EA Corporate Tax Outline PDF

1 STUDY UNIT TWELVE CORPORATIONS 12.1 Businesses Taxed as Corporations........................................ 1 12.2 Controlled Groups and Personal Service Co...

1 STUDY UNIT TWELVE CORPORATIONS 12.1 Businesses Taxed as Corporations........................................ 1 12.2 Controlled Groups and Personal Service Corporations (PSCs).................... 3 12.3 U.S. Source Income.................................................... 6 12.4 Tax Return Filing...................................................... 7 12.5 Additional Corporate Taxes............................................... 9 12.6 Estimated Tax Payments................................................ 11 For tax purposes, the predominant forms of business organizations are C corporations, S corporations, partnerships, and sole proprietorships. A business must choose among the kinds of business organizations based on a number of different factors, including an organization’s tax treatment. C corporations are subject to the most rigid tax rules of all the kinds of business organizations, as their earnings are taxed twice. First, the earnings are subject to a corporate tax, and then the profits are taxed at the individual level when they are distributed to shareholders as dividends. A corporation is a business formed by associates to conduct a business venture and divide profits among investors. A corporation files a charter, prepares bylaws, is overseen by a board of directors, and issues stock. 12.1 BUSINESSES TAXED AS CORPORATIONS Businesses Formed before 1997 1. The following businesses formed before 1997 are taxed as corporations: a. A business that is legally chartered as a corporation b. A joint-stock company c. An insurance company d. Any other business formed before 1997 that has more than two of the following characteristics: 1) Centralization of management 2) Continuity of life 3) Free transferability of interests 4) Limited liability Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 2 SU 12: Corporations Businesses Formed after 1996 2. Under a “check-the-box” system, certain business entities are automatically treated as corporations for federal tax purposes, while others may elect to be treated as corporations for federal tax purposes. a. If an entity has one owner and is not automatically considered a corporation, it may nevertheless elect to be treated as a corporation or, by default, it will be treated as a sole proprietorship. b. Similarly, if an entity has two or more owners and is not automatically considered a corporation, it can elect to be taxed as a corporation for federal tax purposes; otherwise, it will be taxed as a partnership. c. An eligible entity may elect its classification on Form 8832 (Entity Classification Election). 1) Each member of the entity, or any member of the entity authorized to make the election, must sign the election. 2) The taxpayers must indicate the date the election will become effective. 3) This effective date cannot be more than 75 days before or 12 months after the date the election was filed. 4) If an eligible entity makes an election to change its classification, the corporation cannot change its classification by election again during the 60 months succeeding the effective date of the election. a) EXCEPTION: The IRS may allow a corporation to change its classification (by private letter ruling) prior to the 60 months if more than 50% of the ownership interests are owned by persons other than those who made the prior election. d. The following businesses formed after 1996 are automatically taxed as corporations: 1) A business formed under a federal or state law that refers to the business as a corporation, body corporate, or body politic 2) A business formed under a state law that refers to the business as a joint-stock company or joint-stock association 3) An insurance company 4) Certain banks 5) A business wholly owned by a state or local government 6) A business specifically required to be taxed as a corporation by the Internal Revenue Code, e.g., certain publicly traded partnerships 7) Certain foreign businesses 3. In general, any business formed before 1997 and taxed as a corporation under the old rules will continue to be taxed as a corporation. 4. A single-member limited liability company (LLC) may elect to be taxed as a corporation. a. If LLCs do not make this election, they are considered disregarded entities, and income is reported as part of the tax return of the owner. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 12: Corporations 3 5. Any nonexempt closely held corporation is classified as a personal holding company (PHC) if a significant portion of its income is passive in nature. a. Closely held in this case means more than 50% of the value of the corporation’s shares are owned, directly or indirectly, by five or fewer shareholders. b. PHCs are subject to a penalty tax on undistributed PHC income. c. Further details about PHCs and the penalty tax are beyond the scope of the EA exam and therefore not covered in this review course. 