24211_ch21_final_p001-010 - 21 Taxation of Corporate...

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Unformatted text preview: 21 Taxation of Corporate Accumulations Solutions to Problem Materials DISCUSSION QUESTIONS 21-1 Four possible approaches are (1) issuing debt obligations instead of stock, (2) paying officer-shareholders very high salaries, (3) leasing property from shareholders at high rents, and (4) electing to be an S corporation. (See pp. 21-2 through 21-5.) The purpose of AET is to force corporations to pay dividends to their shareholders when they accumulate earnings beyond their needs. (See p. 21-4.) The rate conforms with the top marginal tax rate imposed on dividends received by individuals. (See p. 21-3 and 531). Taxable income plus or minus adjustments minus accumulated earnings credit minus dividends-paid deduction equals accumulated taxable income. (See Exhibit 21-1, and pp. 21-11 and 21-12.) The accumulated earnings tax (AET) credit is the greater of E&P for the current year retained to meet reasonable business needs or $250,000 ($150,000 for PSCs) reduced by prior accumulations. The AET credit is a deduction used to arrive at ATI. (See Exhibit 21-2 and pp. 21-12 and 21-14.) The dividends-paid deduction equals the sum of dividends paid during the taxable year plus dividends paid during the 21=2 months after the close of the taxable year plus consent dividends and liquidating distributions. (See Exhibit 21-3 and pp. 21-14 and 21-15.) A throwback dividend is a dividend paid within the first 21=2 months following the close of the tax year. These dividends are treated as paid during the prior year. (See p. 21-15.) A consent dividend is an agreement by the shareholders to record dividend income without actually receiving a distribution. It reduces the accumulated taxable income for corporations that do not have the cash to actually pay a dividend. (See p. 21-15 and 565.) An unreasonable accumulation may be indicated when there are loans to shareholders, expenditures for the benefit of shareholders, investment in unrelated assets, small or no dividend payments, and accumulations beyond the needs of the business. (See pp. 21-4 and 21-5.) 21-2 21-3 21-4 21-5 21-6 21-7 21-8 21-9 21-1 21-2 Chapter 21 Taxation of Corporate Accumulations 21-10 Reasonable needs include stock redemption from an estate, redemption of excess business holdings, product liability loss reserves, business expansion or plant replacement, retirement of debt, investment or loans to suppliers or customers, contingencies, and working capital. (See pp. 21-5 through 21-7.) The Bardahl formula calculates necessary working capital based on the operating cycle approach. Actual working capital is compared to the amount computed with the formula. As long as the actual amount does not exceed the formula, there has been no unreasonable accumulation. (See pp. 21-7 and 21-8.) The personal holding company tax is a penalty tax on corporations used to shelter passive investment income and other similar abuses. (See pp. 21-15 and 21-16.) It must meet an income requirement and an ownership requirement. (See pp. 21-16 through 21-18.) The ownership requirement is that five or fewer persons own more than 50 percent of the value of the outstanding stock at any time during the last half of the taxable year. The constructive ownership rules in 544 are used. [See p. 21-17 and 542(a)(2).] The income requirement is that at least 60 percent of the corporation'adjusted ordinary gross income is personal holding company income. Terms to be defined are personal holding company income, ordinary gross income, and adjusted ordinary gross income. (See Exhibits 21-4, 21-5, 21-6, and 21-7, and pp. 21-20 to 21-22.) The tests are (1) adjusted income from rent is greater than or equal to 50 percent of AOGI, and (2) dividends paid are equal to or exceed nonrental PHCI minus 10 percent of OGI. If these tests are met, rents are not personal holding company income. (See Exhibit 21-8 and pp. 21-22 through 21-24.) The PHC tax is equal to the highest individual rate on dividends multiplied by the undistributed personal holding company income. (See p. 21-25.) Taxable income plus dividends-received deduction, NOL, 162 expenses in excess of rental income minus federal income taxes, excess charitable contributions, and net capital gains equals adjusted taxable income. [See Exhibit 21-9, pp. 21-18 and 21-19, and 545(b).] The dividends paid within 21=2 months after the tax year are limited to the smaller of the undistributed personal holding company income or 20 percent of the dividends actually paid. PHC is also entitled to a dividend carryover and a deficiency dividend. (See pp. 21-25 through 21-26.) A deficiency dividend is an actual cash distribution following the determination of the PHC tax that the corporation elects to treat as a distribution of the undistributed PHC income. It reduces the tax but not the interest and penalties. (See p. 21-26.) 