Problem 3 C Corporation Form 1120 - PowerPoint

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Problem 3 C Corporation Form 1120 - PowerPoint Powered By Docstoc
					                                         Slide C3-1

For Next Class:
  Read Chapter 3, pages 38 – 41
   (review previously read pages 1-24)
  Problems: C3-58, C3-59, and C3-61
Chapter   3
      The Corporate Income Tax
Dividends-Received Deduction
                                                     Slide C3-4

  Dividends-Received Deduction
Mitigates triple taxation of corporate income
Deduction applies to:
  Dividends received by U.S. corporations from other U.S.
   Corporations [IRC §243(a)]
  Dividend must not be from a corporation that is tax-
   exempt under IRC §501 [IRC §246(a)(1)]
                                             Slide C3-5

  Dividends-Received Deduction
Deduction percentages [IRC §243(a) & (c)]
  70% DRD if ownership < 20%
  80% DRD if 20% < ownership < 80%
  100% DRD if 80% < ownership
                                               Slide C3-6

  Dividends-Received Deduction
Deduction is limited to a percentage of taxable
 income [IRC §246(b)(1)]
  70% limit if DRD is 70%
  80% limit if DRD is 80%
  Unlimited if DRD is 100%
                                                Slide C3-7

  Dividends-Received Deduction
[IRC §246(b)(1)] Limitation on DRD is based on
 taxable income calculated with:
  Charitable contributions deduction allowed
  Capital loss carryforwards allowed
But without:
  Dividends-received deduction
  NOL carrybacks or carryforwards
  Capital loss carrybacks
  IRC §199 deduction
                                                         Slide C3-8

 Example 7: Charitable Contributions
The XYZ Corporation has a $55,000 tax net operating loss
 carryforward from last year. In addition, the corporation
 reported the following income and expenses in its financial
 statements for the current year:
  Operating income                        $1,800,000
  Dividend income (15% owned companies)      175,000
  Charitable contributions                  (300,000)
  Net income before taxes per books       $1,675,000

  Contributions in excess of 10% limit     $108,000
                                                       Slide C3-9

               Example 8: DRD
Using the information from Example 7 above,
 what is the XYZ Corporation’s dividends-received
 deduction and taxable income before the IRC
 §199 deduction for the year?
     DRD = 175,000 x 70% = $122,500
     Net income before taxes per books   $1,675,000
     Add: Nondeductible contributions       108,000
     Total                               $1,783,000
     Limit 70%                           $1,248,100
                                                          Slide C3-10

             Example 8: DRD
    Net income before taxes per books          $1,675,000
    Add: Nondeductible contributions              108,000
    Less: DRD allowed                            (122,500)
    Less: NOL carryforward                        (55,000)
    Taxable income before IRC §199 deduction   $1,605,500
                                               Slide C3-11

  Dividends-Received Deduction
Exception to the taxable income limitation: The
 taxable income limitation does not apply in years
 for which the DRD creates or contributes to a net
 operating loss [IRC §246(b)(2)]
                                                  Slide C3-12

             Example 9: DRD
What amount of DRD and taxable income (before
 the IRC §199 deduction) does a C corporation
 have in each of the three independent situations
 below (the dividends are from companies that are
 less than 20% owned)?
                          (a)    (b)     (c)
  Dividend income      $50,000 $50,000 $50,000
  Other taxable income 80,000 (10,000) (30,000)
  TI before DRD       $130,000 $40,000 $20,000
                                              Slide C3-13

                  Example 9: DRD
                      (a)       (b)         (c)
Dividend Income       $50,000   $50,000     $50,000
Other Income           80,000   (10,000)    (30,000)
TI before DRD        $130,000   $40,000     $20,000

1. Dividend x 70%     $35,000   $35,000     $35,000
2. TI x 70%           $91,000   $28,000     $14,000
DRD allowed           $35,000   $28,000     $35,000

TI b/f IRC §199       $95,000   $12,000    $(15,000)
                                                    Slide C3-14

  Dividends-Received Deduction
  No DRD is allowed if the stock was held < 46 days
   during the 91-day period beginning 45 days before the
   ex-dividend date [IRC §246(c)(1)(A)]
  Short sales are treated similarly [IRC §246(c)(1)(B)]
                                                Slide C3-15

