THE CORPORATE

INCOME TAX
CHAPTER 3

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD

 THE CORPORATE INCOME TAX (1 OF 2)

• Corporate elections
• Computing corporation’s taxable income
• Computing a corporation’s income tax
liability

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 2

 THE CORPORATE INCOME TAX (2 OF 2)

• Controlled groups of corporations

• Tax planning considerations
• Compliance and procedural considerations
• Financial statement implications

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 3

CORPORATE ELECTIONS - TAX YEAR (1 OF
2)

• New corp elects tax year by filing return

• First return may be for short-period
• Some corporations restricted
• S-corporation uses calendar year
• Affiliated group member must be same as
parent
• PSCs usually calendar year

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 4

CORPORATE ELECTIONS - TAX YEAR (2 OF
2)

• Changing the tax year

• Usually requires IRS approval
• Automatic approval if
• Annualizes short-period income
• Keeps books based on new year
• Short period does not have a NOL
• No change in accounting period for 48 mo
• No interest in flow-through entities
• Not a specialized corporation

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 5

 CORPORATE ELECTIONS - ACCOUNTING
METHODS

• Accrual
• GAAP: generally required for C corps
• Cash
• Qualified PSC, or C corp w/ gross receipts <
$5M
• Inventories cannot be significant
• If inventories significant, must use accrual method for
sales, COGS, inventories, accts. rec., & accts. pay. (the
hybrid method)
• Family farm w/ gross receipts < $25M

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 6

COMPUTING A CORPORATION’S TAXABLE
INCOME

• Sales and exchanges of property

• Business expenses
• Special deductions
• Exceptions for closely held corporations

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 7

SALES AND EXCHANGES OF
PROPERTY CAPITAL GAINS AND LOSSES
• Net capital gain taxed at ordinary income
rates
• Net capital losses cannot offset ordinary
income
• Net capital losses
• Carryback 3 years and forward 5 years
• Carryovers classified as short-term
• Expired losses are lost forever

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 8

SALES AND EXCHANGES OF
PROPERTY
§291 TAX BENEFIT RECAPTURE RULE

• §1250 property sold at a gain

• Amount of depreciation in excess of straight
line is characterized as ordinary income plus
• An additional 20% of all depreciation
characterized as ordinary income under §291
• No §1250 recapture under MACRS

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 9

BUSINESS EXPENSES
• General rule
• Organizational expenditures
• Start-up expenditures
• Limitations on deductions for accrued
compensation
• Charitable contributions

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 10

GENERAL RULE
• All ordinary and necessary expenses
reasonable in amount
• No deductions for
• Interest on loans to buy tax exempts
• Illegal bribes or kickbacks
• Fines or penalties
• Insurance premiums if corp is beneficiary

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 11

ORGANIZATIONAL EXPENDITURES
(1 OF 2)

• Expenses incident to creating corp

• E.g., legal, accounting, temporary director fees,
state incorporation fees
• §248 election deemed to be made
• No need to filed election w/ 1st return
• May expense first $5K of org costs
• $5K reduced $ for $ when org costs > $50K

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 12

ORGANIZATIONAL EXPENDITURES
(2 OF 2)

• Amortize remainder over 180 months

• Expenditures must be incurred before end
of first year of business
• May elect to capitalize and not amortize
• Election irrevocable

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 13

START-UP EXPENDITURES
(1 OF 3)

• Non-organizational
• Ordinary and necessary expenses
• Paid or incurred BEFORE the actual start of
business operations

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 14

START-UP EXPENDITURES
(2 OF 3)

• Examples of include expenses to:

• Investigate creation or acquisition of an active
trade or business
• Create an active trade or business
• Conduct an activity engaged in for profit or
production of income before business
operations begin

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 15

 START-UP EXPENDITURES
(3 OF 3)

• Election to expense first $5K of org costs

• $5K reduced $ for $ when org costs > $50K
• Remainder amortized over 180 months Election must
be made by due date for filing tax return for first year
of operation or ownership
• Election deemed to be made w/ 1st return
• May elect to capitalize with no amortization

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 16

LIMITATION ON DEDUCTIONS FOR
ACCRUED COMPENSATION
• Accrued bonuses/compensation must be
paid within 2-1/2 months after close of tax
year
• If paid after 2-1/2 months, payment deemed
deferred compensation and is deductible in
year paid

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 17

CHARITABLE CONTRIBUTIONS
(1 OF 4)

• Timing of deduction
• Deducted in the year paid
• Accrual basis corps may elect to include
payment made w/in 2-1/2 months following
the end of tax year
• Board of directors must have authorized
contribution during year it was accrued
• Must meet substantiation requirements to
deduct contribution

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 18

CHARITABLE CONTRIBUTIONS
(2 OF 4)

