Tax Accounting Notes

Tax Accounting Notes

Tax compliance considerations for the accumulated earnings tax and he personal holding company tax. Highlights of Recent Tax Law Changes The PHS and EAT tax rate are now tied to the highest rate for a dividend which is 15% through 2012. Taxable income (the starting point for calculating ANTI) is net of the L] . S. Production activities deduction. For that purpose the deduction is 6% (in 2008 and 2009, 9% in 2010) times the lesser of qualified production activities income or taxable income before the deduction. For ANTI purposes, the computation is based on the lesser of qualified production activities income or ANTI before the deduction.

The U. S. Reduction activities deduction is allowed for ACE purposes even though not allowed for E&P purposes. Thus, like the 80% and 100% dividend received deduction, this deduction causes no ACE adjustment. Teaching Tips 1. You may wish to incorporate into the discussion the election to depreciate Sec. 1245 property using the straight-line method for both regular and MAT purposes contained in the Tax Planning Considerations section at the end of the chapter. Up. C:5-7 and C:5-35. 2. Point out to the students that when the MAT is paid a minimum tax credit is created that will offset future regular income taxes. P.

C:5-1 3. Lecture Outline I. The Corporate Alternative Minimum Tax. The Tax Reform Act of 1 986 enacted a new alternative minimum tax system for corporations beginning after December 31, 1986. Actually, the corporate MAT produces little tax revenue, $3. 7 billion in 2006 compared to $349 billion from the corporate income tax. Small C corporations are exempt from the alternative minimum tax for tax years beginning after December 31, 1997. Once a C corporation qualifies as a small corporation, the MAT exemption continues as long as its average gross receipts are $7. 5 million or less for the three preceding tax years.

The operating rules for applying the average gross receipts calculation, which exempts small corporations from AM T, are found on p. C:5-2. Example C:5-1 illustrates this calculation. Table C:5-1 outlines the MAT computation. Basic definitions of terms can be found on p. C:5-4. The exemption amount for corporations is $40,000. This exemption amount is reduced by 25% of the amount by which ANTI exceeds $150,000. (Table C:5-1 may be used at this point to illustrate the computation. ) Tax preference items are listed on p. C:5-6. Tax preferences will always increase taxable income.

Adjustments require the recompilation of certain income, gain, deduction, and loss items and may either increase or decrease taxable income. These adjustments are listed beginning on p. C:5-6. For 1 990 and later tax years, a corporation is required to make a positive adjustment equal to 75% of the excess of its adjusted current earnings (ACE) over its pre-adjustment ANTI. ACE is a concept based on the traditional earnings and profits definition found in Sec. 312. ACE equals ANTI for the tax year plus or minus a series of special adjustments described beginning on p. C:5-10. (See Examples C:5-11 and C:5-1 2).

A negative ACE adjustment also can be made when pre-adjustment ANTI exceeds ACE. The negative adjustment is 75% of the excess of pre-adjustment ANTI over ACE, but not in excess of the corporation’s prior net positive ACE adjustments. Topic Review should be used at this point to summarize common alternative minimum tax adjustments. A comprehensive example is provided beginning on p. C:5-1 3 which can be walked through with the students to illustrate the computation of the alternative minimum tax. This example is used to complete the Form 4626 (Alternative Minimum Tax – Corporations) in Appendix B, which should also be referred to.

A. Minimum Tax Credit. The MAT is simply an acceleration of the payment of a corporation’s income taxes. When a corporation pays the AM T, it is allowed a credit that can be carried over and used to offset its regular (income) tax liabilities in subsequent years. For corporations only, the amount of the credit (MET) equals the entire MAT amount paid. The minimum tax credit that can be used by a corporation in a tax year equals the total of the net minimum taxes paid in all prior post-1986 tax years minus the amount claimed as a minimum tax credit in those years. SE of available minimum tax credits in the current year is limited to the excess of (1 ) the corporation’s regular tax liability (minus all credits other than refundable reedits) over (2) its tentative minimum tax. (See Example C:5-13). B. Tax Credits and the MAT. A corporation is allowed to reduce its regular tax liability by any available credit. For most corporations, the general business credit can be claimed only to the extent that the corporation’s regular tax liability exceeds its tentative minimum tax amount. (See Example C:5-14). You may also wish to discuss Financial Statement Implications found in the box.

