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Chapter 13Corporate

Operations -2015 Howard Godfrey, Ph.D., CPA

UNC CharlotteCopyright © 2015, Dr. Howard Godfrey

Edited December 7, 2015. T15F-Chp-13-1B-Corporte-Operations-2015

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Corporations Stock Option Expense-GAAP

Capital gains & losses

Net Operating Loss

Dividends received deduction

Charitable Contributions

Estimated Tax Deposits

Gross Income - Sec. 61Less: Deductible expenses Equals: Taxable income Times: Corporate tax rate Equals: Corporate income tax Plus: Additions to tax Less: Tax credits Equals: Net corporate tax

Big Picture

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Corporate Tax Rates15% on first $50,00025% on $50,001 - $75,00034% on $75,001 - $100,00039% (34% + 5% surtax) on $100,001 - $335,00034% on $335,001 - $10,000,00035% on $10,000,001 - $15,000,00038% (35% + 3%) on $15,000,001 - $18,333,33335% on over $18,333,333

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PSC• Personal service corporation is a corporation– that provides service in the fields of

accounting, actuarial science, architecture, consulting, engineering, health, law, or performing arts and– is substantially owned by its employees

• A flat 35% tax rate applies to its entire taxable income

• The PSC provisions encourage owner-employees to take earnings out as salary

Corporation• Taxable income is determined at the

corporate level under the general formula• Exceptions:–Net capital losses are not deductible–Corporations must recapture additional

depreciation for Sec. 1250 property = 20% of straight-line depreciation taken

Corporation–Passive activity losses•Corporations are not subject to the passive activity

rules–Personal service corporations must follow them–Closely-held corporations may use passive losses to offset

active income but not portfolio income

–Charitable contributions are limited to 10% of taxable income•Before dividend-received deductions and any

carryovers•Excess contributions may be carried forward 5 years

CorporationNet operating loss incurred in current year cannot be used in the current year or distributed to shareholders• May be carried back 2 years and

forward 20 until used• May elect to forego the carry back

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Gross incomeLess: Deductions: Except charity, Div. Rec.,

NOL & C-Loss Carryback

Equals Taxable Income- For Charity Limit

Less: Charitable Cont. < = 10% of T.I. Above

Equals Taxable Income- Before Div. Rec'd Ded.

Less: Div. Rec. Deduct.

Equals Taxable Income- Before carrybacks

Less: NOL and/or Capital Loss carrybacks

Equals Taxable Income

Stock OptionsCompanies recognize compensation cost for options using the fair value method. They compute total compensation expense based on the fair value of the options expected to vest on the date they grant the options to the employee(s) (i.e., the grant date). …In general, a company recognizes compensation expense in the periods in which its employees perform the service-the service period. Company determines total compensation cost at the grant date and allocates it to the periods benefited by its employees' services.

Employee is taxed upon exercising the option and receiving shares if two conditions are met. First, the shares must be transferred to the employee. Second, they must be substantially vested in the employee. If both conditions are met, the employee must recognize income in the amount by which the shares' fair market value exceeds the exercise price paid. I.R.C. §83(a).The employer is allowed a deduction equal to the amount of income recognized by the employer at exercise (or later at vesting).

On Jan. 1, year 1, ABC issued 5,000 Non-qualified stock options with a value of $10 per option. Each option entitles owner to buy one share of ABC stock for $25 a share (per share price of ABC stock on Jan. 1, year 1). Options do not vest at all until year 3 when they vest 100%. All 5,000 stock options were exercised in year 3 when the ABC stock was valued at $31 per share. What is: (1) amount of compensation deduction in year 3, related to the options and (2) the amount of GAAP compensation expense recognized over the 3 year vesting period?

Company will never receive a tax deduction related to the issuance of incentive stock options

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Capital Losses- BakerBaker Corp., had taxable income of $36,000 business operations in Year 1. Baker also had the following: Short term capital gain $8,600 Short term capital loss (9,600) Long term capital gain 1,500 Long term capital loss (3,500)What is taxable income for Year 1? a. $35,000 b. $33,000 c. $36,000 d. $35,500 CPA - Nov. 1995

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Capital Losses-Baker Baker Corp., had taxable income of $36,000 business operations in Year-1. Baker also had the following: Short term capital gain $8,600 Short term capital loss (9,600) Long term capital gain 1,500 Long term capital loss (3,500)What is taxable income for Year-1?

