TaxIIBurke

School: University of San Diego - Course: ACCT MISC - Subject: Accounting

CORPORATE TAXATION Burke Fall 2007 §7701defines a corporation to include associations, joint-stock companies and insurance companies.If an entity if an unincorporated association, it is classified as a corporation. 6 Characteristics of Pure Corporation 1)associates (2+people joining together in shared control and ownership) 2)objective to carry on business for profit 3)continuity of life (corporation continues despite death or withdrawal of one or more SH) 4)centralization of management (management not exercised directly by SH) 5)limited liability (SH not personally liable for debts) 6)free transferability of interests (SH can dispose of their shares) Corporation v Trust: --there is no double tax on trust income—trust income currently distributed to beneficiaries is generally not taxed to the trust.The income is taxed to the recipient beneficiaries to the extent of the trust's distributable net income.If trust income is accumulated, it is taxed to the trust but normally not taxed again when distributed to the beneficiaries. --Ordinary Trust:created to take title to property for the purpose of protecting and conserving it for the beneficiaries --Business/Commercial Trust:created to carry on a business for profit. --Ordinary Trust is a trust and taxed under Subchapter J, business trust is a business entity that is classified under check the box regulations. Classification of the Business: Check the Box Regulations(post 1997): regulations discarded the classification system and replaced it with check the box system in which most new unincorporated entities automatically will be classified as partnerships for tax purposes unless the entity elects to be an association taxable as a C corporation. Reg §301.7701-1(f). --these regs only apple to entities that are treated as being separate from their owners for tax purposes. --election may be designated up to 75 days before or 12 months after the election is filed. --The election must be signed by each member of the electing entity (including prior members affected by a retroactive election) OR by an officer, manager, or member authorized to make the election. --if the entity makes a election, a different classification election can't be made for 60 months unless the IRS allows the election and more than 50% of the ownership interests in the entity are owned by persons that did not own any interests when the prior election was made. Reg §301.7701-2(b)(8). certain business entities formed in specific jurisdictions that will automatically be classified as a corporation. A single owner entity is disregarded for tax purposesand treated as an extension of its owner unless the entity elects to be classified as an association and taxed as a C Corporation.If no such election is made, it will be treated as a sole proprietorship.If a LLC is a partnership and then its membership is reduced to 1, then it becomes a sole proprietorship and is a disregarded entity.If a single member entity gains 1 more member, it is automatically classified as a partnership. Corporations (Subchapter C §§301-385)—income of the corporation is taxable to the corporation and is taxed again when distributed to shareholders in the form of dividends (not deductible by the distributing corporation but are taxed to non-corporate shareholders— currently at the same rate as LTCG).Prior to 2003, individual SH didn't like dividends because they got taxed higher...but corporate SH liked them. so some of your SH wanted dividends and some didn't.Now both corporate and individual SH in general like dividends because they can be taxed at the lower rate.The 15% preferential dividend rate: this cut didn't apply to the people who owned the most stock--pension funds, foreign entities, didn't get the tax break because they weren't taxed on these in the first place. Corporate shareholder likes getting dividends...§243 allows a corporate shareholder to exclude all or a portion of dividends from another corporation. if corporate SH owns at least 20% of the other organization then exclude 80%, owns less than 20% exclude 70% of the dividends from other corporation. If he gets $100 from another corporation, it excludes $70 (not in income) so it has $30 that gets taxed at maximum rate of 35%, so maximum tax burden is 10.5%. Partnerships (Subchapter K)—passthrough entities, don't pay federal income tax but partners include their respective shares of partnership income, deductions, losses, etc when determining their tax liability. Features: (1) income generated by the business is taxed only once to the beneficial owners regardless of whether they receive current distributions and (2) losses pass through to the owners, subject to timing limitations, and may deducted against income from other sources. 1

"S" Corporations—taxed as partnerships with the benefits of incorporation but subject to many limitations. Must met definition of small business corporation within §1361: can't have more than 100 SH, none can be nonresident aliens, estates or certain trusts, can't have more than 1 class of stock.Family members are counted as 1, have to make the election in a timely manner. Personal Service Corporation—subject to 35% flat rate tax on all taxable income.The corporation has to be engaged in the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting if substantially all of the corporation's stock is held (directly or indirectly) by employees performing services for the corporation, retired employees or the estates of employees or retirees. Classification: --if you a form an entity under a non-corporation statute (partnership or LLP statute) then default form your entity is taxed as a partnership (single tax world) --more entities in practice are going to be LLCs taxed as partnerships --publicly traded corporations or partnerships (very few exceptions) of always taxed as corporations --at least 2 members, formed under state default setting..."check the box" to elect to be treated as corporations.only 1 member--it's sole proprietorship or elect taxed as corporation.If you have an LLC in CA as husband and wife, can treat them as 2 owners (could be partnership). --passive income in hedge funds may be taxed as a partnership (compensation income essentially capital gain rate) Nonrecognition—the realization principle says that gains and losses aren't taxable until they are realized in a sale, exchange or other event that makes the gain or loss "real" and more easily measurable.Transactions that qualify for nonrecognition goes forward on a tax-free basis on the theory that they are mere changes in form which result in a continuity of investment. Corporations must pay tax on the appreciation in its assets on a sale or distribution in connection with a complete liquidation.Acquisitions are tax-free reorganizations (ordinarily free of tax to all parties). "Sham Transaction"—a transaction that never actually occurred but is represented by the taxpayer to have transpired with favorable tax consequences...these won't be respected for tax purposes.Often connotes near fraudulent behavior—designation reserved for the more egregious cases.Court must find 1) not motivated by business purpose other than obtaining tax benefits and 2) transaction has no economic substance because no reasonable possibility of a profit exists. What is"economic substance"? transaction must have a real business purposes and must have economic substance.common law....must have a business purpose and a real economic effect other than saving taxes (other than avoiding taxes).courts are split whether the transaction has to meet both of those requirements. Substance v Form—form of transaction frequently determines its tax consequences but courts also evaluate the substance of a transaction. Documents used by the taxpayer may use one label but the courts can examine the arrangement and restructure it for tax purposes to comport with economic realities. Business Purpose Doctrine—linked to sham, economic substance, substance v form tests.Transactions motivated by a business purpose usually is compared to one that has no substance, purpose or utility apart from tax avoidance. This doctrine denies tax-free status to a transaction that would not have been consummated but for the tax savings that would result if its form were respected. Corporation Taxable Income v Individual's Taxable income --no personal expenses, no personal or dependency exemptions, no standard deduction but most of theirordinary expenses in the pursuit if profit are deductible under §162. --Corporate shareholders are generally entitled to deduct 70% (sometimes even 80 or 100%) of the dividends they receive from other corporations so that corporations are subject to tax at a maximum rate of 10.5% on dividends.Dividend Received Deduction (DRD) --Limit on corporatecharitable contributions is 10% of taxable incomecompared to 50% limit for individual charitable contributions. --Publicly traded corporationscan't deduct more than $1mil a year for otherwise reasonable compensationpaid to certain high- level corporate executives. §162(m). --Corporations canonly deduct capital losses to the extent of capital gains during the taxable year.Excesscan't be applied against ordinary income but itcan be carried back for 3 years and carried forward for 5 years.Individuals can deduct capital losses to the extent of capital gains and up to $3000 of excess loss can be deducted against ordinary income, individuals can also carry forward unused capital losses indefinitely.