a
Forming corporations Can transfer property to corporation for stock Count this to determine who has control of corp. shareholders will not recognize gain or loss when property is transferred to corporations its therefore untaxed Shareholder's old basis becomes corporations new basis Corporation will never recognize any gain upon transfer of property Corporate Operations always assume stock received is = to fair value of property contributed 351 stock no gain or loss property for stock 80% stock ownership add up all the stockholders basis of stock is the amount of property transferred shareholder's old basis becomes corporations new basis Service any type of service rendered is taxable if the service is necessary, corporation can deduct it by giving stock if its treated as an expense, corporations never recognize gain when giving up stock and receive assets and services, but can receive deduction If tax free event Dont increases basis otherwise, increase the basis
#3 B receive stock FMV Services 20,000 TAXABLE EVEN IF COVERED BY 351 CUZ OF EQUIP Equipment 5,000 Sh B Basis 3,000 Realized Gain 2,000 Recognized Gain 0 only report the 20,000 as taxable Has to be a minimum amount of property transferred (equipment transferred has to be at least 10% of the stock) 50% A 50% B 100%, control test is met It is now a 351 transaction A Rec stock 25,000 A.B 5,000 Realized20,000 Recognized 0
Sh A: Basis +gain
5,000 0
Corp. Basis Land
5000
Sh. B Stock Services 20,000 Equipment
Corporate Basis Land 3,000 23,000
5,000 Services 20,000 Equipment 3,000
18-1 Building FMV 500,000 A.B 100,000 one shareholder gives corporation a building, its tax free, but is it the best planning? FMV 500,000
Stock Basis 100,000 Potential gain 400,000, if its sold, its recognized gain (this is shareholder view) Corporation View Building FMV 500,000 A.B 100,000 shareholders old basis carries over to new Potential Gain 400,000 The gain ends up doubled, the gain is recognized if the stock is sold, and recognized if building is sold, therefore leaving it open to double taxation Instead, have shareholder rent the building to the corporation , the rent is taxable to the shareholder however deductible to the building, and when the building is sold its the shareholder reports the gain, and its 1231 gain, potentially subject to favorable tax rates This only works for properties that have substantially appreciated in value!
Chapter 19 Forming a corporation Corporation operations Mandatory, no gain or loss is recognized, if property is transferred to corporation, solely for stock. Any property ,not service By 1 or more person No gain or loss Property for stock 80% stock ownership-add up all the stockholders Basis of stock is the amount of property transferred Shareholder's old basis becomes corporations new basis
351 Service
Any type of service rendered is taxable If the service is necessary, corp can deduct it by giving stock-depends on the nature of service Or if treated as expense, Corporation never recognizes gain when giving up stock and receives asset and services. if transferring property and services, it can be counted if a minimum amount of 10% service is property. 20k service, need 2k land. if tax free event, don't increase basis, if taxable increase. The service conducted, even under 351, is still taxable. The land is not Problem 19-1 SH corp. buildingbuilding fmv 500,000 FMV stock 500,000 fMv $500,000 ab 100,000 <--> stock basis 100,000 AB 100,000 potential potential gain 400,000 gain 400,000 if stock sold, gain recognized Under 351, the gain is doubled. shareholder and corporation You can lease the building to corporation, the gain is taxable from shareholder, but also deductable for corporation. After 5years, the property back to shareholders.