$36,000

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Corp. Income Tax Prob. - 1 Gross receipts of $450,000Cost of goods sold of 145,000 Deductible bus. expenses 276,000 Gain on sale of machine 20,000 Interest on Ohio bonds 500 What is its tax liability? a. $4,900 b. $7,350 c. $10,000 d. None of these

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A corporation has Facts Return

Gross receipts $450,000 $450,000Cost of goods sold $145,000 $145,000

Deductible bus. exp. $276,000Gain-sale of machine $20,000Interest- Ohio bonds $500Taxable IncomeFed. income tax liability at 15%

Corporate Income Tax – Problem - 2

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A corporation has Facts Return

Gross receipts $450,000 $450,000Cost of goods sold $145,000 $145,000

$305,000Deductible bus. exp. $276,000 ($276,000)Gain-sale of machine $20,000 $20,000Interest- Ohio bonds $500Taxable Income $49,000Fed. income tax liability at 15% $7,350

Corporate Income Tax – Solution-3

Charitable Contributions - 1Overall limit 10% of taxable income before–Charitable contribution deduction–Dividend received deduction–NOL or capital loss carryback. §170(b)(2), (c)

Excess carried forward up to 5 years. §170(d)(2)Accrual basis corporation can deduct contributions in year accrued if–Payment authorized by board before year

end–Payment made by 15th day of 3rd month after

close of tax year in which accrued. §170(a)(2)

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Charity –Code -2 170(b)(2) Corporations. In the case of a

corporation, the total deductions under subsection (a) for any taxable year shall not exceed 10 percent of the taxpayer's taxable income computed without regard to (A) this section,(B) part VIII (except section 248),(C) any net operating loss carryback to the

taxable year under section 172, and(D) any capital loss carryback to the taxable

year under section 1212(a)(1).

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Cable-Charity Deductions-3 In 2015, Cable Corp., contributed $80,000 to charities. Cable also had carryover contributions of $10,000 from 2014. Cable's 2015 taxable income (after a $40,000 DRD [(Div. Rec. Deduction)- owned 25% of stock] but before Charity deduction was $820,000. Cable’s 2015 charity deduction is?a. $80,000 b. $82,000 c. $86,000 d. $90,000 CPANov1995

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Cable-Charity Deductions-4 In 2015, Cable Corp., contributed $80,000 to charities. Cable also had carryover contributions of $10,000 from 2014. Cable's 2013 taxable income (after a $40,000 DRD) before charity deductions was $820,000. Cable’s 2015 charity deduction is?$86,000 (Charity limit is computed before DRD)

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1 Operating Income 810,000 2 Dividend Income (40% owned) 50,000

3 Subtotal 860,000 4 Dividends Received Deduction

5 Taxable income after div. received deduct.

but before charitable contribution deduct.

6 Contributions made this year7 Carryover from last year

8 Total contribution including carryover9 Cont. deductible - current yr(10% of line 3) 86,000

10 Taxable Income

Cable - Charitable Contribution Deduction-5

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1 Operating Income 810,000

2 Dividend Income (40% owned) 50,000

3 Subtotal 860,000

4 Dividends Received Deduction (40,000)

Taxable income after div. received deduct.

5 but before charitable contribution deduct. 820,000

6 Contributions made this year 80,000

7 Carryover from last year 10,000

8 Total contribution including carryover 90,000

9 Cont. deductible - current yr(10% of line 3) 86,000

10 Taxable Income 734,000$

Cable- Charitable Contribution Deduction-6

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Dividend Received DeductionTo relieve burden of multiple taxationDRD based on % ownership in paying corp

100% DRD for 80% or more owned affiliate 80% DRD for ownership of 20% up to 80% 70% DRD for ownership less than 20%

DRD limited to percentage timeslesser of taxable income or dividend income

Unless deducting DRD % x dividendincome creates or increases NOL

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Grant, Inc. acquired 30% of South Co.’s voting stock for $200,000 on January 1, 2015. Grant’s 30% interest in South gave Grant the ability to exercise significant influence over South’s operating and financial policies. During 2015, South earned $80,000 and paid dividends of $50,000. What amount of income should Grant include in its 2015 Federal income tax return as a result of the investment?a. $15,000 b. $24,000 c. $35,000 d. $50,000 e. $80,000 CPA Nov. 1995.

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Grant, Inc. acquired 30% of South Co.’s voting stock for $200,000 on January 1, 2015. Grant’s 30% interest in South gave Grant the ability to exercise significant influence over South’s operating and financial policies. During 2015, South earned $80,000 and paid dividends of $50,000. What amount of income should Grant include in its 2015 Federal income tax return as a result of the investment?This company will use equity method for GAAP and cost method for Tax Return.

