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Unformatted text preview: Updated by Andrew Appleby Taxation of Corporations and Shareholders Professor Shores – Fall 2007 I. I NTRODUCTION . A. Federal Income Tax’s relation to corporate tax: 1. Transaction with an individual B buys a house for $1000 (1,000 cash + 9,000 non- recourse note). After 2 years, B transfers house to bank in satisfaction of the note. AR=$9,000 ( Crane says include discharge of nonrecourse debt into AR). Basis in land = $10,000 ( Crane also says debt included in basis). SO B realizes a $1,000 loss. But 165(c) limits losses that can be recognized by individuals to losses incurred in business or transactions entered into for profit. 2. Substitute a Corp for the individual everything stays the same except 165 does not limit recognition of the loss. Whole purpose of corp is to make a profit, so no possible personal motivations when corps enter into transactions. Just assume it’s a loss entered into in a profit seeking activity. All expenses and losses for corps are assumed to be profit seeking. a. Dichotomy between personal/non-profit seeking consumption versus business transactions disappears in corporate tax = no “personal” transactions b. Therefore, Code Sections that have no application in corporate tax §132 – Fringe Benefits; §104 – Personal Injuries. B. Double taxation . 1. Congress taxes corporation’s as separate entities from their owners a. Tax imposed on corp’s annual taxable income, and then taxed again when distributed to SHs in form of dividends, which aren’t deductible to the corporation. 2. Problems: a. Increases the cost of operating a business as a C Corp and provides an incentive for TPs to choose Pships or S Corps for business activities. b. Encourages retention of earnings by corp; Encourages corp to disguise dividends as salary; Encourages corp to disguise equity as debt. (Could also elect for Subch. S if applicable). c. Distorts economic decisions – whether to issue stock versus issuing debt, where the interest paid by the Corp on the debt is deductible (so only taxed once). Leads to more highly leveraged Cs than otherwise. 3. Argument FOR double taxation It’s the price for limited liability and ability to operate as a corporation. Each individual is an economic unit that is subject to tax. If lots of individuals create a separate entity that has the same rights as the individuals, they have created a new economic unit that uses government resources and should be taxed just like individuals. a. Counter-argument : Corp is a fictional entity and true owner is indiv SH. Only individuals can consume and enjoy income, therefore, the burden of corporate tax on the artificial entity falls on people. So maybe we should just tax SHs as SHs....
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- Spring '08
- sh, Shareholders Professor Shores, Andrew Appleby Taxation, Andrew Appleby