At this pointy may wish to introduce Topic Review C:5-2 on p. 6, which summarizes the major features of the Alternative Minimum Tax for corporations. II. Personal Holding Company Tax. A closely-held corporation that satisfies both the stock ownership test and the passive income test is classified as a personal holding company for the tax year. A penalty tax is imposed to prevent taxpayers from using closely- held corporations to shelter passive income. A PHS must pay the greater of the regular corporate income tax or the corporate alternative minimum tax and possibly the PHS penalty tax.

A. Personal Holding Company Defined. A personal holding company is any corporation that has five or fewer individual shareholders who own more than 50% of the corporation’s outstanding stock at any time during the last Alfa Of its tax year, and has personal holding company income (PICK) that is at least 60% of its adjusted ordinary gross income (AGOG) for the tax year. Corporations that retain special tax status generally are excluded from the PHS definition. Among those excluded are S corporations and tax-exempt organizations. B. Stock Ownership Requirement.

A corporation satisfies the PHS stock ownership requirement if more than 50% of the value of its outstanding stock is directly or indirectly owned by five or fewer individuals at any time during the last half of its tax year. A summary of the Sec. 544 attribution rules is revived on p. C:5-1 7. C. Passive Income Requirement. A closely held corporation must also satisfy the passive income test to be classified a PHS. The passive income test is met if at least 60% of the closely held corporation’s adjusted ordinary gross income (AGOG) for the tax year is personal holding company income (PICK). 1.

Adjusted Ordinary Gross Income Defined. Figure C:5-1 illustrates the calculation of AGOG. For most corporations AGOG equals the corporation’s gross income minus its Sec. 1231 and capital gains, and interest, property taxes and depreciation connected with its rental income. 2. Personal Holding Company Income Defined. PICK includes 12 categories of income, which are listed and defined on p. C:5-18. Special exclusions apply to these types of income. These exclusions are summarized in Table C:5-2, which may be used at this point as you summarize the exclusions permitted in computing personal holding company income.

The two exclusions, which should be emphasized, are the following: Adjusted income from rents (AIR) is included in PICK unless the special exception applies for a corporation whose earnings are predominantly rental income. PICK does not include rents if (1) AIR is at least 50% of AGOG ND (2) the dividends-paid deduction equals or exceeds the amount by which nonrenewable PICK exceeds 10% of AGO. (See Example C:5-16. ) Income earned from contracts under which the corporation is to perform personal services and income earned from the sale of such contracts are included in PICK if the two special conditions listed on p.

C:5-21 are met. (See Example C:5-17. ) D. Calculate the PHS Tax. Determination of the PHS penalty tax is illustrated in Figure C:5-2. This figure may be used as you discuss the calculation Of this tax. 1. Calculating the Undistributed Personal Holding Company Income UPCHUCK) Amount. A series of adjustments must be made to taxable income to arrive at UPCHUCK. The positive and negative adjustments are listed beginning at p. C:5-22. These adjustments attempt to convert taxable income into a better measure of income retained by the business.

In addition, a dividends- paid deduction can be claimed for cash and noncoms dividends paid during the year plus consent dividends. 2. Calculating the Tax. The PHS tax is 15% times the UPCHUCK amount. Figure C:5-2 illustrates the PHS tax calculation. E. Avoiding the PHS Designation and Tax Liability Through the use of Dividend Distributions. Consent dividends are hypothetical dividends deemed paid to shareholders on the last day of the corporation’s tax year. Consent dividends permit a corporation to reduce its PHS tax liability when it is prevented from making an actual distribution due to a lack of money.

In addition to consent dividends, five different types of actual cash or property dividends qualify for the dividends-paid deduction. 1. Current Year Dividends. A dividends-paid deduction, however, is not available for preferential dividends. Dividends are preferential when the amount distributed to a shareholder exceeds his ratable share of the striation or the amount received by a class of stock is more or less than its rightful amount. 2. Throwback Dividends. Throwback dividends are distributions paid in the first 2 months after the close of the tax year.

