Select Page

Federal Income Tax of Business Entities
West Virginia University School of Law
Wilson, Elaine Waterhouse

Taxation of Business Entities

Elaine Wilson

Spring 2014

Business Tax Outline


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.


· 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)

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


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

o Parent-subsidiary:

§ 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

· Gain

o Sale or other disposition

o Property

· Gain = Amount Realized – Adjusted Basis

· Loss = Adjusted Basis – Amount Realized

§311(a): Codifies General Utilities

· Except as provided in (b)

· No gain or loss

· Corporation

· Distribution

· With respect to stock

o Its stock


o Its property

§311(b): General Utilities was repealed, and they put in this section.

· Corporation

· Distribution

· Shareholder

· Appreciated property

· If

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.

Elliots, Inc.

· §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