Transcript Document
Slide C3-1
Assignments
For Next Class:
Read Chapter 3, pages 38 – 41
(review previously read pages 1-24)
Problems: C3-58, C3-59, and C3-61
Chapter
3
The Corporate Income Tax
Dividends-Received Deduction
Slide C3-4
Dividends-Received Deduction
Mitigates triple taxation of corporate income
Deduction applies to:
Dividends received by U.S. corporations from other U.S.
Corporations [IRC §243(a)]
Dividend must not be from a corporation that is taxexempt under IRC §501 [IRC §246(a)(1)]
Slide C3-5
Dividends-Received Deduction
Deduction percentages [IRC §243(a) & (c)]
70% DRD if ownership < 20%
80% DRD if 20% < ownership < 80%
100% DRD if 80% < ownership
Slide C3-6
Dividends-Received Deduction
Deduction is limited to a percentage of taxable
income [IRC §246(b)(1)]
70% limit if DRD is 70%
80% limit if DRD is 80%
Unlimited if DRD is 100%
Slide C3-7
Dividends-Received Deduction
[IRC §246(b)(1)] Limitation on DRD is based on
taxable income calculated with:
Charitable contributions deduction allowed
Capital loss carryforwards allowed
But without:
Dividends-received deduction
NOL carrybacks or carryforwards
Capital loss carrybacks
IRC §199 deduction
Slide C3-8
Example 7: Charitable Contributions
The XYZ Corporation has a $55,000 tax net operating loss
carryforward from last year. In addition, the corporation
reported the following income and expenses in its financial
statements for the current year:
Operating income
Dividend income (15% owned companies)
Charitable contributions
Net income before taxes per books
Contributions in excess of 10% limit
$1,800,000
175,000
(300,000)
$1,675,000
$108,000
Slide C3-9
Example 8: DRD
Using the information from Example 7 above,
what is the XYZ Corporation’s dividends-received
deduction and taxable income before the IRC
§199 deduction for the year?
Answer:
DRD = 175,000 x 70% = $122,500
Net income before taxes per books
Add: Nondeductible contributions
Total
Limit 70%
$1,675,000
108,000
$1,783,000
$1,248,100
Slide C3-10
Example 8: DRD
Answer:
Net income before taxes per books
Add: Nondeductible contributions
Less: DRD allowed
Less: NOL carryforward
Taxable income before IRC §199 deduction
$1,675,000
108,000
(122,500)
(55,000)
$1,605,500
Slide C3-11
Dividends-Received Deduction
Exception to the taxable income limitation: The
taxable income limitation does not apply in years
for which the DRD creates or contributes to a net
operating loss [IRC §246(b)(2)]
Slide C3-12
Example 9: DRD
What amount of DRD and taxable income (before
the IRC §199 deduction) does a C corporation
have in each of the three independent situations
below (the dividends are from companies that are
less than 20% owned)?
(a)
(b)
(c)
Dividend income
$50,000 $50,000 $50,000
Other taxable income 80,000 (10,000) (30,000)
TI before DRD
$130,000 $40,000 $20,000
Slide C3-13
Example 9: DRD
(a)
(b)
(c)
$50,000
80,000
$130,000
$50,000
(10,000)
$40,000
$50,000
(30,000)
$20,000
1. Dividend x 70%
2. TI x 70%
DRD allowed
$35,000
$91,000
$35,000
$35,000
$28,000
$28,000
$35,000
$14,000
$35,000
TI b/f IRC §199
$95,000
$12,000
$(15,000)
Dividend Income
Other Income
TI before DRD
Slide C3-14
Dividends-Received Deduction
Exception:
No DRD is allowed if the stock was held < 46 days
during the 91-day period beginning 45 days before the
ex-dividend date [IRC §246(c)(1)(A)]
Short sales are treated similarly [IRC §246(c)(1)(B)]
Slide C3-15
Example 10: DRD
Purple Corp. purchases 500 shares of White
Corp. on March 18th. White Corp. pays dividends
of $10,000 to Purple Corp. on April 15th (the exdividend date was March 30th). Purple Corp. sold
the 500 shares of White Corp. on April 28th.
45 days before March 30th is February 13th
91 days from February 13th is May 14th
Purple Corp. gets no DRD since the stock was
only held 42 days during the 91 day period
Slide C3-16
Dividends-Received Deduction
Exception:
Dividends received deduction is reduced by the average
indebtedness percentage if the stock portfolio is debt
financed [IRC §246A(a)]
Slide C3-17
Example 11: DRD
The XYZ Corporation received $50,000 in
dividends from U.S. corporations that are less
than 20% owned. The average indebtedness on
the corporations stock portfolio was 63%. What is
the DRD allowed?
Answer: $50,000 x 70% x (1 – 63%) = $12,950
Net Operating Loss Deduction
Slide C3-19
Net Operating Losses
Net operating losses
NOL is the amount by which allowable deductions
exceed taxable gross income [IRC §172(c)]
NOLs are generally carried back 2 years and forward
20 years [IRC §172(b)]
Election to waive carryback and carry forward only
[IRC §172(b)(3)]
Check the box on Form 1120
Election is irrevocable
Slide C3-20
Example 12: NOL
A C corporation had the following taxable income and
taxes paid for the first three years of operations:
Year 1 $91,000 ($20,550 in taxes paid)
Year 2 $50,000 ($7,500 in taxes paid)
Year 3 $120,000 ($30,050 in taxes paid)
In the current year (Year 4), the corporation has a NOL of
$(475,000). Taxable income for the next two years (before
any NOL carryforwards) is projected to be:
Year 5 $400,000 ($136,000 in taxes paid)
Year 6 $600,000 ($204,000 in taxes paid)
Assuming an 8% discount rate, should the corporation
elect to waive the NOL carryback?
Slide C3-21
Example 12: NOL
Without election:
TI before NOL
NOL deduction
TI after NOL
Tax before NOL
Tax after NOL
Tax savings
PV Factor
PV of tax savings
NPV of tax savings
Year 2
Year 3
Year 5
$50,000
(50,000)
$120,000
(120,000)
$400,000
(305,000)
$0
$0
$95,000
$7,500
0
$7,500
$30,050
0
$30,050
$136,000
20,550
$115,450
1.000
$7,500
$144,448
1.000
$30,050
0.9259
$106,898
Slide C3-22
Example 12: NOL
With election:
Year 5
Year 6
TI before NOL
NOL deduction
TI after NOL
$400,000
(400,000)
$0
$600,000
(75,000)
$525,000
Tax before NOL
$136,000
$204,000
Tax after NOL
Tax savings
PV Factor
PV of tax savings
0
$136,000
0.9259
$125,926
178,500
$25,500
0.8573
$21,862
NPV of tax savings
$147,788
IRC §199 Deduction
Slide C3-24
U.S Production Activities Deduction
IRC §199 was added October 2004 and is
effective for tax years beginning after 2004
IRC §199(a) allows a deduction equal to a
percentage of the lesser of:
(1) qualified production activities income, or
(2) taxable income before this deduction
The percentages are:
3% for 2005-2006
6% for 2007-2009
9% beginning in 2010
Slide C3-25
U.S Production Activities Deduction
Limitation: U.S. production activities deduction
cannot exceed 50% of the corporation’s W-2
wages for the year [IRC §199(b)]
Slide C3-26
U.S Production Activities Deduction
Qualified production activities income is defined in
IRC §199(c)(1) as:
Domestic production gross receipts [IRC §199(c)(4)]
Less: Allocable cost of goods sold
Less: Other directly allocable deductions
Less: Ratable portion of other deductions