What about decrease in value SH FMV stock stock basis potential loss corp. building fMv AB potential gain/loss
buildingfmv ab
100,000 500,000 <-->
100,000 500,000 <400000>
$100,000 100,000 0
basis lower or fmv of building
Election, for corporation to keep its basis to 500,000. Shareholder must agree to lower his basis. Transferred to corp. This will be useful if the shareholder has no intention of selling the stock 19-25 50% J-land R-dep prop cash FMV 100,000 A.B 50,000 J-gain FMV-STock A.B realized recog R-gain FMV-Stock A.B realized loss recog
100,000 50,000 50,000 0
100,000 -110,000 <10,000> 0
50% 100%
70,000 30,000
80,000 30,000 110,000
J basis stock R basis in stock
50,000
Corp land Cash Depre. Prop
50,000 30,000 70,000 losing property is limited to FMV, should corp sell this property, no loss will recognized
110,000
Substantially appreciated property, wouldn't recommend in 351. Gain recognized Business liability where the liability exceeds the basis of property transfers Personal liability transfer Receive anything other than stock Tax rate schedule Problem 19-23 taxable income 150,000 taxable 22,250+(39%*50,000 income ) 41,750 The 8 type of services, flat rate of 35% tax Dividend Corp paid dividend is not deductible The shareholder is taxed as income What if the shareholder is another corp and pass down dividend? Triple taxation 70,80,100% deductible- on outline Must be a taxable domestic US Corp Must own the stock for minimum period of 45days, day of record can be anywhere in between Congress don't want corp to buy stock date before record, then sell afterwards. Extra ordinary dividend-says won't test us on must change the basis No deduction allowed if the funds are borrowed to buy stock Taxable income limitation Problem 19-19 A.
Revenue COGS+expenses net this net is before divid give or receive Div income taxable income before div receive deduction DRD taxable income B. Revenue COGS+expenses net div income DRD
100,000 <30,000+40,000> 30,000 20,000 50,000 <14,000> 36,000 70%*20,000 if positive, income limitation does not apply
100,000 <102,000> <2,000> 20,000 18,000
negative 18,000 <14000> 4,000
of 20k positive if net is negative but after div its positive, the tax limitation is applied
<12600> 5,400 Revenue COGS+expenses net Div income T/I before DRD 100,000 <112,000> <12,000> 20,000 8,000
70%*18,000
negative 8,000 <14,000> <6,000> negative and negative, tax limitation does not apply Carryback... neg ativ e
<14,000> <6,000>
18-2 Building FMV 100,000 A.B 500,000 no gain . Loss recognized, building has now depreciated in value Sh basis FMV Stock Basis Potential Loss 100,000 500,000 400,000
Corporate Basis - Loss is not magnified like gains are Building FMV 100,000 A.B 100,000 Potential Loss 0 - corporation can opt to obtain the higher basis of 500,000 instead of 100,000 but the shareholder has to agree to take the reduced basis of the stock , this helps the corporation because it increases depreciation
Dividend deductions if a corporation owns 60% of stock in another corporation, the amount deductible is 80% if corp owns 40% of stock, the amount deductible is 70% if a parent subsidiary corporation, the deduction from a subsidiary transfer to parent is 100% dividends must be received from taxable domestic corporation to be eligible the corporations receiving dividends must have owned the stock for a minimum of 45 days Substantially appreciated property, wouldn t recommend in 351. o Gain recognized Business liability where the liability exceeds the basis of property transfers Personal liability transfer r Receive anything other than stock Tax rate schedule Problem 19-23 taxable income 150,000 taxable income 22,250+(39%*50,000) 41,750 p The 8 type of services, flat rate of 35% tax Dividend ( Corp paid dividend is not deductible ( The shareholder is taxed as income What if the shareholder is another corp and pass down dividend? Triple taxation
18-30 A.
