Whittenburg Gerald E., Altus-Buller Martha. Income Tax Fundamentals
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Questions and Problems 10-35
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10-36 Chapter 10
Partnership Taxation
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Student Name
Class/Section
Date
KEY NUMBER TAX RETURN SUMMARY
Chapter 10
Comprehensive Problem 1
Ordinary Income (Line 22) ________________
Net Income (Page 5, Line 1) ________________
Long-Term Capital Loss (Page 4, Line 9a) ________________
Contributions (Page 4, Line 13a) ________________
Net Income Per Books (Schedule M-2, Line 3) ________________
Questions and Problems 10-37
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Chapter 11
The Corporate Income Tax
LEARNING OBJECTIVES
.............................................. .........................
After completing this chapter, you should be able to:
LO 11.1 Employ the corporate tax rates to calculate corporate
tax liability.
LO 11.2 Compute basic capital gains and losses for corporations.
LO 11.3 Ascertain how special deductions may affect corporate
taxable income.
LO 11.4 Identify the components of Schedule M-1 and how they
are reported to the IRS.
LO 11.5 Know the corporate tax return filing and estimated tax
payment requirements.
LO 11.6 Understand in general how an S corporation is taxed
and operates.
LO 11.7 Understand the basic tax rules for the formation of
a corporation.
LO 11.8 Describe the rules for the accumulated earnings tax and
the personal holding company tax.
LO 11.9 Define the elements of the corporate alternative minimum
tax (AMT) calculation.
Overview
There are many forms of organization which may be used by individual taxpayers to oper-
ate a business. These include the sole proprietorship (Form 1040, Schedule C, covered in
Chapter 4); the partnership, LLC, and LLP (Form 1065 covered in Chapter 10); and the
regular C corporation and S corporation (covered in this chap ter). Regular C corporations
are taxed as separate legal taxpaying entities, and S corporations are taxed as flow-through
entities similar to partnerships.
This chapter covers corporate tax rates, capital gains and losses, special deductions, the
Schedule M-1, filing requirements, corporat e formations, accumulations, and the corpo-
rate AMT. Additionally, basic coverage of the S corporation election and operating
requirements are presented in this chapter.
This chapter provides a summary of corporate taxation and the tax forms (Form 1120, Form
1120S, and related schedules) related to reporting C or S corporation income or loss.
11-1
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SECTION 11.1
CORPORATE TAX RATES
The United States corporate tax rate structure has eight tax brackets with marginal tax rates
ranging from 15 percent to 39 percent. The situations where the marginal rate increases then
decreases (e.g., from 34 percent to 39 percent and from 35 percent to 38 percent and back)
are called ‘‘bubbles.’’ These bubbles occur when the tax rate schedule recaptures the tax sav-
ings from the prior tax bracket’s progressive marginal rates. For taxable income over
$335,000 and less than or equal to $10,000,000, the corporate tax rate is a flat 34 percent.
For large corporations with taxable income over $18,333,333, the corporat e tax rate is a
flat 35 percent. Table 11.1 contains the tax rates which currently apply to U.S. corporations.
EXAMPLE Jasmine Corporation has taxable income of $175,000 for its tax year
ending December 31, 2010. The corporation’s tax liability for the year
is calculated as follows:
Taxable income $ 175,000
Amount from table
(100,000)
Excess $ 75,000
Rate on excess
39%
Tax on excess $ 29,250
Tax table amount on $100,000
22,250
Tax liability
$ 51,500
N
Qualified personal service corporations are taxed at a flat 35 percent tax rate on all tax-
able income. Thus, they do not receive any benefit from the progressive corporate tax rates
shown in Table 11.1. A qualified personal service corporation is substantially employee-
owned and engages in one of the following activities:
Health
Law
Engineering
Architecture
Accounting
Actuarial science
Performing arts
Consulting
TABLE 11.1
Corporate Tax Rates
Taxable
Income Over But Not Over The Tax Is
Of the
Amount Over
$ 0 $ 50,000 15% $ 0
50,000 75,000 $ 7,500 þ 25% 50,000
75,000 100,000 13,750 þ 34% 75,000
100,000 335,000 22,250 þ 39% 100,000
335,000 10,000,000 113,900 þ 34% 335,000
10,000,000 15,000,000 3,400,000 þ 35% 10,000,000
15,000,000 18,333,333 5,150,000 þ 38% 15,000,000
18,333,333 — 6,416,667 þ 35% 18,333,333
11-2 Chapter 11
The Corporate Income Tax
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EXAMPLE Elm & Ash, Inc., is a professional service corporation of CPAs. For
2010, the corporation has taxable income of $175,000. Because Elm
& Ash, Inc., is a personal service corporation, its tax liability is $61,250
(35% $175,000). The corporate tax liability would be only $51,500
if Elm & Ash, Inc., were a regular corporation. N
SECTION 11.2
CORPORATE CAPITAL GAINS AND LOSSES
Corporations with net long-term capital gains can choose from two alternative tax treatments.