21-11 21-12 21-13 21-14 21-15 21-16 21-17 21-18 21-19 21-20 PROBLEMS 21-21 21-22 $180,000 15% $27,000. (See Example 2 and p. 21-3.) Income from operations Dividends Income before special deductions Special deductions: Charitable contributions Dividends-received deduction Taxable income Add: Dividends-received deduction $200,000 60,000 $260,000 $26,000 42,000 (68,000) $192,000 42,000 $234,000 Subtract: Income tax Contributions in excess of deductions Adjusted taxable income (58,130) (14,000) $161,870 Solutions to Problem Materials 21-3 Taxable income is adjusted as follows: (1) add back the dividends-received deduction of $42,000, and (2) deduct the excess contributions of $14,000 ($40,000 $26,000). (See Example 4, and pp. 21-11 and 21-12.) 21-23 Maximum credit available Opening E&P Minimum earnings credit $250,000 (60,000) $190,000 The minimum accumulated earnings credit is equal to the $250,000 for non-service corporations less the E&P at the beginning of the year of $60,000. (See Example 5, and pp. 21-12 and 21-14.) 21-24 Estimated needs Less: Opening E&P Current needs a. b. $170,000 (60,000) $110,000 $190,000, which is the larger of the above or the answer to Problem 21-23. Yes. The minimum credit is now $90,000 ($150,000 $60,000). Therefore, the $110,000 in current needs is the credit. (See Exhibit 21-2 and pp. 21-12 through 21-17.) 21-25 a. 1. Compute adjusted taxable income: Taxable income Add: Dividends-received deduction Subtract: Income tax Adjusted taxable income (ATI) Compute credit: Reasonable needs Opening E&P General rule credit Compute accumulated taxable income: Adjusted taxable income General rule credit Accumulated taxable income Accumulated earnings tax: $109,900 15% $200,000 28,000 $228,000 (61,250) $166,750 $356,850 (300,000) $ 56,850 $166,750 (56,850) $109,900 $ 16,485 2. 3. 4. b. $109,900, the amount of the accumulated taxable income. Taxable income is adjusted as follows to arrive at accumulated taxable income: add back the dividendsreceived deduction and subtract the income tax. The AE credit is the greater of: 1. Reasonable needs Less beginning E&P Credit or Starting point Beginning E&P $356,850 (300,000) $ 56,850 $250,000 (300,000) $ (50,000) 2. Therefore, the minimum credit equals $56,850. 21-4 Chapter 21 Taxation of Corporate Accumulations The accumulated taxable income is the adjusted taxable income of $166,750 less the $56,850 credit, $109,900. (See Exhibit 21-1 and 21-2 and pp. 21-10 through 21-14.) 21-26 a. Adjusted taxable income Minimum credit ($500,000 $380,000) Accumulated taxable income Tax at 15% b. Accumulated taxable income from (a) Dividends paid Accumulated taxable income AET ($30,000 15%) $200,000 (120,000) $ 80,000 $ 12,000 $ 80,000 (50,000) $ 30,000 $ 4,500 c. d. $30,000 Actual payment within 21=2 months after close of the current tax year The minimum credit will be the reasonable business needs less the beginning E&P since the beginning E&P exceeds the starting point of $250,000. The $30,000 of extra dividends added to the $50,000 of existing dividends gives dividends equal to accumulated taxable income. (See pp. 21-14 through 21-16.) 21-27 a. $57,000, computed as follows: Inventory turnover Accounts receivable turnover Accounts payable turnover $285,000 0.2 $57,000 0.41 0.61 (0.82) 0.20 b. Peak values for all the variables. (See pp. 21-7 and 21-8.) 