            Example 10: DRD
Purple Corp. purchases 500 shares of White
 Corp. on March 18th. White Corp. pays dividends
 of $10,000 to Purple Corp. on April 15th (the ex-
 dividend date was March 30th). Purple Corp. sold
 the 500 shares of White Corp. on April 28th.
  45 days before March 30th is February 13th
  91 days from February 13th is May 14th
Purple Corp. gets no DRD since the stock was
 only held 42 days during the 91 day period
                                                   Slide C3-16

  Dividends-Received Deduction
  Dividends received deduction is reduced by the average
   indebtedness percentage if the stock portfolio is debt
   financed [IRC §246A(a)]
                                              Slide C3-17

            Example 11: DRD
The XYZ Corporation received $50,000 in
 dividends from U.S. corporations that are less
 than 20% owned. The average indebtedness on
 the corporations stock portfolio was 63%. What is
 the DRD allowed?
Answer: $50,000 x 70% x (1 – 63%) = $12,950
Net Operating Loss Deduction
                                                   Slide C3-19

         Net Operating Losses
Net operating losses
  NOL is the amount by which allowable deductions
   exceed taxable gross income [IRC §172(c)]
  NOLs are generally carried back 2 years and forward
   20 years [IRC §172(b)]
  Election to waive carryback and carry forward only
   [IRC §172(b)(3)]
     Check the box on Form 1120
     Election is irrevocable
                                                        Slide C3-20

              Example 12: NOL
A C corporation had the following taxable income and
 taxes paid for the first three years of operations:
  Year 1 $91,000 ($20,550 in taxes paid)
  Year 2 $50,000 ($7,500 in taxes paid)
  Year 3 $120,000 ($30,050 in taxes paid)
In the current year (Year 4), the corporation has a NOL of
 $(475,000). Taxable income for the next two years (before
 any NOL carryforwards) is projected to be:
  Year 5 $400,000 ($136,000 in taxes paid)
  Year 6 $600,000 ($204,000 in taxes paid)
Assuming an 8% discount rate, should the corporation
 elect to waive the NOL carryback?
                                                    Slide C3-21

               Example 12: NOL
Without election:    Year 2        Year 3        Year 5
TI before NOL         $50,000      $120,000      $400,000
NOL deduction         (50,000)     (120,000)     (305,000)
TI after NOL                  $0            $0    $95,000

Tax before NOL         $7,500       $30,050      $136,000
Tax after NOL               0             0        20,550
Tax savings            $7,500       $30,050      $115,450
PV Factor               1.000         1.000        0.9259
PV of tax savings      $7,500       $30,050      $106,898
NPV of tax savings   $144,448
                                               Slide C3-22

             Example 12: NOL
With election:                  Year 5      Year 6
TI before NOL                   $400,000    $600,000
NOL deduction                   (400,000)    (75,000)
TI after NOL                           $0   $525,000

Tax before NOL                  $136,000    $204,000
Tax after NOL                          0     178,500
Tax savings                     $136,000     $25,500
PV Factor                         0.9259      0.8573
PV of tax savings               $125,926     $21,862
NPV of tax savings   $147,788
IRC §199 Deduction
                                                  Slide C3-24

 U.S Production Activities Deduction

IRC §199 was added October 2004 and is
 effective for tax years beginning after 2004
IRC §199(a) allows a deduction equal to a
 percentage of the lesser of:
 (1) qualified production activities income, or
 (2) taxable income before this deduction
The percentages are:
  3% for 2005-2006
  6% for 2007-2009
  9% beginning in 2010
                                                Slide C3-25

 U.S Production Activities Deduction

Limitation: U.S. production activities deduction
 cannot exceed 50% of the corporation’s W-2
 wages for the year [IRC §199(b)]
                                                    Slide C3-26

 U.S Production Activities Deduction

Qualified production activities income is defined in
 IRC §199(c)(1) as:
  Domestic production gross receipts [IRC §199(c)(4)]
  Less: Allocable cost of goods sold
  Less: Other directly allocable deductions
  Less: Ratable portion of other deductions

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