Taxation of Business Entities
Business Tax Outline
Hallmarks of Tax Policy:
} Raise Revenue?
} Promote Economic Growth?
◦ Horizontal – similar burdens on people in like circumstances? Who are people in like circumstances?
◦ Vertical – create an appropriate differential in burdens for people in unlike circumstances?
} Redistribution of Income and/or Wealth?
} Ease of Administration?
· Separate taxpaying entity.
· Double taxation: taxed at corporate level, then at shareholder level when earnings are distributed.
· Pass-through entity.
· Single taxation- only taxed at shareholder level, not corporate level.
· Same as S corp.
C corp tax rates in §11- flush paragraph after (d). Once income gets high enough, basically becomes a flat tax.
On an exchange, taxpayer’s cost (basis) is:
· Amount actually originally paid for the item that he/she is giving up (essentially the his/her basis)
· Gain incurred by taxpayer on the exchange (“tax cost”).
o Ann painting- basis = 20, FMV = 100. Gain = 80.
o Bob rug- FMV = 100
o Exchange the two- Ann’s basis is original $20 plus recognized gain of $80. Her basis in the rug is now $100. Avoids double tax by deferring tax.
Most important question to ask:
· What do I need to know for my client for me to advise them on what entity they should choose?
Corps can’t take a deduction for dividends paid (99% of the time).
Dividends = ordinary income (except for qualified dividends- then 1(h) rate).
Dividend rate at 20%, but the effective rate is 23.8%. Obamacare adds 3.8%- thanks bitch.
Corps can deduct wages.
Table on p. 6-7 VERY IMPORTANT. Double tax table.
S corp and partnership: if you are deemed to have an ownership of 50% of the corp, you have a tax obligation for it, even if you did not get a distribution for it.
Buy-sell agreements help with this- usually a provision that there must be a minimum distribution equal to the tax obligation.
S corps for small, closely held businesses. Family businesses.
S corps and partnerships are only accounting entities for taxpaying purposes.
LLC a different kind of beast.
· §7701(a)(2): (tax definition of a partnership)
§ Joint Venture
§ Other unincorporated organization
· §7701(a)(3): (tax definition of a corporation)
§ Joint stock companies
§ Insurance companies
LLCs usually deemed to be partnerships.
Corporation said to have 6 characteristics:
· Business and gain objective,
· Continuity of life,
· Centralized management,
· Limited liability, and
· Free transferability of interests
Assumed to have first two- needed 3rd and 4th to get corp status.
FICA: 2 parts
· OSDI (Social Security)- Old age, Survivors, Disability Insurance. 6.2%
· Hospital Insurance (Medicare). 1.45% (0.9% increase for employee only).
· OSDI wage cap (2013: $113,700)
· Total: 15.3% + 0.9% = 16.2%
· FICA and FUTA generally apply to employers and employees and “wages”
· Don’t apply to investment income.
· ACA (Obamacare- §1411) 3.8% net investment income tax does apply.
· Self-employed (pays full FICA instead of half/half like employer/employee)
o 12.4% of “self-employment income”- OSDI
o 2.9% of “self-employment income”- Medicare
o 0.9% for high income filers
o Total: 15.3% + 0.9% = 16.2%
· §164(f) allows a 50% above the line deduction
Net Investment Income Tax:
· $250K modified AGI for MFJ
· $200K modified AGI for Single
· Trust and estates
· Not nonresident aliens (NRAs)
· All investment income, including interest, dividends, capital gains, rental and royalty income, non-qualified annuities, etc. etc.
· Does not apply to any capital gain that is EXCLUDED from gross income for regular income tax purposes
· You can deduct related investment expenses (like brokerage fees)
· Does NOT include trade or business income
Form 1120- Corporate income scaffolding. Corps file March 15.
· Section I: What is included in income? What is excluded from income? (basically §162)
· Section II: Deductions- regular deduction, special corp deductions, Subchapter C) (basically §163 and §167, but no deduction for loss, interest expense, or charitable)
· Section III and Schedule J: Calculate tax
Corporations can’t assign income (just like individuals can’t).
Controlled groups- if a bunch of corporations are owned by one corporation and operated as one corporation. Cab company case. Spread money among corps to get into a lower rate- nay nay.
§1561: Limitations on benefits for controlled groups. Code book p. 211.
· Controlled group of corp
§ One or more chain corps (vertical chain)
§ Stock ownership with
· 80% voting
· 80% value, except
re a ton of shareholders and a buyback is uncertain.
§111(a) Revenue Act- 1928 Code
o Sale or other disposition
· Gain = Amount Realized – Adjusted Basis
· Loss = Adjusted Basis – Amount Realized
§311(a): Codifies General Utilities
· Except as provided in (b)
· No gain or loss
· With respect to stock
o Its stock
o Its property
§311(b): General Utilities was repealed, and they put in this section.
· Appreciated property
o FMV more than adjusted basis
o Gain = corporate sale
This is like PPA for business tax- adjust basis up to account for tax paid on it.
Thanks to §311(b), there is really no difference between a corp selling property and a corp distributing property.
§267(a): Can’t go around triggering gains and losses willy nilly with related parties.
Castner Garage, Universal Motor Company, Island Securities, Ltd.
· Island owned Castner and Universal. Pittam was the shareholder of Island. Most stock in the 3 owned by Pittam, some by others.
· Pittam had insurance policies taken out on himself.
· Proceeds for him paid to company.
· “Key Man” insurance.
· Instead of disability, they get life insurance proceeds. Normally excluded under 101, unless transfer for value, unless again a corporate officer, which he is here.
· §118: Gross income does not include contributions to capital.
· §362(a): corp takes contributor’s basis in property contributed as capital.
· §162(a)(1)- authorizes corp to take compensation deduction. Reasonable allowance for services actually rendered.
· CEO, Elliott, of a corp got $2000/month as salary plus year-end bonus capped at 50% adjusted net profits.
· 1975- $2000/year is $24K, which is around $102.5K today.
· Worked 80 hours/week, CEO, sole shareholder, in charge of sales, credit, and purchasing.
· Two part test in §162:
1. Reasonable allowance
2. For personal services