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Chapters 18-19 - Income Taxation Income Chapters 18 and 19...

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Unformatted text preview: Income Taxation: Income Chapters 18 and 19 Chapters Alternative Forms of Business Alternative CORPORATIONS Non Tax Benefits for Non Shareholders Shareholders Limited Liability Centralized management Continuity after a shareholder’s death Ease of Transferability of Stock Non Tax Benefits for Non Shareholders Shareholders Limited Liability Not as significant in professional corporations as in business corporations professional’s corporate liability is limited to investment greatest exposure is personal Non Tax Benefits for Non Shareholders Shareholders Ease of transferability of stock Most state laws do not permit transfer of shares of professional corporation other than to the corporation or person licensed to practice Non Tax Benefits for Non Shareholders Shareholders Ease of transferability of stock Many closely held corporations wish to prevent transfer to outsiders Often form agreements restricting the transfer of stock IRS Concerns/Tax Issues “Check­the­Box” regulations owners can choose tax status by organizing entity as corporate or a noncorporate entity under state law Owners that do not incorporate can elect partnership tax status IRS Concerns/Tax Issues Corporation is a separate taxable entity for federal income tax purposes Corporation must file a tax return & pay federal tax on its taxable income IRS Concerns/Tax Issues Income kept within the corporation may have more of a tax burden than it would be for a proprietorship, partnership or LLC Dividends are taxed at shareholder’s reduced individual 15% rate under JGTRRA of 2003 IRS Concerns/Tax Issues Dividends are not deductible in determining corporation’s taxable income concept of “double taxation” Business expenses are deductible IRS Concerns/Tax Issues Shareholder’s who are employed prefer salary rather than dividends (pre­Tax Act of 2003) Payments of salary are not double taxed Salary payments are only for services rendered IRS Concerns/Tax Issues Shareholder’s who are employed prefer salary rather than dividends If salary is deemed in excess of services the excess is disallowed as deduction to corporation Deemed a “Dividend” to S/H IRS Concerns/Tax Issues Corporations can avoid double taxation by retaining income and accumulating it rather than paying it out in dividends Tax laws impose limitations The accumulated­earnings tax IRS Concerns/Tax Issues This provision permits accumulation of a specified amount of earnings & profits without accumulated­earnings tax. Accumulated-Earnings Tax Minimum accumulated­earnings credit $150,000 for personal­service corporations & $250,000 for other corporations If excess accumulation occurs (above credit), entity must show that accumulation is for reasonable business needs Accumulated-Earnings Tax Reasonable business needs Reinvestment of accumulation in capital equipment Working capital needs Funds to retire existing debt If not justified, the accumulated­ earnings tax will apply Accumulated-Earnings Tax Tax is high penalty tax designed to force corporation to pay dividends Penalty is equivalent to highest individual income tax rate Under JGTRRA of 2003, penalty reduced to 15%...same as tax imposed on Dividends Corporate Alternative Minimum Corporate Tax (A.M.T.) Tax Corporation takes advantage of too many tax preferences in a given year Select tax preferences are added to tax base for the year to reach A.M.T. base Subject to a 20% tax rate Corporate Alternative Minimum Corporate Tax (A.M.T.) Tax If T.M.T. > normal corporate tax, must pay excess (A.M.T.) Current adjusted earnings figure 75% of current adjusted earnings are added to A.M.T. Example: death benefit of corporate­owned life insurance Corporate Alternative Minimum Corporate Tax (A.M.T.) Tax A.M.T. exemption for small businesses 1998 or later corporations with gross receipts averaging $5m or less for previous 3 years are exempt Once initial gross receipts test passed, 3 year average increases to $7.5m or less Section 351 Exchange Business property transferred for stock no gain or loss if persons who transfer are in control of corporation after receiving stock Control means 80% or more ownership Section 351 Exchange Stock must be issued in return for property not services Persons receiving stock for services are excluded from 80% test Net Operating Losses Purpose of NOL deduction: Individual NOLs are normally created by one of the following: Loss from operating a sole proprietorship Casualty or theft loss or Losses attributable to a Partnership or S­Corp, and LLCs Note: x The only nonbusiness items that may create NOLs for individuals are casualties and thefts x