Tax Chapter 2: Corporations: Introduction & Operating Rules

Front 1

What is the tax formula for a C Corp?

Back 1

Income
- Exclusions
= Gross income
- Deductions
= Taxable income (loss)
x Tax rate(s)
= Tax
- Credits
= Tax payable (or refund due)

Front 2

“Income” includes any addition to wealth that is what (3 criteria)?

Back 2

1. measurable
2. realized, and
3. over which taxpayer has complete dominion

Front 3

Source (labor, capital, or good fortune), Form (money, property, or services), Means of acquisition (legally or illegally), Use (consumed or saved), and Contingent obligation to repay (“Claim of right”) are all irrelevant in terms of what?

Back 3

Determining whether something is income.

Front 4

Recovery of capital, Mere increases in the value of property, and Receipts subject to recognized claims of third parties (Funds borrowed with intention to repay) are all examples of what?

Back 4

None count as income.

Front 5

Life insurance proceeds, State and local bond interest, Tenant improvements, Discharge of indebtedness, Certain contributions to capital of a corporation, and Gain from sale of a corporation’s own stock are all examples of what?

Back 5

Items Congress has chosen to exclude from GROSS income. (source can be relevant here)

Front 6

Expenses if “ordinary” and “necessary”, Losses if uncompensated, Depreciation, depletion and amortization (DD&A), Interest, and Taxes (other than federal income tax) are all examples of what?

Back 6

Deductions specifically allowed by law

Front 7

Capital expenditures, Expenditures before commencing business, Fines and penalties
Illegal bribes and kickbacks, Political contributions, Lobbying expenses (except for local legislative bodies, e.g., city council), Meals and entertainment over 50% generally, Business gifts over $25 per donee per year, Club dues, and Expenses to earn tax-exempt income are all examples of what?

Back 7

Non-deductible expenses

Front 8

What two things dictate when an Item is “Income” or “Deductible”?

Back 8

“Taxable Year” and “Method of Accounting”

Front 9

What is a taxable year?

Back 9

A 12-month period ending December 31 (a “calendar year”) or the last day of any other month (a “fiscal year”). Most C corps can choose either. Once chosen, the taxable year cannot be changed without IRS approval.

Front 10

What type of taxable year must service corporations use?

Back 10

Calendar

Front 11

How are net operating losses deducted for tax purposes?

Back 11

Current year loss is carried back 2 years and forward 20 years as a deduction (Can elect to forego carry back)

Front 12

What is the Claim of right doctrine?

Back 12

Tax reduction from repaying previously taxed income cannot be less than the tax paid when the income was reported

Front 13

What is the Tax benefit rule?

Back 13

Recovery of an item deducted in a prior year is included in income only to the extent the deduction reduced tax

Front 14

What does "method of accounting" determine?

Back 14

The time income is recognized and deductions are allowable

Front 15

What are the two most widely used methods of accounting?

Back 15

Cash and accrual method

Front 16

A taxpayer can choose its method of accounting provided the method chosen does what? (2 items)

Back 16

1. Clearly reflects income and
2. Is not expressly denied to the taxpayer
A. Personal service corporations generally may adopt any “over-all” method of accounting (e.g., cash or accrual)
B. Other C corporations generally may not use the cash method if average gross receipts exceed $5 million

Note: Once chosen, a method of accounting cannot be changed without IRS approval

Front 17

How are income and expenses taxed under the cash method?

Back 17

Income: Taxable when “actually or constructively received” in cash, property or services

Expenses: Deductible when paid

Front 18

How are capital expenditures and prepaid expenses taxed under the cash method?

Back 18

Capital expenditures:
a. Having a useful life or recovery period: Deductible ratable over useful life or recovery period (e.g., via DD&A)
b. Not having useful life or recovery period: Deductible at time of sale, exchange or other disposition

Prepaid expenses:
Interest: Must be amortized over period benefited!!
Other: Deductible generally when paid if benefit does not extend beyond end of following tax year; otherwise, must be amortized over period benefited

Front 19

How are income and expenses taxed under the accrual method?

Back 19

Income: Taxable generally when earned, when payment is due, or when payment is received, whichever happens first

Expenses: Deductible generally when two requirements are met:
1. Liability is fixed
2. Economic performance has occurred

Front 20

How are capital expenditures taxed under the cash method?

Back 20

Having a useful life or recovery period: Deductible ratable over useful life or recovery period (e.g., via DD&A)

Not having a useful life or recovery period: Deductible at time of sale, exchange or other disposition

Front 21

How are net capital gains taxed for corporations?

Back 21

Both long-term or short-term net capital gains are taxed at the same rates as ordinary income. No preferential tax rates apply.

Front 22

How are net capital losses taxed for corporations?

Back 22

Both long-term and short-term net capital losses cannot be deducted from ordinary income. Can be carried back 3 years and forward 5 years as an offset against capital gain.

