Taxation of Business Entities “C” Corporation
Example of Corporate Tax Calculation:
Gross Income
Deduction
Taxable Income =
$2,500,000 Inventory Sales
$730,000 Operating Expenses §162(a)
$2.8M gross income
100,000 Dividends
875,000 Depreciation § 167(a)
1.875M deductions
200,000 Capital Gains
200,000 Net Capital losses §1211(a)
$2,800,000 Gross Income
$1,875,000 Total Deductions
925k §63(a) taxable income
§11(b) Corporate Tax Liability:
15% x $50,000 = $7,500 §11(b)(1)(A)
25% x $25,000 = 6,250 §11(b)(1)(B)
34% x $25,000 = 8,500 §11(b)(flush)
* x “ = 11,750 §11(b)(flush)
34% x $825,000 = 280,500 §11(b)(1)(C)
$925,000 $314,500
*Note that the flush language after §11(b) imposes an additional 5% tax on taxable income in excess of $100,000 up to a maximum increase of $11,750.
What result if the corporation distributes $610,500 (= $925,000 – $314,500) to both shareholders as dividends? Each will have a $305,250 dividend which is includible in gross income.
Classification Corporations vs. Partnerships – “Check the Box”:
Ø Reg. §301-7701-2(b)(1): A business entity organized under a federal or state statute, or under a statute of a federally recognized Indian tribe, if the statute describes or refers to the entity as incorporated or as a corporation, body corporate or body politic
Recognition of the Corporate Entity:
Ø Comm’r v. Bollinger: Respected as a true agent with regard to an asset if a written agency agreement, functioned as an agent with respect to the asset for all purposes, and disclosed its agency statute in dealing with third parties.
o Six Factors from National Carbide:
§ Whether the corporation operates in the name and for the account of the principal
§ Binds the principal by its actions
§ Transmits money received to the principal, and
§ Whether the receipt of income attributable to services of employees of principal and to assets belonging to principal are some of the relevant considerations in determining whether a true agency exists
§ If the corporation is a true agent, its relations with its principal must not be dependent upon the fact that it is owned by the principal, if such is the case
§ Its business purpose must be the carrying on of the normal duties of an agent
o The court relied on the 6th factor and said that the first four factors were okay. Held that corporation was an agent and losses were allowed to be passed through.
II. FORMATION OF A “C” CORPORATION:
Ø Raising cash equity capital
Ø Contribution of property for stock
A. Introduction to §351:
§351(a): Transfer to Corporation Controlled by Transferor: General Rule: No gain or loss shall be recognized if property is transferred to a corporation by one or more personssolely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control (as defined in §368(c)) of the corporation.
Basis to Shareholders in Stock Received:
Ø §358(a)(1): Basis to Distributees (Shareholders): General Rule: In the case of an exchange to which §351 applies –
o (1): The basis of the property [here stock] permitted to be received under [§351] without the recognition of gain or loss shall be the same as that of property exchanged [e.g. property contributed].
Shareholder Holding Period in Stock Received:
Ø §1223(1): Holding Period of Property (Shareholder): In determining the holding period for which the TP [e.g. the contributing shareholder] has held property received [e.g. the shares of stock] in an exchange, there shall be included the period for which he held the property exchanged [e.g. the contributed property] if, the property has the same basis in whole or in part in his hands as the property exchanged [see §358(a)], and the property exchanged [the contributed property] at the time of such exchange was a capital asset as defined in §1221 or property described in §1231.
o §1221(a): Capital Asset Defined: The term “capital asset” means property held by the TP (whether or not connected with his trade or business), But Does Not Include:
§ (1): Inventory
§ (2): Depreciable property used in a trade or business
§ (3): Certain intangibles – copyrights etc.
§ (4): Accounts receivable
o §1231(b)(1): Property Used in a Trade or Business: The term “property used in a trade or business” means property used in a trade or business, of a character subject to the allowance for depreciation, held for more than 1 year, and real property used in a trade or business, held for more than 1 year, which is not [among other things]
§ (A): Inventory
Gain/Loss to Corporation on Distribution of Stock:
Ø §1032(a): Exchange of Property for Stock: No gain or loss shall be recognized to a corporation on the receipt of money or other p
d
§ Full basis went into the corporation and therefore Intermountain Lumber could take the depreciation and Shook did not recognize a gain
o Rule: Immediately after the exchange is determined after the transfer of stock pursuant to a binding agreement to dispose of stock.
Transfer of Property and Services:
Ø Reg. §1.351-1(a)(1), (2): What is Property?
o Includes cash, capital assets, inventory, A/R, patents and certain intangibles
o Stock issued for services is NOT considered to be issued “in return for property.” §351(d)(1)
o Shares issued for services do not count towards the total control percentage under §1.351-1(a)(1)(i).
Ø Reg. §1.351-1(a)(1)(ii): Provides: Stock issued for property of relatively small valuein comparison to the value of the stock already owned (or to be received for services) shall not be treated as having been issued in return for property if the primary purpose of the transfer is to qualify [for nonrecognition under §351] . . .
Ø Rev. Ruling 77-37: Property transferred will not be considered to be of relatively small value if the fair market value of the property transferred is equal to, or in excess of, 10% of the fair market value of the stock already owned (or to be received for services by the transferor). (If FMV of property transferred is greater than or equal to 10% of the stock value then it is not relatively small).
Solely for Stock:
Ø Transfers must be made solely in exchange for stock of the controlled corporation
o Stock means an equity investment
o Not included:
§ Stock rights (e.g. stock options); warrants
§ Debt securities (receiving a note back from the company)
§ Nonqualified preferred stock (Generally – you own a percentage of the company but you get the first x% of profit – then let the chips fall where they may – you are preferred. Nonqualified is more like a debt and you want a share of the profits – and can call the money back – then it is more like a loan)
