Chapter 3

The Corporate Income Tax

Filing Requirements and Computing the Tax

Slide C3-3

Filing Requirements

 C corporations are separate tax-paying and tax reporting entities from their owners  Annual tax returns required  Form 1120 or Form 1120-A (corporations with gross receipts, total income and total assets < $500,000)  Original due date is the 15 th day of the third month following the fiscal year-end [IRC §6072(b)]  Can obtain an automatic 6 month extension of time to file using Form 7004 [IRC §6081]  Extension of time to file the tax return does

not

extend the time for paying the tax

The Corporate Tax Formula

Slide C3-4  For C Corporations: Total Income - Allowable Deductions Taxable Income before NOLs and Special Deductions - NOLs and Special Deductions =Taxable Income

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Corporate Tax Rates [IRC §11(b)(1)]

If TI is over $0 50,000 75,000 100,000 335,000 10,000,000 15,000,000 18,333,333 But not over The tax is: 50,000 75,000 15% $7,500 + 25% 100,000 335,000 13,750 + 34% 22,250 + 39% 10,000,000 15,000,000 18,333,333 -------------- 113,900 + 34% 3,400,000 + 35% 5,150,000 + 38% 6,416,667 + 35% Of TI less: $0 50,000 75,000 100,000 335,000 10,000,000 15,000,000 18,333,333

Corporate Tax Rates

 Exception: Personal Service Corporations  Taxed at a flat 35% [IRC §11(b)(2)]  Definition [IRC §448(d)(2)] Slide C3-6

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Example 1a: Computing the Tax

 The Purple Corporation has taxable income of $125,000. What is the tax before credits if this corporation

is not

a personal service corporation?

 Answer: 22,250 + (125,000 – 100,000) x 39% = $32,000

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Example 1b: Computing the Tax

 The Purple Corporation has taxable income of $125,000. What is the tax before credits if this corporation

is

a personal service corporation?

 Answer: 125,000 x 35% = $43,750

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Example 2a: Computing the Tax

 The Green Corporation has taxable income of $425,000. What is the tax before credits if this corporation

is not

a personal service corporation?

 Answer: 113,900 + (425,000 – 335,000) x 34% = $144,500  Alternatively: 425,000 x 34% = $144,500

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Example 2b: Computing the Tax

 The Green Corporation has taxable income of $425,000. What is the tax before credits if this corporation

is

a personal service corporation?

 Answer: 425,000 x 35% = $148,750

Tax Accounting Periods

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Accounting Periods

 Generally, a corporation’s tax period is the same as its fiscal period for financial accounting purposes [IRC § 441(b)(1) and (c)]  Can be any 12 month period ending on the last day of any month [IRC § 441(d) and (e)]  Can elect a 52/53 week around the end of any month [IRC § 441(f)]  Short tax periods (less than 12 months) may occur in a corporation’s first or last years of business, or in the year of a change in accounting period

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Accounting Periods

 Exception: Personal Service Corporations  Definition [IRC § 441(i)(2)]  Principal activity is performance of personal services  By owner-employees who own more than 10% of stock  Must use a calendar year unless can establish, to the satisfaction of the IRS, a business purpose for using a different fiscal year [IRC § 441(i)(1)]  Can elect a different year-end if deferral period is not longer than 3 months [IRC §444(a) and (b)(1)]  If minimum distribution requirements are not met, deductions for payments to owner/employees of PSCs are limited of deferred to future years [IRC §280H]

Changing Accounting Periods

Slide C3-14  Corporation can just pick a year-end for its first tax return but after that, IRS approval is generally required to change tax years [IRC § 442]  Regulations and Rev. Proc 2002-37 allow an automatic approval of a change in accounting period if certain conditions are strictly met [Reg. §1.442-1(c)]

Changing Accounting Periods

Slide C3-15  If a short period return results from a change in accounting period, the tax is calculated using the “annualized” taxable income method [IRC §443]

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Example 3a: Short Periods

 The Blue Corporation (not a PSC) files a tax return for the short period September 1st to December 31st. Taxable income reported in the short period return is $82,000. What is the tax for the short period if this is the corporation’s first year of business?

 Answer: 13,750 + (82,000 – 75,000) x 34% = $16,130

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Example 3b: Short Periods

 The Blue Corporation (not a PSC) files a tax return for the short period September 1st to December 31st. Taxable income reported in the short period return is $82,000. What is the tax for the short-period if the corporation changed its fiscal year from August to December?

 Answer: Annualized TI = 82,000 x 12/4 = $246,000 Tax on ATI = 22,250 + (246,000 – 100,000) x 39% = $79,190 Tax due for the short period = 79,190 x 4/12 = $26,397

Tax Accounting Methods

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Accounting Methods

 Accounting method determines when an item of income or expense is included in taxable income  Method is selected in the corporation’s first tax return  Must get IRS consent to change accounting methods once established [IRC §446(e) and (f)]  Method taxpayer regularly uses to compute income in per books [IRC §446(a)]  Method must “clearly reflect income” or IRS can impose a different method [IRC §446(b)]

Accounting Methods

 Overall accounting methods that are generally permissible include [IRC §446]:  Cash method  Accrual method  Hybrid method Slide C3-20

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Accounting Methods

 Exception: C corporations generally cannot use the cash method [IRC §448(a)(1)]  Exception 1: Qualified farming businesses may use cash method [IRC §448(b)(1) and (d)(1)]  Exception 2: Qualified personal service corporations may use cash method [IRC §448(b)(2) and (d)(2)]  Exception 3: Corporations with gross receipts of not more than $5,000,000 may use cash method [IRC §448(b)(3)]

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Cash Method

 Income is generally taxable when it is received or constructively received [Reg. §1.446-1(c)(1)(i)]  Exception: Inventory sales must be accounted for using the accrual method [Reg. §1.446-1(c)(2)(i)]

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Cash Method

 Expenses are generally deductible when they are actually paid [Reg. §1.446-1(c)(1)(i)]  Exception: Inventory purchases and cost of goods sold must be accounted for using the accrual method [Reg. §1.446-1(c)(2)(i)]  Exception: Prepaid interest must be deducted when accrued rather than when paid [IRC §461(g)]  Exception: Payments creating assets with useful lives of more than one year must be capitalized [IRC §263]  These may then be depreciated or amortized