70% rule applys Revenue Cost of sales Exposed Net Profit
100,000 <70,000> 30,000 <- if this number is positive, the taxable income Limitation does not apply Dividend Income 20,000 Taxable income before divid. Deduct. 50,000 Dividends received deduction <14,000> = (20000*.7) Taxable Income 36,000 Schedule M-1 Reconciles accounting income & taxable income Expenses Not Deductible Income not taxable Taxable income not Accounting income Deductible Expenses Not Accounting Expenses Large corps have to make a huge schedule m-3 Related party transactions Gain is ordinary if property is depreciable regardless of anything else, its automatically ordinary Usually not eligible for installment sale treatment Charitable donations limited to 10% of taxable income
Problem 24 its a corporation Net Income from operations: 150,000 Long term 8,000 <6,000> = 2000 Short Term 3,000 <9,000> = <6,000> Net Short term capital loss Can not deduct because corporations cant deduct net short term capital Dividends : 10,000 Net operating loss carryover :<30,000> Taxable income b4 div. Rec. deduction & b4 donations 130,000 Charitable donations = (130,000 * .1) = 13,000, but donated 30,000 so
30,000 deduct. 13,000 Carryforward 5 yrs: 17,000
Dividends received deduction = .7 * 10,000 dividends = Deduction = 7,000 Taxable income = 130,000 13,000-7000 = 110,000 Tax: income is between 100k & 300k, so its 22250 + (39% * (110000-100000)) = 22250 + 3900 = 26,150 You subtract 100k because the first 100k is in the 15% tax bracket, not the 39% Organizational costs amortize-able usually over 15 years so for corps who have org. costs of 5000$ or less, you can just deduct, no amortization intended to allow smaller corps to deduct them Ex: Org Costs 15,000 5,000 deductible 10,000 Amortization Max. Deduction = 5,000 if organization costs are greater than 50,000, th excess of the cost over 50,000 would reduce corporation's deductions Ex: Org costs are 52000, the 2000 over 50000 is taken away from deduction, so only 3k is deductible now total 52000 deduction -3,000 BAL. 49,000 / 15 3267 Dividends Dividends only if earnings and profits Current earnings and profits or accumulated earnings and profits Calculating Current Earnings and Profits Taxable income adjusted items excluded from taxable income but must be in for E & P PHOTOCOPY PAGE 20-4 FOR NOTES Tax exempt income (add back) Dividends received deduction (add back) if used accelerated method of depreciation, must revert to straight line for E & P Items included in E & P Items Excluded from E & P
Federal income taxes (subtract from taxable income) Net capital losses (subtract from taxable income) Timing Differences Items deductible from E & P Note for using taxes on chart: 22250 is the tax on the first 100,000$, its 39% * whats left over after that up until 300,000$
Ex: Taxable income: 1) Div. Received Deduc. (DRD) 2) Tax exempt income 3)Depreciation
103,000 + 16,000 + 5,000 +(130,000 50,000) accelerated method straight line + 80,000 4) Net Operating loss carryover + 9,000 5) Capital Loss Carryover + 7,000 6) Federal Income Tax (need to calculate) (22250 + (39% * (103,000-100000))) - 23,420 7) Current E & P 196,580 In this analysis, distributions are assumed to have first come from current E&P then second from accumulated E & P Distribution 10,000 Current E & P Acc. E&P 13,000 5,000 -10,000 3,000 (becomes accumulated E&P) Dividend 10,000
Distribution Current E & P Acc. E&P Dividend Return of capital 10,000 3,000 5,000 8,000 -8000 2000 this 2000 is considered return of capital 2,000 Say the shareholder had a basis of 11,000, and they get 2,000 back from this return of capital, its tax free cuz its just a return of what the shareholder put in so Basis = 11,000 - 2,000 (tax free) New A.B 9,000 Now say basis is only 500 Basis 500 - 500 TAX FREE New basis = 0; The remaining 15,000 is considered a capital gain Distribution Current E & P Acc. E&P 10,000 3,000 <5,000> Note: dividend still 3000 even though they have Acc. E&P at a loss 500 Basis 500 Tax free Capital gain = 7000 500 = 6,500 Distribution Current E & P 10,000 <12,000> Radible allocation Date 1/31/09 how much of a loss as of end of january? Distribution Current E & P 10,000 <12,000> (1/12) * 12,000 = Acc. E&P 5,000 Dividend Return of capital Dividend 3,000 Return of capital 7,000
Acc. E&P Dividend 5,000 6,000 <1000> 4000 4,000
Return of capital
Date 11/31/09 how much of a loss as of end of january? Distribution Current E & P 10,000 <12,000> (11/12) * 12,000 = General utilities doctrine land FMV AB 100,000 10,000 if sold by company then dividend to Shareholder (double taxation
