Corporate Tax Spring 2016
An Overview of the Taxation of Corporations and Shareholders
· Introduction
Tax imposed on the taxable income of a corporation and then again when a corporation distributes dividends to its shareholders
Dividends not deductible by the distributing corporation
Transactions between corporations and their shareholders are taxable events
Partnerships – Subchapter K of the Code – treated as pass-through entities that do not pay federal income tax
Partners include their respective shares of partnership income, deductions, losses and other items when determining their tax liability
Principal features of a pass-through tax regime:
(1) income generated by the business is taxed only once to the beneficial owners of the enterprise, whether or not they receive current distributions, and
(2) losses pass through to the owners and, subject to various timing limitations, may be deducted against income from other sources
Has been extended to LLCs recently
· Influential Policies
o The Double Tax
More theoretical than real
Adverse impact of the tax on the allocation of economic resources
P. 5
If a double tax is accepted as the appropriate corporate taxing model, the discussion then turns to the integrity of the corporate-level tax
LLCs are not subject to Subchapter C
o Tax Rates on Ordinary Income: Corporate and Individual
For C Corps. With significant taxable income – corporate income tax is essentially a 34 or 35% flat rate tax with no preferential rate for long-term capital gains
Corps with smaller amounts of income can take advantage of lower rates – 15 or 25% – on their first $75k of taxable income
Service has weapons to combat the self-help tax strategies
o Preferential Capital Gains Rates
Tax advisors devised techniques to ‘bail out’ earnings at capital gains rates
A bailout is a distribution of earnings in a transaction, such as a redemption of stock, that qualifies as a ‘sale or exchange,’ enabling the shareholder to recover all or part of her stock basis and to benefit from preferential capital gain treatment on any realized gain
o Nonrecognition
Transactions that qualify for nonrecognition treatment may go forward on a tax-free basis on the theory that they are mere changes in form which result in a continuity of investment
The typical nonrecognition provision includes corollary rules providing for transferred and exchanged bases and tacked holding periods
A corporation must pay tax on the appreciation in its assets on a sale or distribution in connection with a complete liquidation
Acquisitions known as tax-free reorganizations – ordinarily are free of tax to all the parties, albeit with the trade-off of transferred bases and a carryover of other tax attributes
· The Common Law of Corporate Taxation
o Sham Transaction Doctrine
If a transaction is a sham, it will not be respected for tax purposes
A sham is best defined as a transaction that never actually occurred but is represented by the TP to have transpired – with favorable tax consequences of course
Tend to reserve this for more egregious cases
Fourth Circuit – two part test
Motivated by no business purpose other than tax benefits
No economic substance
o Economic Substance Doctrine
Claimed tax benefits should be denied if the transactions that give rise to them lack economic substance apart from tax considerations even if the purported activity actually occurred
Some apply a conjunctive two-part test – presence of economic substance (an objective inquiry) and then a business purpose (a subjective test)
Congress finally codified
o Substance Over Form
Some courts have shown reluctance to accept attempts by the Service to restructure legitimate transactions to reach a result that will produce more revenue
o Business Purpose
A transaction motivated by a business purpose usually is compared to one that has no substance, purpose or utility apart from tax avoidance
o Step Transaction Doctrine
Combine formally distinct transactions
Some require a binding legal commitment while others require only a mutual interdependence
· The Corporation as a Separate Taxable Entity
o The Corporate Income Tax
Corporation selects its own taxable year and method of accounting and these rates are found in § 11.
Maximum corporate rate is 35% on a corporation’s taxable income in excess of $10,000,000
0 to 50k = 15%
50,001 to 75k – 25%
75,001 to 10,000,000 – 34%
§ 11(b) – imposes an additional 5% tax on taxable income in excess of $100k up to a maximum increase of $11,750, which is the amount of tax savings from the lower rates on the first $75k of taxable income
Creates a 39% marginal bracket on taxable income between $100k and $335k
Corporations with taxable income in excess of $15,000,000 must increase their tax by the lesser of three percent of the excess, or $100k
So corporations with over $18,333,333 are taxed at a flat 35% rate on all their income
§11(b)(2) – denies the lower marginal corporate rates to any qualified personal service corporation as defined in § 448(d)(2)
A qualified personal service corporation is a corporation substantially engaged in the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting, if substantially all of the corporation’s stock is held by employees performing services for the corporation, retired employees, or the estates of employees or retirees
Determination of Taxable Income
Not entitled to any personal or dependency exemptions
Receives no standard deduction
Not concerned with above or below the line
Most personal deductions not available
Virtually all of their ordinary expenses in the
th a timing advantage
Foreign tax credit, which is available to corporations with income from foreign sources
Others include the rehabilitation and energy credits, the work opportunity credit, and the credit for research expenditures
Fo Corporate Tax Class Notes
Overview of Corporate Taxation
Separate taxable entity from its shareholders
The C-Corporation – called so because all the rules are in subchapter C – is the only one that is a separate taxable entity
This means that it is subject to two levels of tax
When it earns the money, it pays tax on it
When it distributes its earnings out to its shareholders, generally by way of dividends, they are taxed again to the shareholders
Not a very good choice of business entity from a tax perspective
Now that the corporate tax rate is high as the individual income tax rate, that deferral method of corporations is gone
For non-tax reasons, and in particular free transferability interests and limited liability, a C-Corporation remains the entity of choice, primarily for publicly held corporations
Corporate Level Income Tax – § 11 of the code
15% – up to $50k
25% – up to $75k
34% – up to $10 million
For taxable income in excess of $100k, add the lesser of 5% of such excess or $11,750
For taxable income in excess of $15 mil, add the lesser of 3% of such excess or $100k
PCs might be attractive now because the individual tax rate has gone back up
Differences between individual and corporate taxation
Some items of income that a corporation will never have
i.e., alimony
some exclusions from income that a corporation will never have
employee fringe benefits
deductions – biggest differences
Not allowed
Medical expenses
Moving
Exemptions
Standard deduction
IRAs [sometimes for individual]
Are allowed
Investment expenses
Not subject to 2% floor – § 162 – no above and below the line deductions, all the deductions are ‘above’ essentially
Corporations are assumed to be engaged in business for profit
[individuals – § 212 – subject to 2% floor]
Comparison of Deduction Treatment Between Corporations and Individuals