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Div. Received- Green - 1Green Corp. owns 25% of Cande Corp. This year, Green received $10,000 dividends on the Cande stock. Assuming no other limit applies, Green’s dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $ - 0 -. (IRS-2003)

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Div. Received- Green – 12Green Corp. owns 25% of Cande Corp. This year, Green received $10,000 dividends on the Cande stock. Assuming no other limit applies, Green’s dividends-received deduction is: a. $7,000. b. $8,000. c. $2,000. d. $ - 0 -. (IRS-2003)

Revenue - operations $500,000

Operating expenses (490,000)

Operating income (loss) 10,000

Dividends from IBM 50,000

Net income before DRD 60,000

Dividend rec. deduction

Local Corp - 1. had the following:

Limit 1:Dividends Received $50,000DRD Percentage 70%Deduction limit - 1 $35,000Limit 2:Taxable income (Adj) $60,000DRD Percentage 70%Deduction limit - 2 42,000 Div. Rec. Deduction $35,000

Dividends Received Deduction

Revenue - operations 500,000$

Operating expenses (510,000)

Operating income (loss) (10,000)

Dividends from IBM 50,000

Net income before DRD 40,000

Dividend rec. deduction

Local Corp - 2. had the following:

Limit 1:Dividends Received $50,000DRD PercentageDeduction limit - 1Limit 2:Taxable income (Adj) $40,000DRD PercentageDeduction limit - 2Div. Rec. Deduction

Dividends Received Deduction

Limit 1:Dividends Received $50,000DRD Percentage 70%Deduction limit - 1 $35,000Limit 2:Taxable income (Adj) $40,000DRD Percentage 70%Deduction limit - 2 28,000 Div. Rec. Deduction $28,000

Dividends Received Deduction

Revenue - operations 500,000$

Operating expenses (520,000)

Operating income (loss) (20,000)

Dividends from IBM 50,000

Net income before DRD 30,000

Dividend rec. deduction

Local Corp - 3. had the following:

Limit 1:Dividends Received $50,000DRD Percentage 70%Deduction limit - 1 $35,000Limit 2:Taxable income (Adj) $30,000DRD Percentage 70%Deduction limit - 2 21,000 Div. Rec. Deduction $35,000

Dividends Received Deduction

Gross Profit $200,000Expenses ($300,000)Operating loss ($100,000)Dividends Received $180,000Tax. Inc. before DRDDRDNet operating loss

Page Corp. Div. Received Ded.Page owns 15% of company

Gross Profit $200,000Expenses ($300,000)Operating loss ($100,000)Dividends Received $180,000Tax. Inc. before DRD $80,000DRD ($126,000)Net operating loss ($46,000)

Page Corp. Div. Received Ded.Page owns 15% of company

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Spring Corp has income from business of $500,000 & expenses of $750,000. Spring also received dividends from the Acme Corp. of $100,000. Spring owns 25% Acme. What is Spring’s NOL for the year? a. ($150,000) b. ($0). c. ($220,000) d. ($230,000). (IRS Exam 2003)

Gross Profit $500,000Expenses ($750,000)Operating loss ($250,000)Dividends Received $100,000Tax. Inc. before DRDDRDNet operating loss

Spring Corp. Div. Received Ded.Spring owns 25% of company

Gross Profit $500,000Expenses ($750,000)Operating loss ($250,000)Dividends Received $100,000Tax. Inc. before DRD ($150,000)DRD ($80,000)Net operating loss ($230,000)

Spring Corp. Div. Received Ded.Spring owns 25% of company

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Spring Corp’s has income from business of $500,000 & expenses of $750,000. Spring also received dividends from the Acme Corp. of $100,000. Spring owns 25% Acme. What is Spring’s NOL for the year? ($230,000)

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This year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for the current year?a. $50,000 b. $30,000 c. $20,000 d. $10,000 IRS-1995

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This year, Pack Corp. had gross income from operations of $350,000 and operating expenses of $400,000. Pack received dividends of $100,000 from Smith Inc., of which Pack is a 20% owner. The NOL carryover from last year is $20,000. What is Pack's NOL for the current year?$30,000

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Gross Profit $350,000Expenses ($400,000)Operating loss ($50,000)Dividends Received $100,000Tax. Inc. before DRD $50,000DRD (80%) ($80,000)Net operating loss ($30,000)

Pack Corp. Net Operating Loss

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Gross Sales $340,000 Cost of Goods Sold $150,000Depreciation - Books 60,000Charitable Contribution 10,000Salaries 130,000Meals & entertainment 20,000Total Expenses 370,000

($30,000)

Maple Corp. had the following for Year 1:

a. $(5,000) b. $(35,000) c. $(25,000) d. $(20,000)

Net income (loss) per books

Taxable income (loss) for the year?Maple’s tax deprec. for the year is $75,000.

