4.5 Consolidated Tax Return

1. Affiliated Group

1) Affiliated group defined

More than 80% of the combined voting power of all outstanding stock AND 80% of the total value of all outstanding stock

2) Controlled group defined

(1) Parent-Subsidiary: 80% of combined voting power OR total value of stock

(2) Brother-Sister

(3) Combined

2. Consolidated Tax Returns

1) Intercompany Dividends

2) Advantage of filing consolidated return

3) Disadvantages of filing consolidated return

3. Transfer Pricing Taxation

4.4 Other Taxes

1. Personal Holding Company Tax

Personal Holding Company (PHC)
(1) Stock ownership: more than 50% owned by 5 or fewer individuals
(2) Gross income: more than 60% of adjusted ordinary gross income as PHC income consisting of dividends, taxable interest, royalties, and net rent.

1) Additional tax assessed
2) PHC tax calculation
Taxable income
- Dividend payments (includes payment within 3.5 months and consent dividend)
= Undistributed income x 20%

3) Consent dividend: not actually distributed, but shareholders include it in gross income

4) Self-assessed tax: Schedule PH

2. Accumulated Earnings Tax (AET)

1) Additional tax assessed
2) Not self-assessed tax
3) AET calculation
Taxable income
- Dividend payments (includes payment within 3.5 months and consent dividend)
- Accumulated earnings credit
= current accumulated taxable income x 20%

(!) Accumulated earnings credit
Greater of (a) $250,000 ($150,000 PSC) or (b) reasonable needs of the business

4.3 Schedule M-1/M-2/M-3

1. Schedule M-1

The reconciliation of the corporation's income per books and its taxable income

1) Income subject to tax - not recorded on books this year
Interest,  rental, and royalty income received in advance

2) Expenses recorded on books - not deducted on this return
(1) Charitable contributions in the excess of 10% of taxable income
(2) 50% of business meals
(3) Estimated liabilities for contingency
(4) Fines and penalties for a violation of a law
(5) Insurance premium on officers' lives where the corporation is the beneficiary
(6) Interest expense incurred to carry tax-exempt municipal and state obligations

3) Income recorded on books - not included on this return
(1) Interest income from municipal or state obligations
(2) Proceeds from life insurance on officers' lives where the corporation is the beneficiary

4) Deductions on this return - not charged against book income
(1) Tax depreciation expense in the excess of books (if any)
(2) Charitable contribution carryover
(3) Sec.179 expense deduction

2. Schedule M-2

"Analysis of Unappropriated Retained Earnings per Book"

3. Schedule M-3

"Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More"

4.2 Corporate Income Tax Return

1. Filing and Payment of Tax

1) Filing requirements: (C corporation) Form 1120 every year

2) Due date and Extension: (C corporation) by 15th day of the fourth month
Automatic six-month extension by filing Form 7004

3) Taxable year: Form 1128 (application to change a tax year)

4) Accrual Basis: for C corporations, partnerships having a C corporation as a partner, or tax shelters

5) Estimated payments of corporate tax: $500 or more and smaller of
(a) 100% of current year's tax (actual or annualized income basis) or
(b) 100% of prior year's tax (if full 12 months and showed tax liability)
*A large corporation must pay 100% of the tax due for the current year

2. Form 1120 Page 1

Gross income - Deductions = Taxable income

3. Gross Income

Gross profit = Gross sales - Cost of goods sold
+ Dividends
+ Interest
+ Gross rent
+ Gross royalties
+ Net capital gains/other gains
+ Other income

1) Prepaid income (include in GI when received)
(1) Interest Income
(2) Rental Income (nonrefundable deposits, cancellation)
(3) Royalty income

2) Tax-exempt income
(1) Interest from municipal or State obligations/bonds
(2) Proceeds from life insurance on officers

4. Deductions

1) Ordinary, necessary, and reasonable expenses

2) Executive compensation

$1,000,000 to CEO, CFO, and three other most-highly officers in a year (publicly held corporation)

3) Bonus accrual

Accrual basis and paid within 2.5 months after the year-end deductible in the taxable year

4) Taxes

Federal income taxes are not deductible.