21-28 a. Inventory cycle: $30; 000 $50; 000=2 0:2 $200; 000 Receivable cycle: $55; 000 $45; 000=2 0:125 $400; 000 Payable cycle: $13; 000 $31; 000=2 0:1 $220; 000 Inventory Receivables Payables (0.2 0.125 0.1) 0.225 Solutions to Problem Materials 21-5 b. Operating expenses: Cost of goods sold Selling expenses Interest Taxes Total c. Working capital needs: $255,750 0.225 $57,544 d. Actual working capital: Current assets (including marketable securities at fair market value) Current liabilities Actual working capital Required working capital Reasonable needs of the business Accumulation beyond needs of business $200,000 25,000 5,000 $,25,750 $255,750 $165,000 , (31,000) $134,000 (57,544) (25,000) $ 51,456 Unless the shareholders can prove that the accumulations were not intended to avoid tax, the accumulated earnings tax will apply to B. (See Example 3 and pp. 21-7 through 21-10.) 21-29 a. Gross income LTCG Ordinary gross income $80,000 (30,000) $50,000 b. c. Adjusted ordinary gross income equals ordinary gross income. K meets the ownership test. Income test: PHCI $10,000 $40,000 $50,000 AOGI $50,000 60 $30,000 Since PHCI is greater than 60 percent of AOGI, K is a personal holding company. AOGI OGI in this case since there were no expenses attributable to rents which would be deducted from OGI. (See pp. 21-20 through 21-24.) 21-30 a. b. Ordinary gross income $116,000 Ordinary gross income Rent expenses AOGI Gross rent Expenses Adjusted income from rent $116,000 (16,000) $100,000 $ 86,000 (16,000) $ 70,000 c. Adjusted income from rent exceeds 50 percent of AOGI but since no dividends were paid, it is PHCI. d. Yes. Gross Income OGI since there were no capital gains to deduct. T Corporation would be a PHC since both the ownership and income test are met. (See Exhibits 21-5, 21-6, and 21-8 and pp. 21-20 through 21-24.) 21-6 Chapter 21 Taxation of Corporate Accumulations 21-31 a. Dividends Interest LTCG Rents Gross income Less: LTCG Ordinary gross income Ordinary gross income Less rent expenses: Depreciation Interest Taxes AOGI Gross rents Deductible expenses Adjusted rent income Adjusted rent income Interest Dividends PHCI Yes. Meets both the income and ownership test. $6,000 Dividends PHCI Less: Adjusted rent income Less:10% OGI $30,000 15,000 10,000 80,000 $135,000 (10,000) $125,000 $125,000 $10,000 9,000 3,000 b. (22,000) $103,000 $80,000 (22,000) $58,000 $58,000 15,000 30,000 $103,000 (no dividends paid) c. d. e. f. $103,000 (58,000) $45,000 (12,500) $32,500 No. Since dividends do not exceed the minimum payment, rent is still personal holding company income. For the answers to (d) and (e) to be affected, the dividends paid must equal the excess of nonrental PHC income over 10 percent of OGI or $32,500 in this problem. (See Exhibits 21-4, 21-5, 21-6, and 21-8 and pp. 21-20 through 21-24.) 21-32 a. b. c. d. Income from sales of inventory would not be personal holding company income. Interest income is PHC income. Since this interest is tax-free, it is excluded from the computation of PHC income. Taxable dividends are included in PHC income. In addition, the dividends-received deduction is added back to taxable income in arriving at undistributed PHC income. Both long-term and short-term capital gains are excluded from PHC income. These are also subtracted from gross income to arrive at ordinary gross income. Normally, rent is considered PHC income. However, in this case, it will meet the tests for exclusion. Service income may be PHC income if the individual performing the services owns at least 25 percent of the corporation and someone other than the corporation designates who is to perform the services. e. & f. g. h. (See pp. 21-20 through 21-25.) Solutions to Problem Materials 21-7 21-33 Sales Less: Cost of goods sold Income from sales Personal Holding Co. Inc.: Interest income Dividend income Total AOGI: Income from sales Interest income Dividend income Total $500,000 (200,000) $300,000 $ 10,000 x $ 10,000 x $300,000 $ 10,000 x $310,000 x ($10,000 x) < [60% ($310,000 x)] ($10,000 x) < ($186,000 0.6x) 0.4x < $176,000 x < $440,000 C Corporation must receive less than $440,000 of dividend income. (See pp. 21-20 through 21-25.) 21-34 Taxable income Plus: Dividends-received deduction (70% $40,000) Minus: Federal income tax Minus: Capital gains Minus: Less: Tax on gains Undistributed PHC income Times: PHC tax rate PHC tax (rounded) (See Exhibit 21-9 and pp. 21-25 through 21-27.) 21-35 a. The maximum amount that can be distributed in the 21=2-month period is 20 percent of the amount distributed during the year. Maximum 0.20 ($50,000) $10,000 b. The minimum that can be distributed during the year and still have all UPHCI distributed for the year is: $120,000 x 0.2x where x is the amount distributed during the year. If x $100,000, the company must have distributed $100,000 during the year and $20,000 in the 21=2-month period to avoid the penalty tax. (See pp. 21-25 through 21-27.) 