• Donated money
• Deduction equals amount donated
• Non-cash property
• Amount USUALLY equal to FMV of property
donated
• Ordinary income property
• Deduction limited to FMV less Ord Inc or STCG that
would have been recognized if property were sold
(includes recapture)

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 19

 CHARITABLE CONTRIBUTIONS
(3 OF 4)

• Non-cash property (continued)

• Certain inventory related to exempt function
• Deduction = adjusted basis + 1/2 gain
• Similar rule for computer technology donated for
educational purposes
• Special rules pertaining to contributions of
computer equipment, book inventory, and
wholesale food inventory

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 20

CHARITABLE CONTRIBUTIONS
(4 OF 4)

• Max deduction is 10% of “adjusted taxable

income” (ATI)
• ATI is taxable income before NOL carryback,
capital loss carryback, dividend received
deduction or charitable contribution deduction
• Excess carried forward for 5 yrs
• Creates a deferred tax asset

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 21

 SPECIAL DEDUCTIONS
• U.S. Production activities deduction
• Other names for the deduction
• Domestic production activities deduction
• Manufacturing deduction

• Dividends-received deduction
• Net operating losses
• Sequencing of the deduction calculations

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 22

U.S. PRODUCTION ACTIVITIES
DEDUCTION
(1 OF 3)

• Deduction is lesser of a % times

• Qualified production activities income OR
• Taxable income before the U.S. production
activities deduction
• Phased-in percentages
• 6% for 2007-2009
• 9% for 2010 and thereafter

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 23

U.S. PRODUCTION ACTIVITIES
DEDUCTION
(2 OF 3)

• Qualified production activities income

• Domestic production gross receipts from lease,
rental, sale, or exchange, of tangible property
manufactured in the U.S. LESS
• Expenses related to qualified income including
CoGS, & indirect allocable expenses

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 24

U.S. PRODUCTION ACTIVITIES
DEDUCTION
(3 OF 3)

• Deduction limited to 50% of W-2 wages

• Not an expense for financial accounting
• Creates a permanent difference

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 25

DIVIDENDS RECEIVED DEDUCTION
(1 OF 3)

• Corps owning < 20% of a domestic

corporation deduct lesser of
• 70% of Dividends Received or
• 70% of taxable income before NOL, capital loss
carryback or DRD
• Exception to taxable income limitation
• If 70% of dividend received creates an NOL, then the
full DRD is deductible

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 26

 DIVIDENDS RECEIVED DEDUCTION
(2 OF 3)

• Corps owning  20% and < 80% of a

domestic corp
• 80% deduction instead of 70%
• Corps owning  80% of domestic corp
• Member of affiliated group
• 100% deduction

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 27

DIVIDENDS RECEIVED DEDUCTION
(3 OF 3)

• No deduction is allowed if :
• Paying corp is a foreign corp
• Stock purchased w/borrowed money
• Stock of paying corp held for < 46 days
• Results in a permanent difference
• Affects effective tax rate, but not deferred taxes

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 28

NET OPERATING LOSSES
(NOL)
• Deductions exceed gross income for the
year before NOL carrybacks
• NOL may be carried back 2 yrs & then
forward 20 yrs
• Corp may elect to forgo carryback & only
carry NOL forward 20 yrs
• Creates a deferred tax asset

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 29

SEQUENCING OF THE DEDUCTION
CALCULATIONS
• Charitable contributions, DRD, NOL, and all
other deductions must be taken in the
following order
• 1. All other deductions
• 2. Charitable contributions
• 3. DRD
• 4. NOL
• 5. U.S. production activities deduction

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 30

EXCEPTIONS FOR CLOSELY-HELD
CORPORATIONS (1 OF 3)
• Special rules apply to shareholders who
own >50% of corp
• §1239 sale of depreciable property to corp
causes gain to be ordinary income to the
controlling shareholder
• §267 disallows loss on sale of property by corp
to controlling shareholder
• Loss may be recovered by shareholder if later sells
prop at a gain

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 31

EXCEPTIONS FOR CLOSELY-HELD
CORPORATIONS (2 OF 3)
• Special rules apply to shareholder who
own >50% of corp (continued)
• Corporation and shareholder using different
accounting methods
• Defers deduction for accrued expenses owed by
accrual-method corp to cash-method controlling
shareholder until income recognized by cash-
method shareholder

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 32

EXCEPTIONS FOR CLOSELY-HELD
CORPORATIONS (3 OF 3)
• Loss limitation rules
• If 5 or fewer s/hs own > 50% of the stock, the
corp’s losses are limited to amount corp has “at
risk”
• Losses not currently deductible are carried over to be
used in a later year
• May also be subject to passive activity rules
• PSCs and closely held corps subject to passive
activity limitation rules