5) Penalties and illegal activities: not deductible

6) Lobbying and political expenditures: not deductible

7) Interest Expense

30% of EBITDA: Earnings Before Interest Taxes Depreciation and Amortization (carry forward indefinitely)
* Not apply average annual gross receipts are less than $25 million for the prior three years

8) Charitable contributions

10% of taxable income before the dividends received deduction (carry forward for five years)
Accrual basis and paid within 3.5 months after the year-end deductible in the taxable year

9) Depreciation and depletion: the same rules as individuals

10) Organizational expenditure

The first $5,000 to be expensed and the remainder amortized over 180 months (same as individuals)
(1) Include: drafting the corporate charter, bylaws, minutes of organizational meetings, and terms of original stock certificates
(2) Exclude: issuing or selling shares of stock, commissions, underwriter's fees, and the cost incurred in the transfer of assets (syndication cost)

11) Research and development expense

(1) Deducted currently (before 2022)
(2) Amortized over 60 months or more
(3) Capitalized and written off when the project is abandoned

12) Amortization expense

Straight-line basis over a 15-years
Intangibles: goodwill, franchises, licenses, trademark, and covenants not to compete

13) Life insurance premium

(1) The corporation is the beneficiary: not deductible
(2) The insured employee is beneficiary: deductible (employee fringe benefit)

14) Business meals and gifts

Business meals: 50% deductible
Business gifts: $25 per recipient per year

15) Losses

(1) Related party loss: disallowed between more than 50% share

(2) Capital loss
a) Deductible only to the extent of capital gains
b) Carried back 3 years and then carried forward 5 years (as a short-term capital loss)
c) Regular tax rate (add to ordinary income)

(3) Bad debt loss: ordinary loss (direct write-off method, specific charge-off method)

(4) Casualty loss: any loss is deductible (no limitation)

(5) Net operation loss
After 12/31/2017: indefinite carryforward, 80% deduction of taxable income
Before 12/31/2017: 20 years carryforward, 100% deduction of taxable income

16) Dividends received deduction (DRD)

To partially mitigate the effects of triple (multiple) taxations, corporations are allowed DRD.

(1) Entities for which the DRD does not apply
a) Personal service corporations
b) Personal holding companies
c) S corporation

(2) Holding period: more than 45 days

(3) Percentage
a) 100% DRD: received from affiliated (at least 80% owned) corporations
b) 65% DRD: domestic unaffiliated corporations that are at least 20% owned
c) 50% DRD: domestic corporations that are less than 20% owned

<Taxable income limitation>

65%/50% of taxable income before the DRD, NOL, and capital loss carryback
* Exception: if the full 65%/50% DRD creates or increases NOL

5. Corporate Tax Rate

A corporation's taxable income is subject to a flat tax of 21%.
Personal service corporations are also subject to a flat tax of 21%.

6. Tax Credits

1) Foreign tax credit: same as individual

2) General business credit
(1) Combination credit
(2) Limit: not exceed "net income tax" less 25% of regular tax liability above $25,000

4.1 Corporation Formation

1. Shareholder's Tax Consequences

1) General rule
(a) Cash
(b) Service (taxable event)
(c) Property (taxable event)

(!) Sec.351: property (nontaxable event)
No gain or loss is recognized (deferred) by the shareholders if the property is transferred to a corporation solely in exchange for stock and immediately after the exchange those shareholders control the corporation.
(1) Property: everything but services
(2) Control: at least 80% of the total combined voting power and 80% of each class of nonvoting stock
(3) Solely: no receipt of a boot (a receipt of boot will cause recognition of gain) but not loss

2. Shareholder's Basis of Stock

a. Cash - Amount contributed
b. Service - Fair market value (taxable to the shareholder)
c. Property - Adjusted basis (NBV)

1) Property subject to liability (C.O.D.)
(1) Under Sec.351: no gain
(2) The basis is reduced by the amount of liability

2) Excess liability: gain recognized by the shareholder

3) Shareholder's holding period for stock
Include the holding period of property contributed, if that was a capital asset or Sec.1231 assets