Acc. E&P Dividend Return of capital 5,000 10,000 <11000> <6000> 0
the doctrine says just divide the property to Shareholder, instead selling it. Share holder still need to recognize the gain though, recognize at FMV of property received
Distribution of loss property will not recognize loss Section 311 requires gain recognition
Property distributions Shareholder's basis of property received Impact to corporate earnings & profits Problem 35 J 50% A corp A. J receive printing press- gain is FMV $10,000 B Corp= div. income - $10,000 b. B corp would get a dividend receive deduction of 80% of the FMV because he owns 50% stock C. printing press A corp FMV 10,000 A.B <6,000> gain 4,000 the character of gain depended on the character of the printing E+P press gain <fmv> net <fmv> total B corp 50%
4,000 <10,000> <6,000> <10,000> <16,000>
Land FMV A.B Mortgage $100,000 10,000 30,000 Div inc. to shareholder Basis in land $70,000 $100,000
Corp aspect FMV A.B gain
ignore the liability when determining corporation's gain 100,000 <10,000> 90,000 taxable
Disguised Dividends Excessive compensation paying people who are not even working / over paying Loans company gave a loan that will never be paid back, no due date, interest, or collateral Free Use of Property Corporation sells property to shareholder if corp. bought @ 60,000 & sold to shareholder at 50,000, the gain is a dividend Purchase of property below market value Payment of personal expenses if they pay off a shareholder's personal expenses its considered a dividend Stock dividends are not considered a taxable event If a shareholder is given a choice of cash or shares, it IS taxable, even if shareholder decides to take the shares Corporation is going out of business sells the assets to shareholders, in exchange, shareholders give up their stock and the corporation goes out of business Shareholder will recognize gain on a liquidation by comparing FMV of assets received with shareholder's basis in the stock and then calculate basis in the assets of the shareholder The basis is the FMV Corporation recognizes gain or loss also Corporation is liquidated 4 assets corporation transfers: calculate gain for shareholder Received assets worth 1,200,000 compare with the shareholders basis in their stock shareholder paid 300,000 for their stock, FMV 1,200,000 AB - 300,000 Gain 900,000 Shareholder basis Cash Mkt. Sec Equip. Land Total FMV AB Corp Gain 40,000 40,000 0 80,000 40,000 40,000 (capital) 200,000 150,000 50,000 Ordinary - 1245 880,000 520,000 360,000- 1231 1,200,000 750,000 450,000
Liquidation of subsidiary parent company recognizes no gain basis of property doesn't change liquidating subsidiary recognizes no gain Ignore Earnings and Profits Parent subsidiary relationship still occurs if a corporation owns 80% of stock in another corporation's P inc. |80% Minority shareholders |20% FMV X AB X
Subsidiary Corp.
Gain X Minority shareholders only NOTE: the gain from the minority shareholders IS TAXABLE TO THE SUBSIDIARY CORP. PORTION ONLY THE PARENT CORP PORTION ISNT TAXABLE
Corporate Acquisitions purchase of stock cash is given to shareholders of target company, so the acquiring corporation ends up owning the target company Selling shareholders recognize gain acquiring company cant have any gain target recognizes no gain target's basis in assets unchanged tax attributes acquired by the acquiring corporation earnings and profits accounting methods potential for future liabilities the acquiring company can be held liable now for the target company's actions purchase of assets the acquiring corporation buys all the assets of the target company and therefore in effect, now own the company Shareholders recognize no gain target company recognizes gain basis of acquired assets = FMV Tax attributes don't transfer 338 Election Stock Acquired Treated as Asset Purchase Elected by acquiring corporation 80% stock acquired in 12 months 338 election tax impact Selling shareholder recognizes Gain Target recognizes Gain as if it sold all its assets Basis of assets changes basis changed to approximate FMV new tax attributes old tax attributes disappear like earnings and profits free to use new accounting methods target is "new corporation"
20-50 target company had 4 assets, Z corporation is the acquiring corporation, Z has purchased the stock of the target for 1,000,000, the target corporation then becomes a subsidiary of the acquiring, A. what is Z's recognized gain/loss? 0 B. what is shareholder's gain? SP 1,000,000 A.B 300,000 purchased 10 years ago Gain 700,000 Long term capital gain