12.2 CONTROLLED GROUPS AND PERSONAL SERVICE CORPORATIONS (PSCs) A controlled group of corporations includes corporations with a specified degree of relationship by stock ownership. Parent-Subsidiary 1. A parent-subsidiary type of controlled group consists of a. and b. presented below: a. Two corporations if one of the corporations owns stock that represents 1) 80% or more of total voting power or 2) 80% or more of total value outstanding of the stock of the other NOTE: Distinguish the controlled group 80% test from that of affiliated groups in which both the 80% voting and 80% value tests must be met. b. Any other corporation that meets the requirements above (if the two corporations discussed there and others in the group own stock in it) EXAMPLE 12-1 Parent-Subsidiary Controlled Group Each corporation has a single class of stock. P owns 80% of S stock. P and S own 40% each of O stock. P, S, and O own 30% each of T stock. As shown in the diagram below, per the 80% test, P, S, O, and T are a controlled group. Figure 12-1 Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 4 SU 12: Corporations Brother-Sister 2. Any two or more corporations are considered a brother-sister controlled group if the stock of each owned by the same five or fewer persons (only individuals, trusts, or estates) a. Represents either 1) 80% or more of voting power of all classes or 2) 80% or more of value of all classes and b. Represents either (counting for each person only the smallest amount owned by that person in any of the corporations) 1) More than 50% of voting power of all classes or 2) More than 50% of value of all classes. EXAMPLE 12-2 Brother-Sister Controlled Group Alpha, Bravo, and Charley Corporations, each with one class of stock, have the following ownership: 80% Test Shareholders Alpha Bravo Charley 50% Test Mike 45% 5% 30% 5% Sierra 30% 65% 10% 10% Oscar 25% 30% 60% 25% 100% 100% 100% 40% Alpha, Bravo, and Charley passed the 80% test but not the 50% test. Therefore, they are not a controlled brother-sister group. 3. Rights to acquire stock are treated as the stock would be. 4. Stock both actually and constructively owned is counted. Generally, a person constructively owns stock owned by a a. Family member [spouse (not legally separated), child, grandchild, parent, or grandparent] and b. Corporation, partnership, estate, or trust 1) In which (s)he has a 5% or more interest 2) In proportion to that interest Excluded Corporations 5. Without regard to stock ownership, certain types of corporations are excluded from a controlled group, e.g., a. Tax-exempt corporations, with respect to unrelated income b. Insurance corporations, with respect to non-insurance corporations Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 12: Corporations 5 Limit on Tax Benefits 6. Each of the following is an example of a tax benefit item that must be shared by the members of a controlled group: a. Section 179 expensing maximum of $1,160,000. b. General Business Credit $25,000 offset. c. AET $250,000 presumed deduction base. NOTE: A controlled group generally may choose any method to allocate the amounts among the members of the group. In default, an item is divided equally among members. If a controlled group adopts or changes an apportionment plan, each member must attach a copy of this consent to his or her tax return. EXAMPLE 12-3 Limit on Tax Benefits -- Section 179 Alpha, Bravo, Charley, and Delta corporations are a controlled group. Each corporation purchased and placed in service $400,000 of qualified Sec. 179 equipment for a total of $1.6 million in qualified equipment for the group. Barring selection of any other allocation, each corporation’s Sec. 179 deduction for the year is limited to only $290,000 ($1,160,000 ÷ 4). Personal Service Corporations 7. A corporation is a PSC if it meets all of the following requirements: a. Principal activity during the “testing period” is performing personal services, including any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts. 1) Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of a) The last day of its tax year or b) The last day of the calendar year in which its tax year begins. b. Employee-owners substantially perform the services in item a. above. 1) This requirement is met if more than 20% of the corporation’s compensation cost for its activities of performing personal services during the testing period is for personal services performed by employee-owners. 