Taxation of Business Entities Outline
Johnathan Forman
Spring 2016
C Corporation Operations
Corporate Income Tax
I.R.C. § 11(b)(1): taxes assessed against corporate income
Amount
Tax Percentage
<$50k
15%
$50k>$75k
25%
$75>$10 mil.
34%
>$10 mil.
35%
Scope of Corporate Gross Income
Inclusionary Aspects–Income from services
Haag v. Commissioner (U.S. Tax Ct. 1988)
physician entered into a partnership with Hilltop Medical Clinic as a professional corporation (PC) through which he took his salary
Tax returns:
Year
Share of Hilltop Income
Haag’s actual salary
Haag’s salary absent corporation
Deficiency
1979
$205,383
$94,060
1980
$204,716
$72,057
1981
$228,802
$84,240
PC gains income
Gross Income: $100k
under §162: minus $50k salary deduction
$50k x 15% = $7500 tax on gross income
$42,500 dividend
tax = 15% on dividends under §1(h)
Individual income
-$4k p.c.
-$6k s.a.
=$40k taxable income
$3,315 +28% (40k-22,100)—>§1(a)(2)
The PC was in a lower bracket than the shareholder employee, and the maximum tax on corps. was 35% while the maximum tax on individual income was 39.6%, so there was a higher incentive to leave money in the PC rather than take all of the income as salary
When they come to the shareholder, are taxed at 15% (or 20% in a higher bracket)
Not deductible for the corporation, implying that there is going to be a corporate tax, probably at 34%
IRS arguments
Contract was a sham
Assignment of income doctrine
Income is taxed to the person who earned it (Lucas v. Earl)
Since Haag earned the income, and did not pay taxes on it, he is liable for the deficiency
Court holds: not a sham, income was taxed to the PC
Congressional power under IRC §482:
IRS, when it looks at the tax returns filed by the entities and individuals, can reapportion and reallocate the income necessary to reflect the actual income and prevent evasion
standard: abuse of discretion
Court does not find an abuse of discretion in assignment of the doctor’s income to the PC
§269(a) argument
Inclusionary Aspects–Gains from Property
Realization event:
event whereby the corporation realizes a profit
e.g. a sale
I.R.C. § 1001(a):
The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the adjusted basis provided in 1011 for determining gain, and the loss shall be the excess of the adjusted basis provided in such section for determining the amount realized
Adjusted Basis:
I.R.C. § 1012:
the basis of property shall be the cost of such property
I.R.C. § 1011:
the adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis adjusted as provided in § 1016
I.R.C. § 1016:
Basis of property is adjusted for
expenditures, receipts and losses chargeable to a capital account,
amortization, depletion, depreciation
Realized Gain
I.R.C. §1001(a): the excess of amount realized over the adjusted basis
(i.e. value-cost=profit)
§ 1001(c): except as otherwise provided in this subtitle, the entire amount of the gain or loss…on the sale or exchange of property shall be recognized
So, property that is merely redistributed within a corporation’s own assets does not constitute a gain or a loss, and is not recognized
§§ 1031-1045: Nonrecognition rules
Capital Gain: profit that results from the sale of a Capital Asset
§ 1221: a capital asset means property held by the taxpayer, but does not include
stock included in the inventory of the taxpayer, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business
property of a character which is subject to the allowance for depreciation, or real property used in the business
hedging transaction
Organizing a Corporation: Individual (S) purchases an asset for $700, transfers it to the corporation in exchange for 100 shares in common stock in C corporation, which is now worth $3,300 (value – basis) (§351 organizing transaction)
Started as a sole proprietor, incorporated
Basis of the asset = $700
Value of the asset = $4,000 (amount realized)
Gain realized under § 1001(a)= $3,300
§ 351(a) provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation
Basis in the 100 shares of C stock that S received = $700
§ 358(a)(1): basis of the property received is the same as the property exchanged
Don’t want a tax on incorporation
§1032: no recognition of gain or loss on the receipt of property in exchange for stock
What is the basis of C corp’s stock?
§ 362(a): the basis of the asset in the hands of the corporation is the same as it was in the hands of the transferor (S) increased by the amount of any gains realized by the transferor, so the basis is $700
Contributions to Capital (§ 118)
Asset 2: B = 200, V = 1000
transferred to C corporation to give it operating capital
for an individual
could be income under §61, or a gift
for a corporation, the general rule is § 61, but we don’t want that to happen, so § 118 provides that contributions to capital are generally not included in gross income
So, now C corp has asset 2 with a value of 1000, and the basis of the property received under § 362 is the same as it was in the hands of the transferor, so $200
Doesn’t just have to be from shareholders, so a municipality could contribute land to a corporation for development, w
to shareholders without triggering a corporate level tax on the appreciation; only a shareholder level tax was imposed
Repealed by the Tax Reform Act of 1986
Both corporate operating income and unrealized appreciation in corporate assets (generally characterized as capital gains) are generally subject to double taxation, both at the same rate (up to 35%)
§ 305(a)
§ 311(a) says that gain or loss is not recognized on distribution of stock, but
§ 311(b) says that gain shall be recognized as if it were sold to the distributee at its fair market value when a corporation distributes property to a shareholder in a distribution
So, both the corporation and the shareholder are taxed
If you have a gain, you will always be taxed, whereas if you have a loss, you may not always be able to have that loss recognized
Exclusionary Aspects
Castner Garage, Limited v. Commissioner Universal Motor Co. v. CommissionerIsland Securities, Ltd. v. Commissioner (Bd. of Tax Appeals 1940)
Company is getting money from insurance policy
governed by § 61(a)
But, 104(a)(3): GI does not include compensation for injuries or sickness
§ 101(a): GI does not include amounts received under a life insurance contract
IRS tried to argue that life insurance exclusion was not meant to apply to corporations, however, the court held that there was no evidence of that intent, and so there is no separate rule for corporations
Scope of Corporate Deductions
Whereas § 61 includes all receipts in Gross Income unless otherwise provided, § 161 bars a deduction for any disbursement unless specifically allowed
Deductions allowed
for individuals and corporations
§ 162: Trade or business expenses
only for corporations
§ 163(d) and (h): Interest expense
§ 165(c): Loss
§170(b)(2): Charitable Contributions
only for individuals
Corporations do not have to distinguish between deductions to and from adjusted gross income
§62: Adjusted Gross Income – Gross income minus deductions, for individuals
§67: For individuals, miscellaneous deductions (other than the ones enumerated) are limited to 2% of adjusted gross income, but not so for corporations
Reducing Double Taxation
Because corporate income is subject to individual income tax when distributed to shareholders, the deductions that apply to other corporate expenses would seem to also apply to dividends in computing the corporation’s gross adjusted income, but this is not the case
A corporation may not deduct the dividends it pays