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Maple Corporation Facts Return

Gross Sales $340,000

Cost of Goods Sold 150,000

Depreciation - Books 60,000 Depreciation - TaxCharitable Contribution 10,000

Salaries 130,000 Meals & entertainment 20,000

Total Expenses 370,000

Net income (loss)-books ($30,000)Taxable income?

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Maple Corporation Facts Return

Gross Sales $340,000 $340,000

Cost of Goods Sold 150,000 150,000

Depreciation - Books 60,000 Depreciation - Tax 75,000 Charitable Contribution 10,000 -

Salaries 130,000 130,000 Meals & entertainment 20,000 10,000

Total Expenses 370,000 365,000

Net income (loss)-books ($30,000)

($25,000)Taxable income?

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Tax vs. GAAP Numbers Tax GAAPGross revenue from sales $289,000 $289,000

Cost of sales (98,000) (98,000)

Gross margin 191,000 191,000

Section 179 deduction (20,000)

(GAAP Deprec. = $5,000)

Operating expenses (122,000)

Gain on sale of machine 21,000

(Gain is $14,000 for GAAP).

Taxable IncomeGAAP Income before tax

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Tax vs. GAAP Numbers Tax GAAPGross revenue from sales $289,000 $289,000

Cost of sales (98,000) (98,000)

Gross margin 191,000 191,000

Section 179 deduction (20,000)

(GAAP Deprec. = $5,000) (5,000)

Operating expenses (122,000) (122,000)

Gain on sale of machine 21,000

(Gain is $14,000 for GAAP). 14,000

Taxable Income $70,000

GAAP Income before tax $78,000Impact on def. tax account (40% tax rate)?

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Info. Tax

Book net income before tax $450,000 $450,000

Included in this $450,000 were:

State corp. income tax refunds $4,000

Life insurance - officer's death $15,000

Loss-stock bought for

investment in 2001 ($20,000)

Bard's taxable income for the year

a. $435,000 b. $451,000 c.$455,000 d.$470,000 (CPA-87)

Bard-Inc. Reported the following this year:

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Info. Tax

Book net income before tax $450,000 $450,000

Included in this $450,000 were:

State corp. income tax refunds $4,000

Life insurance - officer's death $15,000 ($15,000)

Loss-stock bought for

investment in 2001 ($20,000) $20,000

Bard's taxable income for the year $455,000

a. $435,000 b. $451,000 c.$455,000 d.$470,000 (CPA-87)

Bard-Inc. Reported the following this year:

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Compute Tax. Income Debit Credits Sales $700,000 Cost of sales $400,000 Mun. bond interest 2,000 Compensation 100,000 Meals (gross) 20,000 Other Expense 140,000 Subtotal 660,000 702,000 Net Income before tax

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Debit Credits Sales $700,000 Cost of sales $400,000 Mun. bond interest 2,000 Compensation 100,000 Meals, entertain. (Gross) 20,000 Other Expense 140,000 Subtotal 660,000 702,000 Net Income before taxAdd: one half of entertain.Less: Mun. bond interestTaxable incomeIncome TaxCompute E & P (Similar to Retained Earnings)

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Debit Credits Sales $700,000 Cost of sales $400,000 Mun. bond interest 2,000 Compensation 100,000 Meals, entertain. (Gross) 20,000 Other Expense 140,000 Subtotal 660,000 702,000 Net Income before tax 42,000 Add: One half of entertain. 10,000 Less: Mun. bond interest (2,000)Taxable income 50,000 Income Tax 7,500 Compute E & P (Similar to Retained Earnings)

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Income per books for Year-1 $400,000 Book Income includes:Municipal bond Interest 8,000Meals & entertain. Exp. 20,000Prem. Paid on officers' life ins. (corporation is beneficiary) 3,800Capital losses 1,000Fines 200What is taxable income?a. $400,000 b. $408,000 c. $426,000 d.

Charlotte Corp. was organized 1-1-Yr-1

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Return

Income per books - Year 1 $400,000 $400,000

Book Income includes:

Municipal bond Interest 8,000

Meals & entertain. Exp. 20,000

Prem. - officers' life ins.

(corp. is beneficiary) 3,800

Capital losses 1,000

Fines 200

What is taxable income?

Char. Corp.-organized 1-1-Yr-1

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Return

Income per books - Year 1 $400,000 $400,000

Book Income includes:

Municipal bond Interest 8,000 (8,000)

Meals & entertain. Exp. 20,000 10,000

Prem. - officers' life ins. (corp. is beneficiary) 3,800 3,800

Capital losses 1,000 1,000

Fines 200 200

What is taxable income? $407,000

Char. Corp.-organized 1-1-Yr-1

The End