2) A person is an employee-owner if both of the following apply: a) (S)he is an employee of the corporation or performs personal services for, or on behalf of, the corporation on any day of the testing period. b) (S)he owns any stock in the corporation at any time during the testing period. c. Its employee-owners own more than 10% of the fair market value of its outstanding stock on the last day of the testing period. 8. Like corporations, PSCs are taxed at a flat rate of 21%. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 6 SU 12: Corporations 12.3 U.S. SOURCE INCOME Income received by a foreign corporation is considered U.S. source income if the income is effectively connected with the conduct of a trade or business within the United States. 1. Income is considered “effectively connected” if it satisfies one of the following tests: a. The income was derived from assets used in, or held for use in, the conduct of a U.S. business (the “asset use” test). b. The U.S. trade or business was a material factor in the production of income. 2. No withholding is required from income when effectively connected. 3. Fixed, determinable, annual, or periodical (FDAP) income of a foreign corporation received from U.S. sources not effectively connected with the conduct of a U.S. trade or business is generally taxed at a flat 30% rate. a. Tax must be withheld from payment of income. 4. Gross income from the sale of inventory purchased for resale is sourced on the basis of where the sale occurs (i.e., where title passes). 5. An annual withholding tax return (Form 1042) for U.S. source income paid to foreign persons must be filed whether or not any income tax was withheld. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 12: Corporations 7 12.4 TAX RETURN FILING Every corporation subject to taxation must file a federal income tax return. 1. The corporate tax return is filed on Form 1120. 2. A C corporation’s tax return is due by the 15th day of the 4th month after the end of the corporation’s tax year. A short-period return must be filed by a new corporation or a dissolved corporation by the 15th day of the 4th month after a short period ends or the date it dissolved. a. If the 15th falls on a Saturday, Sunday, or holiday, the tax return is due the next succeeding day that is not a Saturday, Sunday, or legal holiday. b. An exception to the rule applies to C corporations with a June 30 fiscal year. These C corporations will continue to have a due date of the 15th day of the 3rd month following the close of the tax year. This will continue until tax years beginning after December 31, 2025. The extension date is April 15. 3. Calendar year C corporations and fiscal year C corporations that file Form 7004 and pay their estimated unpaid tax liability are allowed an extension of up to 6 months. a. However, an extension of time to file the return does not extend the time for paying the tax. 4. The penalty for late filing is 5% of the tax due for each month or part of a month the return is late, but it does not exceed 25%. a. However, the minimum penalty for filing a return more than 60 days late is the smaller of the tax due or $485. 5. Corporations having gross receipts for the tax year of less than $250,000 and total assets at the end of the year of less than $250,000 are not required to file a balance sheet per books (Form 1120, Sch. L), a reconciliation of income per books with income per return (Sch. M-1), or an analysis of unappropriated retained earnings per book (Sch. M-2). These forms show the difference between book and tax income. International Information Returns 6. Generally, U.S. tax on the income of a foreign corporation is deferred until the income is distributed as a dividend or otherwise repatriated by the foreign corporation to its U.S. shareholders. 7. The IRS applies international information reporting requirements to U.S. persons with foreign activities that require extensive financial information (e.g., balance sheet, income statement, related party descriptions, etc.) for the IRS to examine. a. Failure to file accurate foreign forms and schedules can lead to the assessment of substantial penalties. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 8 SU 12: Corporations 8. Some of the more widely used forms include the following: a. Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, is used to report certain transfers of tangible or intangible property to a foreign corporation, as required by Sec. 6038B. b. Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, is used to report (1) certain transactions with foreign trusts, (2) ownership of foreign trusts under the rules of Secs. 671 through 679, and (3) receipt of certain large gifts or bequests from certain foreign persons. c. Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, is the annual information return of a foreign trust with at least one U.S. owner. The form provides information about the foreign trust, its U.S. beneficiaries, and any U.S. person who is treated as an owner of any portion of the foreign trust under the grantor trust rules (Secs. 671 through 679). d. Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, is used by certain U.S. persons who are officers, directors, or shareholders in certain foreign corporations. The form and schedules are used to satisfy the reporting requirements of Secs. 965, 6038, and 6046. e. Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, is used to provide information required under Secs. 6038A and 6038C when reportable transactions occur during the tax year of a reporting corporation with a foreign or domestic related party. f. Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, is used to report the information required under Sec. 6038, Sec. 6038B, or Sec. 6046A. g. Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs), is used by certain U.S. persons who operate an FB or own an FDE directly or, in certain circumstances, indirectly or constructively. 1) The form and schedules are used to satisfy the reporting requirements of Secs. 6011, 6012, 6031, and 6038, as well as related regulations. h. Form 8938, Statement of Specified Foreign Financial Assets, is used to report certain foreign financial assets if the total value of all the specified foreign financial assets in which the interest is held is more than the appropriate reporting threshold. i. Form 8991, Tax on Base Erosion Payments of Taxpayers With Substantial Gross Receipts, is used to determine an applicable tax on the taxpayer’s base erosion minimum tax amount for the year. The tax is based on the taxpayer’s base erosion percentage, modified taxable income, and credits that reduce regular tax liability in computing the base erosion minimum tax amount. 1) Section 59A applies to large corporations that have the ability to reduce U.S. tax liability by making deductible payments to foreign related parties. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 12: Corporations 9 j. Form 8992, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI), is used to compute a U.S. shareholder’s GILTI inclusion. Section 951A requires U.S. shareholders of CFCs to include in gross income their GILTI for years in which they are U.S. shareholders of CFCs. k. Form 8993, Section 250 Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI), is used to determine the allowable deduction under Sec. 250. The deduction is allowed only to domestic corporations [not including real estate investment trusts (REITs), regulated investment companies (RICs), and S corporations]. 12.5 ADDITIONAL CORPORATE TAXES 1. A corporation may be subject to accumulated earnings tax if it does not distribute enough profits beyond what is needed for the conduct of its business. 2. Formula Taxable Income + Positive Adjustments 1. Dividends-received deduction claimed 2. NOL deduction claimed 3. Excess charitable contributions carried over from a preceding tax year and deducted in determining taxable income 4. Capital loss carryover deduction – Negative Adjustments 1. Accrued U.S. and foreign income taxes 2. Charitable contributions made in excess of the 10% corporate limitation 3. Net capital losses (if capital losses for the year exceed capital gains) 4. Net capital gain minus the amount of any income taxes attributed to it – Dividends-paid deduction claimed – Accumulated Earnings Credit = Accumulated taxable income (AMTI) × 20% = Accumulated earnings tax (AET) NOTE: For all other tax years, the charitable contribution deduction limitation is 10% of TI. The increased corporate limit does not automatically apply. C corporations must elect application of the increased corporate limit on a contribution-by-contribution basis. The multiple choice questions in this publication are based on the 25% limit. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 10 SU 12: Corporations 3. The following organizations are exempt from the accumulated earnings tax: S corporations Tax-exempt corporations PHCs (personal holding companies) FPHCs (foreign personal holding companies) PFICs (passive foreign investment companies) 4. The Accumulated Earnings Credit reduces accumulated taxable income. It also allows corporations to accumulate E&P up to $250,000 ($150,000 for certain personal service corporations) or up to the level of its earnings accumulated for the reasonable needs of the business. a. Reasonable needs of a business include the following: 1) Specific, definite, and feasible plans for use of the earnings accumulation and 2) The amount necessary to redeem a corporation’s stock included in a deceased shareholder’s gross estate. The proceeds are limited to the sum of estate, inheritance, legacy, or succession taxes imposed and the funeral and administrative expenses. Corporate Alternative Minimum Tax (CAMT) 5. A total repeal of the CAMT was in place for years after 2017. Beginning