted

 Deduction is lesser of a % times

©2011 Pearson Education, Inc. Publishing as Prentice Hall 3-23

 Qualified production activities income

©2011 Pearson Education, Inc. Publishing as Prentice Hall 3-24

 Deduction limited to 50% of W-2

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 Corpsowning < 20% of a domestic

owning  20% and < 80% of a

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 Deductions exceed gross income for

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 Charitablecontributions, DRD, NOL,

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Regular Tax Liability before credits

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Regular Tax Liability

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 PSCs taxed at a flat 35%

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Substantially all stock must be owned

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 One corp directly owns at least:

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 Threeor more corps which meet the

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The $25,000 general business credit limit

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 One or more chains of includible

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 Each corp owned at least 80/80 by

 Losses of one member offset gains of

 Electionbinding on all subsequent

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©2011 Pearson Education, Inc. Publishing as Prentice Hall 3-54

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