?Default Position(what the rules would be without Sub C)Under Code section 1001, when there is a transfer of property in exchange for other property, the transferor recognizes gain or loss in the difference between:The FAIR VALUE of the property received, AND His ADJUSTED BASIS (determined under Code section 1012) in the property transferred EXAMPLE OF DEFAULT POSITION X has land worth $400,000 and in which he has basis of $150,000. X transfers the land to Corp in exchange for 100 shares of Corp stock It is assumed that this is a value for value exchange.
X will realize and recognize gain of $250,000 (the difference between the value of the stock ($400,000) and his basis in the land ($150,000). Depending on how X held the land, the gain will be either capital or 1231 Corp recognizes no gain or loss on transactions involving its own stock…ever… Code section 1032 §351 DEFERRING GAIN or LOSS UPON INCORPORATION No gain or loss recognized to transferors if:PROPERTY transferred in exchange for stock and Transferors have control (80%) of corp .
Immediately after the exchange, transferors must own at least:80% of total combined voting power of all classes of stock and 80% of total number of shares of all other classes of stock Contribution of services & property: Stock received counted toward 80% if FMV of property ? 10% of service’s value BUSINESS PURPOSE REQUIREMENT The corporation is not an INVESTMENT COMPANY Effect of §351 on transferors AND Effect of §351 on transferee corp Assumption of the transferor’s liabilities AND Other considerations in a §351 exchange.
Effect of §351 on Transferors RECEIPT OF BOOT Gain recognized LESSER of gain realized or FMV of boot received. Gain recognized when liabilities transferred > basis in assets transferred per Code section 357(c). Basis in stock ^by gain recognized. Basis in boot property is FMV, Holding period of boot begins day after exchange. A S/H’s Basis in stock received isvby liabilities assumed by the corp. transferor’s holding period for any stock rec in exchange for a capital asset includes the holding period for the property transferred Computing Shareholder Basis – OUTSIDE.
BASIS Adj. basis of property transferred (“substituted basis”) +Gain recognized by transferor (boot) -Money received -FMV of non Cash Boot -Liabilities assumed by transferee corp Shareholder’s basis in corp stock Effect of §351 on Transferee Corp (2 of 3) Loss property limitation: When transferor BASIS > FMV of prop transferred Corp’s basis = FMV AND (Reduction in basis allocated to other assets OR Contributing s/h reduces her basis in corp stock). Why? Would result in two losses Corporation “steps into the shoes” of the transferor: Depre.
recapture potential transfers to transferee corporation. Assumption of Transferor’s Liabilities (Liabilities in Excess of Basis – §357c)Consider all properties Total liabilities transferred to corp -Total adj basis of property transferred Gain recognized Corporate Formula Recognized Income Deductions =Taxable Income xIncome Tax Rate =Income Tax Liability +Other Taxes (AMT, AET etc) Payments Credits =Tax Due (Refund) Surtaxes imputed in the previous table. A 5% surtax is charged on TI between $100,000 and $335,000, which eliminates the “tax savings” on the first $100,000 of TI.
A 3% surtax is charged on TI between $15,000,000 and $18,333,333, which recaptures the “tax savings” from $335,000 to $10,000,000. Once corporate taxable income is over $18,333,000, the corporate tax rate is flat Capital gain rates. Same as ordinary rates. No rate breaks as with individual tax rates. Capital losses. Not deductible as with individuals, offset only against capital gains. Accrual Method of Tax Accounting – Income RECOGNITION: GAAP: Income is recognized when realized (i. e. , earned) regardless of when payment is received.
TAX: Income is recognized when the all events have occurred to fix the taxpayers right to receive income, and the amount of the income can be determined with reasonable accuracy. Reg. section 1. 446-1(c)(1)(ii). *Note that the right to receive income is fixed at the EARLIER of when the income is earned or when payment is received. *Thus, income that is reported as unearned revenue (a liability) for GAAP is generally RECOGNIZED in full for tax TIMING OF DEDUCTIONS: GAAP: The Matching Principle: Expenses R recorded when the related revenue is earned or during the time period to which they relate.
Tax: The “All-Events” Test + Economic Performance: Taxpayers deduct expenses when all events have occurred that establish the fact of the liability for the expense and the amount of the liability can be determined with reasonable accuracy. Code section 461(h)(4). Economic Performance (Code section 461(h)(1)): In addition, most deductions are allowed only when economic performance has occurred Computing Corporate Taxable Income Default: The rules you learned in Tax 1 Items treated differently due to corporation -Capital Gains & Losses (1211-1222) -Real property depreciation recapture (1250/291) Certain business deductions.
Organizational Expenditures & Start-up Costs (248/195) Compensation (404) Charitable Contribution Deduction (170) Dividends-Received Deduction (241-250, mainly 246) Net Operating Loss Deduction (172) Domestic Production Activities Deduction (199) Special Issues for Corporations controlled by a single shareholder (1239, 267, 465, 469) 1250 recapture refers to depreciation taken on real property BUT ONLY to the extent that such depreciation was “accelerated. ”Generally, real property is depreciated over long periods using straight-line. Thus, not all depreciation related to real property is going to generate 1250 recapture.