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 33

COMPUTING A CORPORATION’S INCOME
TAX LIABILITY

• General rules
• Regular income tax formula
• Personal service companies

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 34

GENERAL RULES
• The tax rates are graduated
• Rate surcharges eliminate benefit of lower
graduated tax rates from lower income
brackets
• Corps with income >$18.33M pay a flat
35% on all income

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 35

REGULAR TAX FORMULA
(1 OF 3)

Gross Income
- Deductions and Losses
- Special Deductions
=Taxable Income
xAppropriate Rate (or rates)
=Regular Tax Liability before credits

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 36

REGULAR TAX FORMULA
(2 OF 3)

Regular Tax Liability before credits

- Foreign tax credit
- Other Credits
+ Credit recapture
=Regular tax liability

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 37

REGULAR TAX FORMULA
(3 OF 3)

Regular Tax Liability

+ AMT Liability
+ Special Taxes (if any)
- Estimated Payments
=Refund or tax due

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 38

PERSONAL SERVICE
CORPORATIONS
(1 OF 2)

• PSCs taxed at a flat 35%

• PSC is defined as a corp that:
• Substantially all of the activities involve
services in the following fields:
• Health, law, engineering, architecture, accounting,
actuarial science, performing arts, and consulting

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 39

PERSONAL SERVICE
CORPORATIONS
(2 OF 2)

• Substantially all stock must be owned by

employees, former employees or survivors of
employees

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 40

CONTROLLED GROUPS

• Why special rules are needed

• What is a controlled group?
• Special rules applying to controlled groups
• Consolidated tax returns

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 41

WHY SPECIAL RULES ARE NEEDED
• Prevent shareholders from using multiple
corporations to avoid having income taxed
at 35%
• Each corporation would be able to take
advantage of lower graduated rates
• Lower graduated rates must be spread
among all corporations in a controlled
group

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 42

WHAT IS A CONTROLLED GROUP?
• Two or more corps owned directly or
indirectly by same shareholder or group of
shareholders
• Types of controlled groups
• Parent-subsidiary
• Brother-sister
• Combined

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 43

PARENT-SUBSIDIARY CONTROLLED
GROUP
• One corp directly owns at least:
• 80% of voting power of all classes of voting
stock OR
• 80% of total value of all classes of stock of
subsidiary corporation

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 44

BROTHER-SISTER CONTROLLED
GROUP

• 50%-80% definition
• Five or fewer individuals, trusts or estates own:
• At least 80% of voting power or at least 80% of value
of stock of two or more corporations AND
• > 50% of the voting power or value is held by identical
owners (common ownership)
• 50%-only definition is 2nd test above

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 45

COMBINED CONTROLLED GROUPS
• Three or more corps which meet the
following criteria:
• Each corporation is a member of a parent-
subsidiary or brother-sister group
• At least one is both a parent and a member of a
brother-sister group

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 46

SPECIAL RULES APPLYING TO
CONTROLLED GROUPS (1 OF 2)
• Benefits allocated among members
• 5% and 3% surcharge
• 50%-only test for brother-sister groups
• $40,000 AMT exemption amount
• 50%-only test for brother-sister groups
• The $250,000 minimum accumulated earnings
credit
• 50%-only test for brother-sister groups

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 47

 SPECIAL
RULES APPLYING TO
CONTROLLED GROUPS (2 OF 2)
• Benefits allocated (continued)
• §179 expense amount
• 50%-80% test for brother-sister groups
• 50% used for parent-sub test instead of 80%
• The $25,000 general business credit limit
• 50%-80% test for brother-sister groups
• No loss on sale of assets between members

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 48

CONSOLIDATED TAX RETURNS
• Affiliated groups
• Advantages of filing a consolidated return
• Disadvantages of filing a consolidated
return

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 49

AFFILIATED GROUPS
(1 OF 2)

• One or more chains of includible corps

connected through stock ownership to a
common parent
• Common parent directly owns 80% of
voting power AND value of at least one
includible corporation

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 50

AFFILIATED GROUPS
(2 OF 2)

• Each corp owned at least 80/80 by another

member of the group
• An affiliated group MAY file a consolidated
return
• Capital losses offset capital gains from other
group members
• Operating losses reduce operating income from
other group members

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 51

CONSOLIDATED RETURN
ADVANTAGES
• Losses of one member offset gains of
another member
• Capital losses of one member offset capital
gains of another member
• Profits and gains from intercompany
transactions deferred until sale outside the
group

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 52

CONSOLIDATED RETURN
DISADVANTAGES
• Election binding on all subsequent tax
years
• Unless IRS grants permission otherwise
• Losses from intercompany transactions
deferred until sale outside the group
• Additional administrative costs

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 53

TAX PLANNING CONSIDERATIONS

• Compensation planning for shareholder-

employees
• Special election to allocate reduced tax rate
benefits
• Using NOL carryovers and carrybacks