C. What income must the target company recognize? Must record gain / loss as if it sold the assets (338 election) Assets: FMV Cash 40,000 Marketable Securities 80,000 Equipment 200,000 Land 880,000 Total 1,200,000 have to net all 1231 gains and use lookback/carryforward rule Tax rate = 34% Now adjust basis of target's assets Basis: Price paid for stock: Add liabilities on targets B/S : Tax Liability Total basis allocated to assets: AB (acquiring corp) 0 40,000 capital gain cuz inv. Prop. 150,000 = 50,000 ordinary gain 1245 520,000 = 360,000 1231 gain 450,000 * .34 = 153,000 Tax
1,000,000 0
153,000 =1,153,000 - 120,000 (allocate to cash and M/S) 1,033,000 Best to elect for 338 when appreciation is small because the target will lose old tax attributes and if the target has unused losses which it can used to offset this gain Basis: (this is if the company paid 2,000,000 instead of 1,000,000 Price Paid 2,000,000 FMV 1,200,000 Goodwil 800,000 Consolidated income tax returns remember that a corp. is a legal person and is a taxable entity Parent owns 100% of corporations S1 & S2, they may elect to file 1 income tax return that reflects the activities of all 3 companies Corporations that cant use consolidated income tax returns Tax exempt corporations Foreign corporation's S Corporation To be eligible to file a consolidated income tax return parent company must own at least 80% of stock of the subsidiary Non-parent (even a corporation thats owned by a subsidy) corporation must have 80% of its stock owned by group members If just a single individual rather than a corporation owns 100% of two subsidiary corporations, they can not use consolidated income taxes say owned by individual, S1 owns 80% of another corporation and S2 owns 20% of it, its eligible to be added to picture because s1 at least owns 80%, but S2 is not eligible to be combined with the 3rd corporation if s1 and s2 owned by individual if S1 owns 60% and S2 owns 40%, neither can file a consolidated return with the 3rd company say owned by corporation, S1 owns 80% of another corporation and S2 owns 20% of it, its eligible to be added to picture because s1 at least owns 80% if s1 and s2 owned by corporation if S1 owns 60% and S2 owns 40%,and theyre both 100% owned by another corporation, they can still file consolidated because 60% + 4-% adds to 100%
Ex: Pinc owns s1 and s1, say they file 3 separate returns Note: Capital loss not deductible so taxable income for S1 only 10,000! Ord. Income Capital Gain/loss Taxable Income Tax P Inc. 100,000 20,000 120,000 30,050 S1 10,000 <19,000> 10,000 1,500 S2 <80,000> 0 <80,000> 0 Total $31,550
Now say they filed a consolidated return P Inc. S1 S2 Total Ord. Income 100,000 10,000 <80,000> 30,000 Capital Gain/loss Taxable Income Tax (15%) 20,000 120,000 30,050 <19,000> 10,000 0 <80,000> + 1,000 = 31,000
1,500 0 4,650
Use of tax credits use of deductions otherwise limited for charitable donations, the deductions 10% of taxable income, if S2 donated 10% of 31000, it would be deductible in a consolidated scenario, but not if it filed individually Inter-company profits deferred if s2 sold product to s1, those inter company profits aren't subject to taxation until the products sold to another group Disadvantages binding and change of year once you make the election you cant change back Controlled groups File separate returns but treated as one return Types of controlled groups This ex is what corporations used to do Ex: Corporation T/I Tax Auto dealership: 150,000 41,750 New car sales 50,000 7,500 Used Car Sales 50,000 7,500 Parts / Service 50,000 7,500 Total 150,000 22,500 Corporations would split up their corporation so they would be in the lowest tax bracket With controlled groups however, they all become combined so that either way the tax is the same Brother Sister two or more corporations at least 80% owned by 5 or fewer individuals and those individuals collectively own more than 50% of the stock Parent Subsidiary one corporation owns 80% of stock on another if they decide to file returns the same, its consolidated, if they decide to file separate returns, its group controlled under controlled group rules, a loss can not offset the gains if an individual owns 80% of the stock in two corporations, they cannot file consolidated returns this would put them under a brother-sister control group
Final Review 351 Transfers if personal liability Is transferred, its considered boot and is taxed if corporation liability is transferred wil cost boot if liability is more than service done personal services rendered are always taxable depends on services rendered however Dividends Received deduction Ownership % Deduction % <20% 70% >=20% 80% >=80% 100%