A NOL from the above is reported on the individual’s tax return NOL Carryback & Carryforward Years Deduct Over 18 or 22 Year Period Pre 8/5/97 Post 8/4/97 3 yr. Carryback 15 yr. Carryforward 2 yr. carryback 20 yr. carryforward TP may elect to forgo carryback period x Election must be made by due date of loss return Election (including extensions) (including x Election is irrevocable once made Statute of limitations for the carryback year is Statute extended to coincide with that of the loss year extended Corporate Carrybacks & Carryforwards NOL: 2 yr Carryback / 20 yr Carryforward CAPITAL LOSSES: 3 yr Carryback / 5 yr Carryforward (can only offset capital gains) CHARITABLE CONTRIBUTIONS: No Carryback / 5 yr Carryforward Advantages of “S” Election Corporate income & deductions are passed through to shareholder’s individual return Double taxation of income is avoided Capital gains on corporate property avoids corporate level tax Advantages of “S” Election Corporate penalty taxes are avoided NO corporate A.M.T. NO accumulated­earnings tax NO personal­holding­company tax Advantages of “S” Election Avoids the personal­service­ corporation 35% rate & provides passthrough Income can be shifted to inactive family members through gifts of stock “S” Corporation Requirements Not all corporations eligible to make subchapter “S” election No more than 100 shareholders Have NO nonresident alien shareholders No more than one class of stock “S” Corporation Requirements Not all corporations eligible to make subchapter “S” election Corporation must be incorporated in U.S. All shareholders must be individuals, estates, or certain types of trusts Dividends a corporate distribution in any form to • Generally taxed as “ordinary income” • pre­arranged stock redemptions may achieve capital gain treatment as opposed to dividend treatment • shareholders from the surplus of the corporation, such as cash, notes, or other property NOTE: Under JGTRRA of 2003, the rules have changed…both Dividends and Capital Gains are taxed at 15% (May 6 for LTCGs) General Rules for Taxation of Corporate Distributions a corporate distribution is taxable as a dividend to the extent of the Corporation’s Current and Accumulated Earnings and Profits Distributions in excess of the Corporation’s Earnings and Profits are treated as a “Capital” transaction: ­ The excess distribution is taxed as a “return of capital” to the extent of the shareholder’s basis in the stock ­ The balance, if any, will be treated as a capital gain See Example in textbook Redemptions that are taxed as Capital Transactions a redemption that is “not essentially equivalent to a dividend” • • a “complete” redemption • a “substantially disproportionate” redemption a distribution to a non­corporate shareholder in “partial liquidation” of the distributing corporation Substantially Disproportionate Redemptions requirements for a substantially disproportionate redemption are that: after the redemption, the shareholder must own less than half the total voting power of the corporation; also, the shareholder’s percentage ownership of voting stock and of common stock after the redemption must be less than 80 percent of his or her ownership of voting stock and of his or her ownership of common stock before the redemption. See Example in textbook Attribution of Ownership means that stock owned by one individual or entity is considered to be owned by another individual or entity for the purpose of determining how a particular transaction is taxed. For example, the rules governing Family Ownership state that stock owned by an individual shareholder’s parents, spouse, children, and grandchildren will be attributed to the shareholder for purposes of determining the tax treatment of a redemption. However, stock owned by the shareholder’s grandparents or siblings will not be attributed. Reattribution refers to situations in which two or more constructive ownership rules would be combined to attribute ownership from one shareholder to another shareholder not directly related under the attribution rules. Examples: A father will be considered to own the stock owned by a trust of which his son is the sole beneficiary; A corporation will be considered to own 50% of the stock owned by a partnership in which the corporation’s sole S/H is a 50% partner. Sec. 303 Redemption provides a relief provision that applies to estates in which stock of a closely held corporation constitutes a substantial portion of the total estate assets(>35% of Adjusted Gross Estate). It allows distributions in redemption of such stock to be treated as made in exchange for a capital asset and, therefore, eligible for capital­gains treatment, subject to certain requirements and limitations. ...
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