The net long-term capital gain can be included in ordinary income and the tax computed at
the regular rates, or the corporation can elect to pay an alternative tax on the net long-term
capital gain. For 2010, the alternative tax rate is 35 percent, the same as the maximum regular
corporate tax. Thus, Congress intends the ordinary income and capital gains rates to be the
same for corporations, so there will be no benefit to having long-term capital gains in a cor-
poration. Net short-term capital gains of a corporation are taxed as ordinary income.
Capital Losses
Corporations are not allowed to deduct capital losses against ordinary income. Capital losses may
be used only to offset capital gains. If capital losses cannot be used in the year they occur, they
may be carried back 3 years and forward 5 years to offset capital gains in those years. When a
long-term capital loss is carried to another year, it is treated as a short-term capital loss.
EXAMPLE In 2010, Eucalyptus Corporation incurs a long-term capital loss of
$8,000, none of which may be deducted in that year. The loss is carried
back to tax years 2007, 2008, and 2009, in that order. If the loss is not
entirely used to offset capital gains in those years, it may be carried
forward to 2011, 2012, 2013, 2014, and 2015, in that order. When the
long-term loss is carried to another year, it is considered to be short-
term, and may offset either long-term or short-term capital gains. N
Self-Study Problem 11.1
Maple Corporation has taxable income of $275,000 for its tax year ending
December 31, 2010. Calculate the corporation’s tax liability for 2010, before
tax credits.
Tax liability $ ____________
Self-Study Problem 11.2
During 2010, Taxus Corporation has ordinary income of $110,000, a long-term
capital loss of $20,000, and a short-term capital loss of $5,000. Calculate Taxus
Corporation’s tax liability.
$ ____________
Section 11.2
Corporate Capital Gains and Losses 11-3
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SECTION 11.3
SPECIAL DEDUCTIONS AND LIMITATIONS
Corporations are allowed certain ‘‘special deductions,’’ including the dividends received
deduction and the deduction for organizational expenditures. In addition, corporations
are subject to limitations on the deduction of charitable contributions.
Dividends Received Deduction
When a corporation owns stock in another corporation, income earned by the first corpora-
tion could be taxed at l east three times in the absence of a special prov isio n. The incom e
would be taxed to the first corporation when earned by the first corporation. Then
it would be taxed to the corporation owning the stock in the first corporation when the
income is distributed as dividend income. Finally the income would be taxed to the sharehold-
ers of the second corporation when that corporation in turn distributes the earnings to
its stockholders as dividends. To mitigate this potential for triple taxation of corporate earn-
ings, corporations are allowed a deduction for all or a portion of dividends received from
domestic corporations. Corporations are entitled to a divide nds received deduction based
on their percentage of ownership in the corporation paying the dividend. The deduction per-
centages are described below:
Percent Ownership
Dividends Received
Deduction Percentage
Less than 20% 70%
20% or more, but less than 80% 80%
80% or more 100%
The dividends received deduction is limited to the applicable deduction percentage times
the corporation’s taxable incom e calculated before the dividends received deduction, the
net operating loss deduction, and capital loss carrybacks. This taxable income limitation,
however, does not apply if the receiving corporation has a net operating loss after reducing
taxable income by the dividends received deduction.
EXAMPLE During 2010, Hackberry Corporation has the following income and
expenses:
Gross income from operations $240,000
Expenses from operations 200,000
Dividend received from a 30 percent-owned
domestic corporation 100,000
The dividends received deduction is equal to the lesser of $80,000
(80% $100,000) or 80 percent of taxable income before the dividends
received deduction. Since taxable income (for computing this limitation)
is $140,000 ($240,000 $200,000 þ $100,000) and 80 percent of
$140,000 is $112,000, the full $80,000 is allowed as a deduction. N
EXAMPLE Assume the same facts as in the previous example, except Hackberry
Corporation’s gross income from operations is $190,000 (instead of
$240,000). The dividends received deduction is equal to the lesser of
$80,000 or 80 percent of $90,000 ($190,000 $200,000 þ $100,000),
$72,000. Therefore, the dividends received deduction is limited to
11-4 Chapter 11
The Corporate Income Tax
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Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
$72,000. Note that deducting the potential $80,000 dividends received
deduction from taxable income does not generate a net operating
loss. Accordingly, the taxable income limit is not avoided. N
Organizational Expenditures
Corporations amortize qualifying organizational costs over 180 months, and there is no
upper limit to the amount of qualifying costs t hat can be amortized. Corporations can
elect to deduct up to $5,000 of organizational costs in the year they begin business.
