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Lecture 11

ACCT 40610 Lecture 11: Chapter 11
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5 Pages
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Department
Accountancy
Course Code
ACCT40610
Professor
O' Brien

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Chapter 11
Corporation Characteristics
o Limited liability of shareholders.
Owners of closely-held corporations often are required to
personally guarantee repayment of debt.
Licensed professionals must still carry malpractice insurance.
o Unlimited life.
Legal existence not affected by changes in ownership.
o Free transferability of interests.
Through regulated markets with maximum convenience and
minimal transaction cost.
For closely-held corporations, a buy-sell agreement may
prevent transferability.
o Centralized management.
Affiliated groups = a parent corporation that directly owns at least 80% of at
least one domestic subsidiary + all other domestic subsidiaries that are 80%
owned within the group.
Affiliated groups may elect to file a consolidated tax return - applies to all
members of affiliated group.
o Advantage: losses and profits of affiliated members offset each other.
Nonprofit Corporation
o Includes corporations formed exclusively for religious, charitable,
scientific, literary, educational purposes, etc.
o Section 501(c)(3) organizations require IRS recognition of tax-exempt
status.
o Nevertheless, tax-exempt organizations may pay tax on unrelated
business taxable income.
Dividends Received Deduction
o Corporations receiving dividends from other taxable domestic
corporations are entitled to this deduction.
% < 20% of stock
70% DRD
20% < % < 80%
80% DRD
80% < %
100% DRD
o What was Congress reasoning behind the DRD?
To mitigate triple taxation.
Schedules M-1 and M-3 reconcile book income to taxable income.
The M-1 was used by all corporations until 2004 and can still be used by
corporations with total assets less than $10 million.
In 2004, the IRS developed the M-3 for use by large corporations (assets >
$10 million); it requires more detailed information than the M-1 and
enhances the transparency of book/tax differences.
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Schedule M-1
o Net book income - line 1.
o Federal tax expense for books - line 2.
o Lines 3 - 6 explain increases in taxable income relative to books.
o Lines 7 - 9 explain decreases in taxable income relative to books.
o Line 10 = taxable income before NOL and DRD = Line 28, page 1, form
1120.
Computing Regular Tax
o The surtax rates of 3% and 3% eliminate bracket benefits for rich
corporations.
o Corporations with taxable income:
Between $335,000 and $10 million actually pay a flat rate of
34%.
Greater than $18.33 million pay a flat rate of 35%.
o Personal service corporations are taxed at a flat 35% rate:
Includes health, law, engineering, architecture, accounting,
actuarial science, performing arts, & consulting professionals.
Domestic Production Activities Deduction
o Available to US taxpayers deriving income from domestic production
activities.
o For 2017, deduction is equal to 9% of the lesser of net production
income or taxable income before the deduction.
o Deduction cant exceed 50% of US compensation expense.
o Deduction is equivalent to a reduced tax rate on domestic production
income.
Tax Credits
o Credits directly reduce computed tax:
$1 of credit provides $1 of benefit.
$1 of deduction only provides ($1 x the tax rate) of benefit.
o Tax credits are generally limited to some % of tax before credits.
Often a provision permits carry back or carry forward of excess
credits.
o Biggest credits: R&D credit, foreign tax credit
o To be eligible, taxpayers must engage in specific activities that
Congress believes are worthy of government support.
o The list of credits changes as Congress experiments with new credits
and discards those that fail to produce the intended behavioral result.
AMT
o A second federal tax system parallel to the regular income tax.
o Created to ensure that every corporation pays a fair share of taxes.
o New corporation is exempt in Year 1.
o Exempt in Year 2 if Year 1 sales <=$5 million.
o Exempt in Year 3 if average sales in years 1 and 2 <= $7.5 million.
o Exempt in subsequent years if average gross receipts for three prior
years <= $7.5 million.
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Description
Chapter 11 Corporation Characteristics o Limited liability of shareholders. Owners of closely-held corporations often are required to personally guarantee repayment of debt. Licensed professionals must still carry malpractice insurance. o Unlimited life. Legal existence not affected by changes in ownership. o Free transferability of interests. Through regulated markets with maximum convenience and minimal transaction cost. For closely-held corporations, a buy-sell agreement may prevent transferability. o Centralized management. Affiliated groups = a parent corporation that directly owns at least 80% of at least one domestic subsidiary + all other domestic subsidiaries that are 80% owned within the group. Affiliated groups may elect to file a consolidated tax return - applies to all members of affiliated group. o Advantage: losses and profits of affiliated members offset each other. Nonprofit Corporation o Includes corporations formed exclusively for religious, charitable, scientific, literary, educational purposes, etc. o Section 501(c)(3) organizations require IRS recognition of tax-exempt status. o Nevertheless, tax-exempt organizations may pay tax on unrelated business taxable income. Dividends Received Deduction o Corporations receiving dividends from other taxable domestic corporations are entitled to this deduction. % < 20% of stock 70% DRD 20% < % < 80% 80% DRD 80% < % 100% DRD o What was Congress reasoning behind the DRD? To mitigate triple taxation. Schedules M-1 and M-3 reconcile book income to taxable income. The M-1 was used by all corporations until 2004 and can still be used by corporations with total assets less than $10 million. In 2004, the IRS developed the M-3 for use by large corporations (assets > $10 million); it requires more detailed information than the M-1 and enhances the transparency of book/tax differences. Schedule M-1 o Net book income - line 1. o Federal tax expense for books - line 2. o Lines 3 - 6 explain increases in taxable income relative to books. o Lines 7 - 9 explain decreases in taxable income relative to books. o Line 10 = taxable income before NOL and DRD = Line 28, page 1, form 1120. Computing Regular Tax o The surtax rates of 39% and 38% eliminate bracket benefits for rich corporations. o Corporations with taxable income: Between $335,000 and $10 million actually pay a flat rate of 34%. Greater than $18.33 million pay a flat rate of 35%. o Personal service corporations are taxed at a flat 35% rate: Includes health, law, engineering, architecture, accounting, actuarial science, performing arts, & consulting professionals. Domestic Production Activities Deduction o Available to US taxpayers deriving income from domestic production activities. o For 2017, deduction is equal to 9% of the lesser of net production income or taxable income before the deduction. o Deduction cant exceed 50% of US compensation expense.
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