21-36 Probably not, based on Revenue Ruling 75-67. (See pp. 21-24 and 21-25.) $200,000 28,000 (60,750) $10,000 (3,400) (6,600) $160,650 15% $ 24,098 21-8 Chapter 21 Taxation of Corporate Accumulations 21-37 a. b. c. d. e. f. g. Yes Yes. The fact that it is property is immaterial. A limited amount of dividends may qualify. The limit is 20 percent of the amount actually paid in 2011. If the dividends paid in 2011 exceed the adjusted taxable income of 2011, the excess can be carried forward to 2012. No. Normally consent dividends qualify. However, the consent form must be filed with the tax return on or before the due date of the return. Yes. A deficiency dividend may be paid in cash within 90 days following the determination that a personal holding company tax is due. Yes. Liquidating distributions to noncorporate shareholders qualify to the extent designated by the distributing corporation. [See pp. 21-25 through 21-27 and 316(b)(2).] 21-38 a. Yes. b. Yes. c. Yes. There is no limit on the amount of dividends that can be paid in the 21=2-month period. d. No. There is no dividend carryover. e. No. f. No. There is no deficiency dividend provision. g. Yes. Liquidating distributions made within 24 months after adoption of a plan of liquidation qualify to the extent of the earnings and profits of the corporation for the taxable year of the distribution. (See pp. 21-14 through 21-15.) 21-39 a. True. The tax is self-assessed and must be paid with the regular tax. b. False. Neither S corporations nor partnerships are subject to the PHC tax. c. False. Intent is not a factor. If the corporation meets the income and ownership tests, it will be subject to this tax. d. True. Publicly traded corporations generally do not meet the ownership test. e. True. If the rent is virtually all the income, then it would fall under the exception to PHC income. f. True. Federal income taxes reduce undistributed PHC income. g. True. Capital gains are subtracted from taxable income to determine undistributed PHC income. h. False. The payment of a dividend is not sufficient. The dividend must reduce undistributed PHC income to zero. i. False. The amount of throwback dividends is limited to 20 percent of the dividends paid during the prior year. j. False. The shareholder can agree to report current dividends. k. False. The deficiency dividend eliminates the tax but not the interest and penalty for failure to pay the tax. l. False. A personal holding company is exempt from the accumulated earnings tax. (See pp. 21-15 through 21-27.) Solutions to Problem Materials 21-9 21-40 a. False. The tax is assessed by IRS following an audit. b. False. Neither an S corporation nor a partnership is subject to the tax. c. True. The tax is assessed only if there is an intent to reduce the tax on shareholders by accumulating income. d. False. A publicly traded company can be subject to the tax, especially if large blocks of stock are owned by related individuals. e. False. The type of income is immaterial. The question is the reason for the retention by the corporation. f. True. Federal income taxes are subtracted from taxable income to arrive at accumulated taxable income. g. True. Long-term capital gains are subtracted from taxable income to arrive at accumulated taxable income. h. True. The payment of regular dividends is an indication that the forbidden intent does not exist. i. True. All dividends paid within 21=2 months after year-end reduce prior years' accumulated taxable income. j. False. The shareholders can agree to report current dividends. k. False. There is no deficiency dividend procedure. l. False. Personal holding companies are not subject to the accumulated earnings tax. (See pp. 21-2 through 21-15.) TAX RESEARCH PROBLEMS Solutions to the Tax Research Problems (21-4121-42) are contained in the Instructor's Resource Guide and Test Bank for 2012. ...
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This note was uploaded on 02/05/2012 for the course ACCT 110 taught by Professor Smith during the Spring '11 term at Adrian College.

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