Applies only to buildings placed in service before 1987 Corporations – Code section 291: Corporations must recapture 20% of the excess of full depreciation recapture over the actual amount of recapture under 1250). This ensures some recapture for real property depreciation even if only SL used. EX. A corporation sells Sec. 1250 property on Jan 1 ‘11, at a gain of $50K. At the time of the sale, the company had $25K of acc Dep. , the excess of full dep recapture ($25K) over actual 1250 recapture ($0) is $25K SO The corporation would recapture $5K (20% x $25K) of the gain as ordinary income under Code Sec. 291. The remaining $45K gain is 1231.
Organizational (248) and Start-up (195) Costs Tax Treatmen: if no election made, these amount are capitalized and no part of the costs are deductible. If elected, the first $5,000 of these amounts R fully deductible. remaining amount is capitalized and amortized over 180months beginning in the month the business starts. Accrued bonuses/compensation must be paid within 2-1/2 months after close of tax year (sec404) Charitable Contributions – Sec 170 Compute the Maximum Deductible Amount THEN Determine limitations on deduction MAX Ded AMT Inventory related to exempt function; Deduction = adjusted basis + 1/2 gain.
Deduction limited to smaller of actual deductionOR 10% of “adjusted taxable income” (ATI= taxable income before charitable contribution deduction, NOL carryback, capital loss carryback, dividend-received deduction, & Domestic prod. activities ded. )Excess carried forward for 5 yr Levels of DRD:Affiliate (80+%, non-consolidated): 100% DRD (“controlling” investor) 20% – 80% ownership: 80% DRD (“direct” inv) 80% ownership: 100% of dividends received from an affiliated corporation are deducted. Recv corporation must own at least 80% of the payer, and the receiving and paying corporation do not file tax returns as a consolidated group.
No limitations (may create or increase an NOL) DPA DEDUCTION = 9% of the lesser of net US production income OR tax income before the deduction(Deduction can’t exceed 50% of US compensation expense) Deduction is equivalent to a reduced tax rate on domestic production income. EX Hallick, a Michigan corporation, operates two facilities for the manufacture of tangible goods; one facility is located in Michigan and the other is located in Canada. In 2012, Hallick earned the following net income from those facilities: Sales$1,978,000$1,642,000 CGS(1,233,000)(1,001,000) Gross Mfg. Profit$745,000$ 641,000 Other Deductions( 316,000)( 298,000).
Net Income$429,000$ 343,000 Hallick’s total US compensation was $635,000 and total Canadian compensation was $409,000. In addition, Hallick had $39,400 of investment income in 2010. Compute Hallick’s 2012 taxable income Net income from U. S. production activity$429,000 U. S. production activities deduction ($429,000 * 9%) (38,610)* Net income from Canadian production activity 343,000 Investment income 39,400 Hallick’s taxable income $772,790 *Limit: 50% of US compensation (635,000 x 50% = 317,500: Because basic 9% deduction is $38,610 and less than limit, deduction not limited) What happens if the Canadian operations have a loss of $112,700?
The deduction is lesser of 9% of domestic production income or taxable income (prior to the deduction). Taxable Inc will b $429,000 (US prod)+ 39,400 (inv. Income) – $112,700 (Canadian Loss)= $355,700. Taxable income is < US domestic production ($429,000). DPA production deduction = 9% x $355,700 = $32,013 (still lower than salary limitation, so the deduction is not limited) Taxable income prior to DPA deduction$355,700 Less DPA deduction( 32,013) Taxable Income$323,687 Reconciling Book to Tax Corporate Taxpayers do not keep separate systems figuring book (GAAP) and tax income Typically, systems are based on GAAP
When preparing tax returns, we start with book and reconcile to tax Reconciling book to tax Understand what is included in book and what is not Tax exempt income must be deducted Tax exempt expenses must be added back Net capital losses must be added back Federal income taxes deducted must be added back Add back charitable contribution deduction, organizational and start up costs to be recomputed based on tax rules Add back dividends received ….. many, many more book/tax adjustments then…make sure to account for tax-specific adjustments (carrybacks, the DRD, tax charitable contribution, DPA deduction, among others).
These are items that would not be reflected on the books 11) Identify which of the following statements is true. A) The dividends-received deduction is designed to reduce double taxation of corporate dividends. 12) Identify which of the following statements is true. C) The NOL deduction claimed by a corporation must be taken after the dividends-received deduction. 13) Bright Corporation purchased residential real estate five years ago for $450,000, of which $50,000 was allocated to the land and $400,000 was allocated to the building.
Bright booked straight-line MACRS deductions of $55,000 during the past five years. This year, Bright sells the property for $550,000, of which $100,000 is allocated to the land and $450,000 is allocated to the building. What is the amount and character of Bright’s recognized gain or loss on the sale? 14) Items that pertain to Ward Corporation for the year are presented below. Taxable loss before capital transactions $(15,000) Short-term capital gains 10,000 Long-term capital losses (30,000) For the year, Ward Corporation has a net operating loss of:
D. $15,000 and a long-term capital loss of $20,000. 9) Island Corporation has the following income and expense items for the year: Gross receipts from sales $60,000 Dividends received from 15%-owned domestic corporation 40,000 Expenses connected with sales 30,000 The taxable income of Island Corporation is D) $42,000. 10) Maxwell Corporation reports the following results: Gross income from operations $90,000 Dividends received from 18%-owned domestic corporation 70,000 Expenses 100,000 Maxwell’s dividends-received deduction is A) $42,000.