Subject to a dollar limitation (I. E. , 20% of dividends other than cash dividends paid during the year), an election may be made to treat these dividends as a dividend distribution made in the prior year for PHS tax purposes. 3. Liquidating Dividends. A dividends-paid deduction is available for liquidating distributions that are made by a PHS within 24 months of the adoption of a plan of liquidation. 4. Deficiency Dividends. A corporation that determines that it owes the PHS penalty tax can avoid paying the tax by electing to pay a deficiency dividend under Sec. 47. Under this procedure, an income tax is levied on the dividend payment at the shareholder level instead of the payment of the PHS tax at the corporate level. The shareholders include the deficiency dividend in their gross income for the tax year in which it is received, not the tax year in which the PHS claims a dividends-paid deduction. 5. Dividends Carryover. In addition, dividends that are paid in the preceding two tax years can be used as a dividend carryover to reduce the mount of the current years PHS tax liability.

The amount by which dividends eligible for the dividends-paid deduction exceeds SAPPHIC income for the two preceding years can be carried forward and claimed as a dividends- paid deduction in the current year. Topic Review C:5-3 on p. C:5-25 may be used at this point to summarize the provisions of the Personal Holding Company tax. Example C:5-19 illustrates the PHS Tax Calculation. You may wish to use the “What Would You Do in This Situation? ” material on p. C:5-26 to illustrate the planning that must be done when a formerly active corporation becomes a personal holding company.

II. Accumulated Earnings Tax The accumulated earnings tax is a penalty tax assessed on corporations that accumulate income beyond the reasonable needs of their business. An exemption of $250,000 of accumulated earnings is permitted during the corporation’s lifetime. The exemption is limited to $1 50,000 in the case of certain service corporations. A. Corporations Subject to the Penalty Tax. The accumulated earnings tax applies to every corporation used to avoid the income tax on shareholders by permitting earnings and profits to accumulate instead of being divided or distributed.

Corporations exempt from this tax are listed on p. C:5-25. The two primary exceptions are personal holding companies and S corporations. In theory, the penalty tax applies to all corporations. In practice, the tax applies to closely-held corporations where management can utilize the corporate dividend policy to reduce the tax liability of the shareholder group. B. Proving a Tax-Avoidance Purpose. The accumulation of earnings and profits beyond the reasonable needs of the business indicates a tax avoidance motive unless the corporation can prove that earnings are not being accumulated to avoid taxes.

Tax avoidance is indicated, for example, here there are loans made between the shareholders and the corporation, investments are made that have no clear connection with the business, or where there is a low dividend and wage payout accompanied by an accumulation of earnings. Holding and investment companies are held to a stricter standard than are operating companies. C. Evidence Concerning the Reasonableness of an Earnings Accumulation. No single factor has been held to be indicative of an unreasonable accumulation of earnings and profits. A discussion of some of these factors follows: 1.

Evidence of a Tax-Avoidance Motive. A list of factors to be avoided n order to minimize exposure to the accumulated earnings tax is found on p. C:5-27. 2. Evidence of Reasonable Business Needs. Reasonable business needs include reasonably anticipated needs of the business, Sec. 303 redemption needs, and excess business holdings redemption needs. In order to show reasonable business needs, there must be a specific, definite, and feasible plan for the use of accumulations. The Barbuda formula is used for determining working capital requirements. This formula is found on p. C:5-29.

See Example C:5-20 for an application of the Barbuda formula. D. Determining the Accumulated Earnings Tax Liability. Determination of the accumulated earnings tax liability is illustrated in Figure C:5-3, which should be used at this point to illustrate the computation of the accumulated earnings tax liability. The tax is levied ATA 15% rate. The tax base can be reduced by making dividend distributions. Once the IRS or the courts have determined that the accumulated earnings tax is owed, its payment cannot be avoided by deficiency dividends. 1. Accumulated Taxable Income.

The starting point for the accumulated taxable income calculation is the corporation’s tax bled income. A series of positive and negative adjustments is then made in an attempt to invert taxable income into a better measure of income retained by the business. These adjustments are found on p. C:5-31. 2. Dividends-paid Deduction. The dividends-paid deduction is available for four types of distributions. These include dividends paid during the tax year, throwback dividends, consent dividends, and liquidating distributions. The throwback dividend rules are mandatory unlike the PHS tax where it is elective.

Please follow and like us:
Haven’t found the essay you want?