Professional Documents
Culture Documents
Types of Businesses
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Taxpayer is owner(s) of flow-through type entities
Sole proprietorship
Partnerships
S Corporations
o
Taxpayer is corporation
C Corporation is taxed first, then shareholders may be taxed on distributions, resulting in double taxation
Sole Proprietorship
What does IRC section 162 provide with regard business expenses?
Utilities, Home mortgage interest and taxes (*), Insurance, Repairs, Depreciation
o
Home office deduction cannot exceed taxable income of the business before this deduction
o
(*) Reduces the amount reported in schedule A
Employer portion:
o
FICA = 6.2% Social Security tax on wages up to $117,000 (2014) + 1.45% Medicare tax on all wages
Employee portion:
o
FICA = 6.2% Social Security tax on wages up to $117,000 (2014) + 1.45% Medicare tax on all wages
Owner is treated as self-employed persons who will pay SE tax on net earnings from self employment
Self-employment tax is paid via estimated tax payments and your 1040 rather than through withholdings as for employees
50% of self-employment tax (2014) on Form 1040 as deduction or adjustment from gross income for AGI
o
Artificial legal entity separate and distinct from its owners
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Corporations have shares of stock- authorized & outstanding
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Shares or ownership can be closely-held or widely-held like a publicly held corporation traded on one of the exchanges
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Articles of incorporation and bylaws
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Shareholders, board of directors, officers and employees
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Registration & annual fillings with state corporation commissions
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Examples: Regular C Corp., S Corp, & Associations
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Distinguish from the Limited Liability Company or LLC
What are the legal characteristics of a corporation?
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Limited liability
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Unlimited life
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Free transferability
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Centralized management
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Big issue for IRS back in the late 70s and 80s with limited liability partnerships, LLCs and publicly traded LLPs whether they could be partnerships versus
corporations matter largely resolved today by the check the box regulatory guidance. The States played a big role in creating greater options for choice
of entities
What is the big issue on corporations?
o
Double taxation:
Shareholders in turn pay tax on the distributions (e.g. dividends) they receive from the corporation
Mitigated by qualified dividends for individuals and dividend received deduction for corporations receiving dividends
What is a single corporation? Affiliated Group?
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Single corporate entity
Corporation with shareholders who are individuals and/or corporations who are not significantly related
o
Multiple corporation entities connected through ownership
5 or fewer persons own 80% of the stock of two or more corps and these persons common or identical ownership exceeds 50%
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New Law
5 or fewer persons owned the stock of two or more corporations and these persons have common or identical ownership that exceeds
50%
How do you determine taxable income of a corporation?
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Start with book net income or financial statements
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Determine the financial or book to tax differences
so called M-1 items or M-3 items found on schedule M-1 or M-3 of 1120
Taxable income is computed with regard to NOL and capital loss carryovers (forward)
Charitable contributions in excess of the limitation may be carried forward 5 years and deducted as long as contributions do not exceed 10% of
taxable income
What is the domestic production activities deduction?
o
Congress wanted to reduce the tax burden for domestic production activities to incent business to invest in US based production activities.
o
Domestic production activities deduction is available for US taxpayers who derived:
Income from qualified activities of leasing, selling, licensing, etc of tangible property, computer software and sound recordings
From manufacturing, producing, growing or extracting activities within the US
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The deduction equals the lesser of 9% times:
The corporations net income from the qualified activity or
Taxable income computed before the deduction.
This is an additional deduction over and above the ordinary and necessary expenses used in computing the net income from the qualified activity or
taxable income
What is the M-1, M-2 and M-3 of the Form 1120?
o
M-1 reconciles net income or loss for book purposes and taxable income before NOLs and dividend received deduction
o
M-2 reconciles beginning and ending retained earnings from the schedule L on the 1120
o
M-3 is detailed book to tax differences for large corporations with 10 Million and more in assets
Surtax recaptures the 15% and 25% rate in the 100K to 335K bracket
Plus/minus: AMT adjustments (like depreciation and ACE) Plus: AMT preferences
Amount of cash is taxable to the extent of current and accumulated E&P (E&P)
o
Distributions of property
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Unearned income tax of 3.8% on net investment income
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Existence of alternative choices of entity in some cases
Dividends are part of the total return
After tax return would reflect dividends (net of tax)
After tax return would reflect capital gains on disposition (net of tax)
Growth stocks typically do not pay dividends
Total return is tied to growth in stock value
After tax return would reflect capital gains on disposition (net of tax)
Distributions to corporate debt holders on debt instruments:
Public corporate bond market
Debt holders or creditors receive interest income and principal payments
Interest payments are part of the return to credit/debt holders
Interest payments are deductible and taxable to the debt holder or creditor
Principal payments are a payment of debt and not deductible while the payments are return of debt to the holder and not taxable
Sale of bonds may appreciate or depreciate based on interest environment
Chapter 13
What else?
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Some states use a gross receipts tax levied on the corporation:
Total gross receipts in the state (not a sales or use tax)
Net gross receipts (reduced for CGS or compensation)
Business and occupation tax
o
Using different rates by industry and no reduction for expenses
o
Tax planning for state income involves:
High and low state tax rates: choice of property, location of plants with employees
Typically, you are taxed only by your home country unless you create permanent establishment through your physical presence and activities
Existence of a permanent establishment in a foreign country:
Income attributable to the permanent establishment is taxable in the foreign country under based on the jurisdictions individual laws
o
The existence of a bilateral treaty provides guidance on the existence of permanent establishment and other potential implications of doing business.
o
The nonexistence of a bilateral treaty creates more uncertainty to the implications of doing business and is highly subjective (e.g. presence of
employees)
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There are guides produced on doing business in X, Y and Z countries
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The legal implications and protections are as important
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Management oversight is a big issue too
US companies, citizens, and residents can elect to take a foreign tax credit annually
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Foreign tax credit is in lieu of the foreign tax deduction
Arrives at the portion of foreign sourced income doubled taxed at the US tax rate typical tax credit approach
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A good summary:
The U.S. will only grant a credit up to the amount of [U.S. tax rate x foreign source taxable income]
FTC limit = U.S. tax x (foreign income / worldwide income)
If the firm has paid more foreign tax than the FTC limit, the firm is allowed 1 year carryback, 10 year carryforward
o
Carryovers are limited to the annual
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FTC limit discussed above
Sole proprietorship
Partnerships
S Corporations
o
Taxpayer is corporation
C Corporation is taxed first, then shareholders may be taxed on distributions, resulting in double taxation
Debt to equity