(1)
(a) The Corporate Double Tax
Highest rate of 35%
If corporate profits are distributed annually, the SH is taxed at 39% rate imposed on ordinary income. If retained until distribution, taxed to SH at capital gains rate.
When individual rates are higher than corporate rates, there is incentive for corporation to accumulate profits rather than to distribute them
Accumulated Earnings concernt
Who really pays the corporate tax?
(b) Corporate Tax Rates and Base
§ 11
Rate
$1-50K
15%
$50-100K
25%
$75-10M
34%
Over $10M
35%
+ Surtax on excess over $100K to $335K of 5%
+ Surtax over $15M of 3% to $18.333M
Progressive
For income of $100K or less
Flat Tax and Qualified Personal Service Corporations
Flat 35% for “Qualified” personal service corporations.
§ 448(d) – Function and Ownership test
Function – substantially all of the activities of the corporation must involve performance of services in fields of health, law, engineering, architecture, accounting, acturial science, performing arts or consulting.
Ownership – substantially all of the value of the stock must be held directly or indirectly by employees performing the services or who performed the services in the past two years.
Entitled to use cash basis method of accounting (§ 448 denies this to C Corps other than qualified personal service corporations.
Income tax – incentive for taxpayers to use corporate form to shelter income from top individual rates
Individuals – capital gains rate of 20%; top rate of 39.1% on OI
Capital Losses
Can use excess capital losses to offset up to $3,000 of OI. § 1211(b)
Can carry forward capital losses indefinitely
Corporations –
§ 1201 – alternative to § 11
Takes effect if § 1201 tax is less than § 11 (if tax rate under § 11 exceeds 35%)
Equals
Sum of (1) § 11 tax on the corporation’s taxable income minus net capital gains and (2) 35% of the net capital gains
Capital losses
Corp can deduct capital losses only to the extent of capital gains.
Can carry forward capital losses only 3 years back and 5 years forward.
Deduction
§ 162 allows to deduct expenses incurred for preduction of income even f income is not derived from trade or business.
Charitable contribution deduction up to 10% of taxable income § 170(b)(2)
Credits
Once corp’s taxable income is determine, tax liability offset
ATM
§ 55(a) – each corporation pays the excess, if any, of its minimum tax liability over its regular tax liability.
Corporate minimum tax equals 20% of corporation’s ATMI less an exemption of $40,000 or less.
AMTI – § 55
Regular taxable income, increased by specified tax preferences and other adjustments. Exemption amount is $40,000 less ¼ of the corporation’s AMTI above $150K.
Exemption amount is zero for corporations with AMTI equal to $310,000 or more.p
(2)
(a) Associates Taxable as Corporations – subject to § 11 and AMT of § 55
Reg. § 301.7701-3(b)(1)(i)
Eligible entities can elect to be taxed as a partnership or corporation, with default rule being partnership
Reg. § 301.7701-2(b)(1)-(8)
Denied elective classification to incorporated entities, heavily regulated entities such as insurance companies and banks, entities wholly owned by state or municipality, and variety of foreign businesses traditionally treated as corporations.
§ 7704 – publicly traded partnerships (including LLC and similar organizations otherwise taxable as partnerships) would be taxed as corporations if their interests were traded on an established securities market o for which there was a secondary market making the interests readily tradable.
Check-the-Box
Corporation – if formed by the law of a state
LLC or Partnership– check the box, what do you want to be taxed as?
Default – if no check, treated as partnership
Publicly traded partnerships treated as corporations
(b) Ignoring the Corporation: Dummy Corporations
Common situations taxpayers try to ignore the corporate identity
Ie – Real Estate Amalgamation
Moline Properties – Piercing corporate veil and trying to avoid corporate tax
Corporation engaging in any business activity will be treated as a taxpayer distinct from its SH
IRS may not be stuck with the form that the business adopted. But the taxpayer is stuck with the choice of entity they had.
UNLESS, basically no business activity takes place.
Rule 1 – IRS can step in and establish that these are not separate entities
Rule 2 – Taxpayer is only allowed to say “disregard the corporate entity” if there was no business activity of the corporation.
Bollinger – Agenty or Dummy corporation as agent for the SH and therefore not properly taxable on income nominally received by “dummy corp.’
Taxpayers can get around recognition of the entity for tax purposes by saying “we have an agency.”
Bollinger Test for Agency
(1) A writing memorializes the principal-agency relationship,
(2) the corporation indeed functions as an agent,
(3) and the corporation is held out as an agent and not the principal in all third-party dealings.
(3) Forming a Corporation
§ 1031 – Taxation on exchange is inappropriate where a taxpayer has sufficient continuity of investment before and after the exchange.
§ 351
· whether a transferor has a sufficiently continuous relationship with the property transferred to a corporation to justify nonrecognition
· Non-Recognition if:
o (1) transfers property to a corporation;
o (2) receives stock in exchange; and (along with any other transferors, if any)
o (3) is in control of the corporation immediately after the transaction
o to either a newly formed, or existing corporation.
(a) § 351 Roadmap
· § 351, 357 – determine whether gain or loss realized on exchange is taxable to transferor.
· § 358 – determines basis taken by transferor in stock rec
ney or other property and does not preclude non-recognition under § 351.
· There is a gain first rule for boot, and a basis first rule for liabilities assumed.
· § 357(b) – Where under the nature of the liability, circumstances surrounding its assumption by the transferee, and the principal purpose of the taxpayer with respect to the assumption is to avoid income tax or is not a bona fide purpose – the assumption will be treated as money or other property received, for purposes of § 351.
o In general, liabilities incurred in the normal course of business should escape § 357(b). But if tax-avoidance motive exists with respect to any assumed liability, all liabilities are treated as boot.
· § 357(c) – Exception to (a): where the assumption exceeds the transferor’s basis, excess is considered gain. This subsection treats such excess as gain from the sale or exchange of the underlying property.
o * transferor allowed to aggregate the total of the adjusted basis of all assets transferred before determining whether gain must be recognized.
o (c)(3) Exception to exception (c): exception to exception (where liability exceeds basis of assets transferred) if it would be deductible if paid by the transferor
· If expected that the transferor will ultimately satisfy the responsibility, then the liability is not considered to be assumed.
· Transferring a note by transferor
o Peracchi: Transferring a note of promise to pay down the road, the transferor’s basis in the note is face value, and therefore doesn’t have to recognize gain under § 357(c)
(iii) Definition of “Stock”
· § 351 stock does not include stock rights, options, warrants, or other rights to purchase stock at a fixed price.
· Hamrick – Contingent stock (contingent on valuation of transferor’s property) is ok
· § 351(g) — “Nonqualified Preferred Stock” is treated as boot if received in § 351 transaction along with stock other than nonqualified stock.
o If receive only nonqualified preferred stock, then TR will be taxed on difference between FMV of preferred stock and AB in the property transferred. § 1001. If the difference produced a loss, TR can recognize a loss. §§ 165, 267.
o If TR receives any other stock, then the nonqualified preferred stock is treated as boot for § 351 and C could not recognize any loss on the transfer.