3. Corporation Tax Consequences

No gain or loss is recognized in:
a. Formation - issuance of common stock
b. Reacquisition- purchase of treasury stock
c. Resale - sale of treasury stock

4. Corporation's Basis of Property Received

Generally, the same basis as the contributing shareholder's hands (carryover basis)

1) Corporation's holding period for contributed property
Include the period that was held by the shareholders

3.6 Distribution from Partnership

1. Nonliquidating (Current) Distribution

1) General rule: nontaxable

2) Basis of property distributed by the partnership: NBV

3) Reduction in the partner's basis for the partnership interest

4) The assigned basis may not exceed the partner's basis for the partnership interest
(!) Gain recognized by the partner

2. Liquidating (Complete) Distribution

1) Complete withdrawal (liquidation)
(!) Loss recognized by the partner

2) Retirement or death of the partner
(1) Payment for a partnership interest
(2) Other payments: ordinary income

3) Sale of the partnership interest
(1) General rule: capital gain/loss
(2) Hot assets (appreciated inventory or unrealized receivable): ordinary income
(3) Mid-year change of ownership

3.5 Termination of Partnership

1. Termination of Partnership

1) As there are less than two partners
2) As the partnership's business and financial operations are discontinued

3.4 Transaction Between Partner & Controlled Partnership

1. Related Party Loss

1) Related party loss is disallowed (directly or indirectly over 50% of interest)
2) Constructive ownership rule

2. Related Party Gain

1) Ordinary income:
(1) Depreciable asset (2.3 Loss not recognized 2. Related Party Transaction) or
(2) Not capital assets in the hands of the transferee

3.3 Partnership Information Return

1. Pass-thru & Form 1065

1) Separate line items: Schedule K -> K-1
(1) Charitable contributions
(2) Capital/Sec.1231 gain and loss
(3) Net income (loss) from rental activity
(4) Interest and dividend income
(5) Sec179 expense deduction
(6) Investment interest expense
(7) Partner's health insurance premiums
(8) Keogh (retirement) plan contribution for partners
(9) Tax credits
(10) Foreign income tax
* Guaranteed payments to partners
* Ordinary business income/loss

2) Other: Form 1065 Page 1

2. Guaranteed Payments

(1) Partnership: tax deduction
(2) Partner: taxable income - Form 1040 Schedule E (Schedule SE)

1) Payments not guaranteed: distribution
2) Fringe benefits: partnership: tax deduction, partner: taxable income

3. Organizational Expenditures

Organizational expenditure: first $5,000 to be expensed and the remainder is amortized over 180 months

(1) Included costs
The filing fee, accounting fees for establishing the initial accounting system, and legal fees for negotiating and preparing partnership agreements

(2) Excluded costs
Expenditures connected with issuing and marketing of interests in the partnership (e.g. offering materials) (syndication cost)

4. Distributive Share

1) Distributive share: the partnership agreement

2) Special allocation - Sec. 704
Precontribution gain or loss must be allocated to the contributed partner

5. Partners' Tax Reporting

1) K-1 to Form 1040
K-1 line 1: ordinary business income (loss) -> Schedule E (passive or nonpassive)
K-1 line 5&6: Interest and dividends -> Schedule B
K-1 line 8&9: Capital gain (loss) -> Schedule D
K-1 line 13: Other deductions: charitable contribution -> Schedule A

2) Reporting partnership losses: loss limitation
(1) Limited to basis / "At-Risk" basis
(2) Carryforward of losses indefinitely
(3) Passive activity loss limitation (if not materially participate)
(4) Excess business loss limitation: $250,000/$500,000

6. Taxable Year of Partnership

1) Calendar year (Generally required)
2) Fiscal year: maximum three-month deferral

3.2 Partner's Basis of Partnership Interest

1. Original Basis

1) Property subject to liability
The basis is reduced by the resulting decrease in the partner's individual liability.