Note: long-term capital losses become short-term when carried back or forward.

Front 23

What is Section 1245 property (full recapture)?

Back 23

1. Depreciable tangible personal property (e.g., machinery, equipment, furniture, computers, etc.)
2. Amortizable intangible personal property (e.g., goodwill, patents, copyrights, etc.)
3. Non-residential real property placed in service after 1980 and before 1987 -- the “ACRS” period -- if an accelerated method of depreciation was used

Front 24

How are gains from disposition of “Section 1245 property” treated?

Back 24

As ordinary income to extent of all prior depreciation

Front 25

What is Section 1250 property (partial recapture)?

Back 25

1. Depreciable tangible or intangible residential real property (e.g., apartments but not hotels and motels);
AND
2. Depreciable tangible or intangible non-residential real property that does not qualify as Section 1245 property (e.g., factories, stores, office buildings, warehouses, hotels, motels, etc., other than those placed in service after 1980 and before 1987 for which accelerated depreciation was used).

Front 26

How are gains from disposition of “Section 1250 property” placed into service before 1987 treated?

Back 26

As ordinary income to extent of “additional depreciation”

Note: “Additional depreciation” = Actual depreciation minus straight-line depreciation

Front 27

What is the Section 291 20% additional recapture rule?

Back 27

Gains from disposition of Section 1250 property are treated as ordinary income to the extent of 20% of the difference between –
(1) Gain that would be recaptured as ordinary income if Section 1245 (full recapture) applied, and
(2) Gain, if any, actually recaptured as ordinary income under section 1250 (partial recapture)

Note: Section 291 applies only to C corporations (and S corporations for three years after ceasing to be C corporations)

Front 28

What is the general rule applicable to personal service corporations in regards to deducting passive activity losses?

Back 28

Passive activity losses cannot be offset against either “active” (earned) or “portfolio” (investment) income, but must be carried forward to offset passive income of subsequent years.

Front 29

What is the general rule applicable to regular C corporations in regards to deducting passive activity losses if closely-held or not?

Back 29

If “closely-held”:
Passive activity losses can be offset against “active” income but not “portfolio” income. A passive loss that exceeds active income must be carried forward to offset active and passive income of subsequent years.
(Note: “Closely-held” means 5 or fewer individuals own more than 50% of the corporation’s stock.)

If not “closely-held”:
Rules limiting deduction of passive activity losses do not apply.

Front 30

What is a passive activity and how does a corporation materially participate in an activity?

Back 30

Any trade or business in which the taxpayer does not “materially participate”; and
Any “rental activity” unless it is owned by a real estate professional who “materially participates” in the activity

A corporation “materially participates” in an activity if shareholders owning more than 50% of its stock are involved in day-to-day operations on a regular, continuous and substantial basis (a standard which usually requires working in the activity for more than 500 hour a year).

Front 31

What is the exception to the general rule that the charitable contribution deduction is allowed when paid regardless of the corporation’s method of accounting.

Back 31

A corporation using the accrual method of accounting can elect to deduct contributions authorized by its board of directors during the tax year if the contributions are paid within 2 1/2 months after the tax year ends.

Front 32

What is the maximum charitable contribution deduction allowed?

Back 32

10% of taxable income computed without regard to the deductions for:
Charitable contributions;
Dividends received;
Net operating loss carryback;
Capital loss carryback; and
Domestic production activities deduction.

Front 33

What can a corporation do with charitable contributions made in excess of the limit?

Back 33

Contributions over the 10% limit may be carried forward 5 years. Current year’s contributions are applied before carryover contributions.

Front 34

How are charitable contributions of the different types of property measured?

Back 34

1. Ordinary income property (e.g., inventory, Section 1245 and 1250 recapture income, etc.): Lesser of FMV or adjusted basis.
2. Short-term capital gain property: Lesser of FMV or adjusted basis.
3. Long-term capital gain (and Section 1231) property:
A. Tangible personal property (e.g., auto, furniture, equipment, purchased work of art, etc.) …
i. If put to unrelated use by donee (e.g., property is sold): Lesser of FMV or adjusted basis.
ii. If put to related use by donee: FMV.
B. All other LTCG property: FMV.

Front 35

What is the increased deduction for qualified contributions of inventory?

Back 35

Amount of deduction = Adjusted basis plus one-half of amount FMV exceeds adjusted basis (but not more than twice the property’s adjusted basis)

Front 36

What type of inventory qualifies for the increased deduction?

Back 36

1. Property is used solely for care of the ill, needy, or infants
2. Property is books and is used by a public school (K through 12) in its educational program
3. Property is constructed research property and is used for R&D or research training
4. Property is computer equipment and software used for educational purposes

Front 37

What is the dividends received deduction and how do ownership percentages correlate to deduction amounts?