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 54

COMPENSATION PLANNING
• Salary payments
• Reduce double taxation if paid to shareholder-
employees
• Fringe benefits
• Deducted by corporation and certain benefits
are not be taxable to shareholder-employee

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 55

ALLOCATING REDUCED TAX RATE
BENEFITS
• A controlled group may apportion lower
tax rates in any manner to member
corporations
• Reduce benefits to members with little or no
income
• Increase benefits to members with the highest
income

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 56

USING NOL CARRYOVERS AND
CARRYBACKS
• Two options
• Carryback to 2nd previous year, then 1st
previous year, then forward
• Forgo the carrybacks and carry forward
• Examine marginal tax rates in prior years
and expected marginal tax rates in future
years to maximize tax benefit

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 57

 COMPLIANCE AND PROCEDURAL
CONSIDERATIONS ESTIMATED TAXES

• Estimated taxes required if corp owes >$500

for current year.
• Pay in four installments
• Each installment 25% of annual liability
• Underpayment of estimated tax penalty
• Small corps exempt from penalty if
• Pay in lesser of 100% of prior or current year’s tax
liability

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 58

COMPLIANCE AND PROCEDURAL
CONSIDERATIONS FILING REQUIREMENTS

• Return is required each year regardless of

income
• Use form 1120
• Use form 1120A if gross receipts, total
income & total assets each < $500K
• Large corps (assets>$10M) must fill out
more detailed schedule M-3

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 59

FINANCIAL STATEMENT IMPLICATIONS

• ASC 740 - Income Taxes (SFAS 109)

• Temporary differences
• Deferred tax assets and the valuation
allowance
• ASC 740 - Uncertain Tax Positions (FIN 48)
• Balance sheet classification
• Tax provision process

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 60

ASC 740 - INCOME TAXES
SCOPE

• Establishes principles of accounting for

current and deferred taxes
• Arising from temporary differences

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 61

 ASC 740 - INCOME TAXES
PRINCIPLES

• Addresses financial statement consequences

of
• Rev, exp, gains/losses recognized in different
years for tax and financial statement purposes
• Events affecting book/tax differences in bases of
assets and liabilities
• Loss & credit carrybacks or carryforwards

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 62

 ASC 740 - INCOME TAXES
OBJECTIVES

• Recognize current yr taxes payable or

refundable
• Recognize deferred tax liabilities and assets
for future tax consequences of events on fin
stmts or tax return

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 63

 TEMPORARY DIFFERENCES
(1 OF 2)

• Deferred tax liabilities occur when

• Rev/gains recognized earlier for book than tax
• Exp/losses deducted earlier for tax than book
• Tax basis of asset < book basis
• Tax basis of liability > book basis

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 64

 TEMPORARY DIFFERENCES
(2 OF 2)

• Deferred tax assets occur when

• Rev/gains recognized earlier for tax than book
• Exp/losses deducted earlier for book than tax
• Tax basis of asset > book basis
• Tax basis of liability < book basis
• Loss/credit carryforwards exist

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 65

DEFERRED TAX ASSETS AND THE
VALUATION ALLOWANCE
• Deferred tax asset
• Firm will realize tax benefit of event in the
future
• Valuation allowance used for portion of benefit
not likely to be realized
• Use “more likely than not” standard

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 66

ASC 740 - UNCERTAIN TAX
POSITIONS
FORMERLY FIN 48

• Two-step to account for uncertain tax

positions
• Determine if position exceeds “more likely than
not” (>50%) probability of being sustained on its
merits by IRS
• If not, corp cannot recognize tax benefit
• Records liability for unrecognized tax benefits
• If yes, measure amount of benefit

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 67

BALANCE SHEET
CLASSIFICATION
• Classify as current or noncurrent
• If related to another asset or liability use
classification of related asset/liab
• Net current assets and liabilities
• Net noncurrent assets and liabilities

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 68

TAX PROVISION PROCESS
(1 OF 3)

1. Identify temporary differences and tax

carryforwards
2. Prepare “roll forward” schedules
3. Apply appropriate tax rates in roll forward
schedules to determine deferred tax
asset/liability balances
4. Adjust deferred tax assets by valuation
allowance if necessary

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 69

TAX PROVISION PROCESS
(2 OF 3)

5. Adjust income tax expense for uncertain

tax positions under FIN 48
6. Determine current federal income taxes
payable (current tax expense)
7. Determine total federal income tax
expense (benefit)

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 70

TAX PROVISION PROCESS
(3 OF 3)

8. Prepare and record tax journal entries

9. Prepare tax provision reconciliation
10. Prepare tax rate reconciliation
11. Prepare financial statements

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD 71

Prof. Anisur Rahman, Head of Faculty of Business Administration, RUD