Limitations: Taxable income if you have a loss, before considering dividend income, need to calculate to see if its limited, if it is you multiply tax rate by taxabke income rather than % of dividends 45 day rule minimum holding period for stock
Charitable contributions deduction limited to 10% (excess carryforward to 5 yrs) Calculations of tax regular calculations personal service corporation's Schedule m-1 Purpose reconciles financial statement income with taxable income Operation if a shareholder owns 50% of the stock in a corp and sells property to corp and the property is subject to depreciation by the purchasing corporation of the entity then it is all ordinary income / ordinary income, regardless of the kind of asset that was sold Calculations of earnings and profits Distributions and dividends to the extent of E & P Single distributions Current E & P & accumulated first look @ current E & P, if theres enough in current, then take out of current E & P, if it isnt enough, then look to acc. E&P, if thats still not enough then its a capital distribution If theres a deficit in current E & P but positive in accumulated E & P, need to know the date of the distribution so you can allocate the loss from E & P current to accumulated E & P up to the date the distribution was made Property distributions Shareholder recognitions: dividends return of capital capital gain Shareholders basis: FMV of the assets transferred Corporate gain if corp gives assets to shareholdersm must recognize the gain as if the asset was sold, if it was capital asset capital gain, 1231 asset is 1231 gain, ordinary asset ordinary gain etc. E&P + Gain FMV
FMV 100,000 AB 40,000 Liability 30,000 shareholder's Dividend income: = (100,000 30,000) = 70,000 shareholder's basis = FMV = 100,000 Corporation's gain = 100,000 40,000 = 60,000 E&P + Gain FMV + Liability = 10,000 affect on corp's E & P Complete liquidation Shaeholder recognizes gain / loss and subtract their basis in the stock, if they held stock more than 1 year its long term capital, less is short term capital Subsidiary liquidation parent corp's gain / loss parent or sub will not recognize gain acquired assets new basis is the old basis parent can be owned 80% or more for subsidiary if parent company only owns 80% the other holder 20% when assets are receuived from sub, its taxable to liquidating sub and parent
Corporate acquisitions Purchase of assets purchase of stock purchase of stock with 338 target corp. recognizes gain it considers gain as if it were property purchase basis of assets adjusted Consolidated returns not eligible: S corp Foreign corporation Non profit org. parent subsidiary practical tax impact if one corp has a loss and others have gains, you can use loss to offset the gains, capital losses offset capital gains etc. Controlled groups parent subsidiary 80% Control Brother sister 5 or fewer shareholders owning Collective ownership why control groups suck higher tax deductions limited Tax benefits limited
M-1 CLASS WORKSHEET Facts: 1. Taxable income = 100,000 2. Tax-exempt interest income from state of california bonds 3. a capital loss of 5000 incurred in 2008 4. 179 expensing claimed in 2008 50,000 5. fin statement depreciation related to the asset that was expensed for tax purposes using section 179 expensing above was 13,000 6. a previously unusable charitable contributions carryforward from 2005 was deducted this year in the amount 7000 7. nondeductible officers life insurance premium of 11,000 were reflected on the financial statements 8. federal income tax 22,250 Net income per books Federal income tax Excess capital losses over gain Inc. subject to tax not on books Expenses on books not deducted : Depreciation Contributions carryover 13000 11000 57000 107750 22250 Inc. on books not included in this return: Tax Exempt interest Deductions on this return not charged against book income this year Depreciation Contributions carryover 50000 7000 2000
Travel & entertainment Add all above lines
Add all lines above Income
59000 100000
X corp owns 70% of S1 X corp owns 100% of R1, Xcorp owns 90% of W1 R1 owns 10% of W1 Which can file a consolidated tax returns? R1 and W1 can, S1 cant Gary owns 100% of A, B, and C corp, which can file consolidated? None because hes an individual C owns 100% of S1, 60% of S2, 80% of S3, 100% of s5; S1 owns 30% of S2, S3 owns 100% of S4, S5 is a foreign corp, which can file consolidated? All except S5 Corp. A Corp. B Corp. C Combined Look @ Lowest % 40% 20% 30% 10% 10% 20% 30% 40% 50% If its > 50%, the test is met and they are bro sis
James Susan Carol
20% 10% 30% 60%