Federal Income Tax of Business Entities Outline

Taxation of Business Entities

Elaine Wilson

Spring 2014

Business Tax Outline

Intro

Hallmarks of Tax Policy:

} Raise Revenue?

} Promote Economic Growth?

} Equity

◦ 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?

} Neutrality?

} Incentives/Disincentives?

} Ease of Administration?

C corp:

· Separate taxpaying entity.

· Double taxation: taxed at corporate level, then at shareholder level when earnings are distributed.

S corp:

· Pass-through entity.

· Single taxation- only taxed at shareholder level, not corporate level.

Partnership:

· 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)

AND

· Gain incurred by taxpayer on the exchange (“tax cost”).

Example:

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)

o Partnership

§ Syndicate

§ Joint Venture

§ Other unincorporated organization

· §7701(a)(3): (tax definition of a corporation)

o Corporation

§ Association

§ Joint stock companies

§ Insurance companies

LLCs usually deemed to be partnerships.

Corporation said to have 6 characteristics:

· Associates,

· 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%

Self-Employment Tax:

· 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

C Corporations

Operations

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.

§1563:

· Controlled group of corp

o Parent-subsidiary:

§ One or more chain corps (vertical chain)

§ Stock ownership with

· 80% voting

OR

· 80% value, except