2) Excess Liability: Gain recognized by the partner
The basis is zero

2. Partnership Operation: Partner Basis Formula

1) Effect of subsequent transactions
(1) Subsequent contribution: increase a partner's basis
(2) Subsequent withdrawal: decrease a partner's basis

2) Effect of partnership income/loss (pass thru)
(1) Distributive share of income/gain: the partner's basis increase by ALL INCOME
(2) Distributive share of loss/Expense: the partner's basis decrease by ALL LOSSES

3) Effect of partnership's liability
(1) Increase in the partnership liability: increases each partner's basis
(2) Decrease in the partnership liability: decreases each partner's basis

3.1 Partnership Formation

1. General Rule

No gain or loss is recognized by the partner

2. Exceptions to Non-recognition of Gain

(1) Capital Interest acquired for services rendered: FMV
(2) Property subject to (excess) liability: NBV

3. Original Basis

1) Partner's basis of the partnership interest (outside basis)
Cash: amount contributed
Service: FMV (taxable)
Property: adjusted basis (NBV)

2) Partnership's basis of contributed property (inside basis)
Partner's adjusted basis (NBV)

4. Holding Period

1) Partner's holding period for the partnership interest
The contributed property was a -
(a) capital asset or Sec. 1231 asset: include the holding period of the property contributed
(b) ordinary income assets: begin on the date the property is contributed

2) Partnership's holding period for contributed property
It includes the period of time the property was held by the partner.

2.4 Section 1231 and Recapture

1. Section 1231 Assets

Sec. 1231 assets are real or depreciable business property held for more than one year.

2. Tax Treatment for Sec. 1231 Assets

1) Sec. 1231 gains
Lower capital gain tax rate (15% for most taxpayers)

2) Sec. 1231 losses
Ordinary loss

3) Netting procedures of Sec. 1231 gains and losses

3. Recapture Provision of Sec. 1245

1) Section 1245 asset
Sec. 1245 assets are generally depreciable personal property.

2) Section 1245 recapture
All accumulated depreciation is recaptured as ordinary income.

4. Recapture Provision of Sec. 1250

1) Section 1250 asset
Section 1250 assets are depreciable real property.

2) Section 1250 recapture

3) Section 291 recapture (for C corporations)

2.3 Loss Not Recognized (Nondeductible)

1. Wash Sales

Within 30 days before or after the sale date

(1) Basis of new security
 = Purchase price of new security + Loss not recognized

(2) Holding period of new security

(3) Gain recognized

2. Related Party Transaction

1) Related parties defined
(a) Husband and wife
(b) Brothers and sisters
(c) Lineal descendants (father, son, grandfather)
(d) Entities that are more than 50% owned
(e) Personal service corporation and any of its owner-employee

2) Related party loss: disallowed
Any gain recognized on related-party sales transactions is ordinary income if the property is a depreciable asset in the hands of the transferee

3) Basis of buying relative: cost basis
However, future gain on the disposition of the property is reduced by the amount of the disallowed loss.

3. Personal Losses (Not Bussiness or Investment)

No deduction is allowed

2.2 Gain Not Recognized (Nontaxable)

1. Like-Kind Exchange

1) "Like-Kind" property defined
Real property held for investment or used for trade or business

2) Boot
(1) Boot: cash, unlike-kind property, C.O.D
(2) Receipt boot
Gain recognized lesser than realized gain or FMV of boot received
* Giving boot: no gain/loss

(3) Basis of property received
= Adjusted basis of the property given up (carryover basis)
 + Gain recognized
 - FMV of boot received
 - Loss recognized
 + Basis of boot given

(4) Holding period of property received

2. Involuntary Conversions

(condemnation, theft, seizure or fire)

1) Replacement property defined: similar or related
2) Time limitation of replacement
Personal use property: two years from year-end
Business property: three years from year-end

3. Homeowner's Exclusion

Sale of Personal Residence ($250,000)

(1) To qualify for the full exclusion: Two years or more during the five-year period

(2) Nonqualified use provision
The exclusion amount is not adjusted, but the portion of the gain attributable to the nonqualified use is not eligible for the exclusion.
Exclusion = period of nonqualified use / total period x gain

(3) Partial (on a prorated basis) exclusion

(4) Multiple-use of exclusion
(5) No age and replacement residence

4. Divorce Property Settlement

5. Installment Sales