in 2023, a new variation of the CAMT returned; however, it is only applicable to very large corporations and not a topic expected to be covered in detail on the exam, if at all. The following are some of the basic elements of this version of the tax: a. Applicable Corporations are corporations other than S corporations, RICs, or REITs that meet a 3-year annual average Adjusted Financial Statement Income (AFSI) test of $1 billion. b. Unlike individual AMT, which uses taxable income as its starting point, CAMT uses income as determined on the financial statements with some adjustments. This is AFSI. c. Corporate Tentative Minimum Tax (CTMT) is 15% of AFSI, reduced by the CAMT Foreign Tax Credit (FTC). d. CAMT is CTMT in excess of the sum of regular corporate tax and any Base Erosion and Anti-abuse Tax (BEAT). e. The CAMT calculation follows: AFSI × 15% (CAMT FTC) CTMT (Regular tax) (BEAT) CAMT Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].  SU 12: Corporations 11 1% Stock Repurchase Tax 6. After 2022, domestic corporations that repurchase during any year more than $1 million of the corporation’s traded stock in excess of the value of any stock issuances during the same year are subject to a 1% tax on the buyback. a. In addition to the $1 million threshold, repurchases are not subject to the tax if they are part of a reorganization where the shareholders have no recognized gain or loss or if the repurchased stock is contributed to employee retirement plans, such as an ESOP or employer-sponsored plan. 12.6 ESTIMATED TAX PAYMENTS A corporation is required to make estimated tax payments unless its estimated tax liability is less than $500. The payments are required on the 15th day of the 4th, 6th, 9th, and 12th months of the tax year. For a calendar-year taxpayer, required quarterly installments are due April 15, June 15, September 15, and December 15. 1. Tax includes the regular income tax, net of credits and payments. 2. Each quarterly estimated tax payment required is 25% of the lesser of a. 100% of the prior year’s tax (provided a tax liability existed and the preceding tax year was 12 months) or b. 100% of the current year’s tax. 3. A corporation with uneven income flows has the option of annualizing income and paying its estimated taxes accordingly. a. Any shortfall is made up in later quarters so that 100% of the tax due is paid on the last installment date (December 15 for calendar-year taxpayers). b. Corporations are required to use general annualization rules or elect to use one of two sets of optional annualization rules. Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected]. 12 SU 12: Corporations 4. Paying 100% of the prior year’s tax is not an option for a large corporation, i.e., one with taxable income above $1 million during any of the 3 preceding years. a. A large corporation must pay 100% of the current year’s tax. b. However, a large corporation may make its first-quarter estimated tax payment based on the preceding year’s tax liability and make up any difference in its second-quarter payment. 5. Generally, a corporation must make federal tax deposits (FTDs) of estimated tax payments using electronic funds transfer. Generally, electronic funds transfer is made using the Electronic Federal Tax Payment System (EFTPS). a. However, if the corporation does not want to use EFTPS, it can arrange for its tax professional, financial institution, payroll service, or other trusted third party to make deposits on its behalf. b. The corporation should keep for its records a cleared check, bank receipt, or money order as a receipt for the deposit. 6. A penalty is imposed in the amount by which any required installment exceeds estimated tax paid, multiplied by the federal short-term rate plus 3% (5% for underpayments in excess of $100,000). a. The penalty accrues from the installment due date until the underpayment is paid or, if earlier, the due date for filing the tax return. b. The penalty is not allowed as an interest deduction. c. If any underpayment of estimated tax is indicated by the tax return, Form 2220 should be submitted with the return. 7. No estimated tax penalty is imposed if a. Tax liability shown on the return for the tax year is less than $500. b. The IRS waives all or part of the penalty for good cause. c. An erroneous IRS notice to a large corporation is withdrawn by the IRS. 8. A corporation may obtain a quick refund of estimated tax paid, but adjustment is allowed only if the overpayment is both ≥ $500 and ≥ 10% of the corporation’s estimate of its tax liability. a. The application is filed (Form 4466) after the close of the tax year but before the return due date (without extensions). Copyright © 2024 Gleim Publications, Inc. All rights reserved. Duplication prohibited. Reward for information exposing violators. Contact [email protected].