The $5,000 amount is reduced by each dollar of organizational expenses exceeding
$50,000. Costs not expensed as part of the first-year election to expense are amortized rat-
ably over the 180-month period beginning with the month the corporation begins busi-
ness. Generally, organizatio nal expenditures that qu alify for amortization include legal
and accounting services incident to organization, expenses of temporary directors and
organizational meetings, and fees paid to the state for incorporation. Expenses such as
the cost of transferring assets to the corporation and expenses connected with selling
the corporati on’s stock are not organizational expend itures and, therefore, are not sub ject
to amortization.
EXAMPLE Coco Bola Corporation, an accrual-basis, calendar-year taxpayer,
incurred $500 in fees to the state for incorporation, legal and
accounting fees incident to the incorporation of $1,000, and tempo-
rary directors’ expenses of $300. Assuming the corporation does not
make an election to expense in the first year, the total $1,800 ($500 þ
$1,000 þ $300) may be amortized over 15 years at a rate of $10 per
month ($1,800/180 months). If the corporation began operations on
June 1, 2010, $70 ($10 per month 7 months) may be deducted for
organizational expenditures for 2010. Alternatively, the corporation
could elect to deduct the full $1,800 of organization costs in the first
year of business. N
Charitable Contributions
Corporations are allowed a deduction for contributions to qualified charitable organiza-
tions. Generally, a deduction is allowed in the year in which a payment is made. If, how-
ever, the directors of a corporation which maintains its books on the accrual basis make a
pledge before year-end and the payment is made on or before the fifteenth day of the third
month after the close of the tax year, the deduction may be claimed in the year of the
pledge.
A corporation’s charitable contribution deduction is limited to 10 percent of taxable
income, computed before the deduction for charitable contributions, net operating loss
carrybacks, capital loss carrybacks, and the dividends received deduction. Any excess con-
tributions may be carried forward to the 5 succeeding tax years, but carryforward amounts
are subject to the 10 percent annual limitation in the carryover years, with the current
year’s contributions deducted first.
EXAMPLE Zircote Corporation had net operating income of $40,000 for 2010
and made a charitable contribution of $6,000 (not included in the
above amount). Also not included in the above operating income
were dividends received of $10,000. The corporation’s charitable
Section 11.3
Special Deductions and Limitations 11-5
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contribution deduction is limited to 10 percent of $50,000 ($40,000 þ
$10,000), or $5,000. Note that the dividends received deduction is not
used in calculating taxable income for purposes of determining the
limitation on the charitable contribution deduction. The $1,000
($6,000 $5,000) of the charitable contribution that is disallowed is
carried forward for up to 5 years. N
SECTION 11.4
SCHEDULE M-1
Because of various provisions in the tax law, a corporation’s taxable income seldom is the
same as its accounting income (commonly referred to as ‘‘book income’’). The purpose of
Schedule M-1 of the corporate tax return is to reconcile a corporation’s accounting income
to its taxable income, computed before the net operating loss and special deductions such
as the dividends receive d deduction. On the left side of Schedule M-1 are adjustments that
must be added to accounting in come, and on the right side of the schedule are adjustments
that must be subtracted from accounting income to arrive at the amount of taxable income.
The amounts that must be added to book (accounting) income include the amount of fed-
eral income tax expense, net capital losses deducted for book purposes, income recorded on
the tax return but not on the books, and expenses recorded on the books but not deducted
on the tax return. Alternatively, the amounts that must be deducted from book income are
income recorded on the books but not included on the tax return, and deductions on the
return no t deducted on the books .
EXAMPLE For 2010, Wisteria Corporation, an accrual basis taxpayer, has net
income from its books of $40,000. Included in this figure are the fol-
lowing items:
1. Net capital loss $ 5,000
2. Interest income on tax-exempt
bonds 9,000
3. Federal income tax expense 16,000
4. Depreciation deducted on the tax
return, not deducted on the books 3,500
5. Interest deducted on the books, not
deductible for tax purposes 4,000
Self-Study Problem 11.3
During 2010, Fraxinia Corporation has the following income and expenses:
Gross income from operations, excluding dividends $ 90,000
Expenses from operations 100,000
Dividends received from a 25-percent-owned
domestic corporation 70,000
Calculate the amount of Fraxinia Corporation’s dividends received deduction.
$ ____________
11-6 Chapter 11
The Corporate Income Tax
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