Back 37

DRD = Deduction allowed for dividends received from a taxable domestic corporation. DRD is limited to that percentage of “taxable income” corresponding to the deduction percentage (i.e., 70%, 80% or 100%)

Amount of deduction depends on percentage ownership of the corporation paying the dividend:
Ownership % - Deduction %
Less than 20% - 70%
20% or more butless than 80% - 80%
80% or more and affiliated group status - 100%

Front 38

What is the exception to the DRD "taxable income" limitation and what is considered "taxable income"?

Back 38

Exception: Limitation does not apply if DRD creates or increases an NOL
“Taxable income” = Taxable income computed without regard to: DRD, NOL, Capital loss carryback, & Domestic production activities deduction

Front 39

What are organization expenditures?

Back 39

“Organization expenditures” are expenditures incident to creation of the corporation, such as:
1. Legal services in drafting the articles of incorporation, by-laws, minutes of the organizational meetings, and terms of the original stock certificates;
2. Necessary accounting services;
3. Expenses of temporary directors and organizational meetings of directors and shareholders; and
4. Fees paid to the state of incorporation.

Front 40

How are organization expenditures treated for tax purposes?

Back 40

Unless taxpayer “elects out”, up to $5,000 (reduced dollar-for-dollar to extent expenditures exceed $50,000) of “organization expenditures” is deductible in the year business begins, with any remainder amortized ratably over 180 months beginning with the month business begins.

Note: Only expenses incurred before the end of the year in which the corporation begins business qualify for deduction.

Front 41

What are start-up expenditures?

Back 41

Investigatory expenses involved in entering a new business, AND
Operating expenses incurred before beginning business

Front 42

How start-up expenditures treated for tax purposes?

Back 42

Unless taxpayer “elects out”, up to $5,000 (reduced dollar-for-dollar to extent expenditures exceed $50,000) of “start-up expenditures” is deductible in the year business begins, with any remainder amortized ratably over 180 months beginning with the month business begins.

Front 43

What deduction is allowed for expenditures related to issuing or selling stock (e.g., commissions, professional fees, and printing costs), or transferring assets to the corporation?

Back 43

No deduction is allowed.

Front 44

What is a related person in terms of corporation taxation?

Back 44

1. An individual who owns more than 50% of the corporation’s stock
2. Two corporations that are members of the same controlled group

Front 45

When can an accrual method corporation deduct an amount owed to a cash method “related person”?

Back 45

Not until payment is made

Note: If payment is not made within 2 ½ months after the end of its taxable year, an accrual method corporation cannot deduct compensation owed to a cash method service provider (even if not a “related person”) until payment is made

Front 46

When is an expense ordinary?

Back 46

If it is “Normal, Usual, or Customary” (i.e., It is an Everyday Happening in the Business World)

Front 47

When is an expense necessary?

Back 47

If “Appropriate or Helpful”; It Need Not be Indispensable.

Front 48

What are some examples of deductible business expenses?

Back 48

Cost of goods sold. Salaries and wages. Rent. Utilities. Repairs and maintenance. Taxes and licenses. Advertising. Depreciation. Bad debts. Losses. Supplies. Interest.

Front 49

What are the limitations on Multiple Tax Benefits for members of a “Controlled Group”?

Back 49

Members must share …
1. Each graduated tax bracket amount in computing regular tax (e.g., 15% rate on first $50,000 of taxable income)
2. One $250,000 accumulated earnings tax credit in computing the accumulated earnings tax
3. One $40,000 exemption in computing alternative minimum tax
4. One Section 179 amount (e.g., $250,000 for 2009; $134,000 for 2010) of depreciable assets that can be expensed annually
5. One $25,000 general business tax credit limitation amount

Front 50

What are the two types of controlled groups?

Back 50

1. “Parent-subsidiary controlled group”:
One or more chains of corporations connected with a common parent through at least 80% stock ownership
2. “Brother-sister controlled group”:
Two separate tests exist depending on the tax benefit
“80%/50% test” (previous question tax benefits “4” and “5”): Five or fewer individuals, estates or trusts own 80% or more of the stock of each corporation, and the same persons own more than 50% of the stock of each corporation, taking into account the identical interest owned (i.e., lowest percentage) in each corporation
“50% only test” (previous question tax benefits “1” – “3”): Five or fewer individuals, estates or trusts own more than 50% of the stock of each corporation, taking into account the identical interest owned (i.e., lowest percentage) in each corporation

Front 51

How are "Net” Long-Term or “Net” Short-Term Capital Gain (Loss) computed?

Back 51

Steps in the netting process:
1. Offset short-term gains and losses to compute net short-term gain (loss)
2. Offset long-term gains and losses to compute net long-term gain (loss)
3. Compare net short-term gain (loss) and net long-term gain (loss):
A. If both are positive (gain) or both are negative (loss), no further netting is required. Each will be reported separately for tax purposes.
B. If one is positive (gain) and the other negative (loss), offset the two to determine one amount -- either a net short-term gain (loss) or a net long-term gain (loss)