REG 3 Text Notes

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Chapter 3: Corporation
Formation:
1. Corporate Tax Consequences a. GR: no gain or loss recognized b. Basis of property: it is the greater of i. Adjusted NBV (plus gain recognized by the shareholder) or ii. Debt assumed by corporation c. In case if the FMV > NBV, the basis will be FMV 2. Shareholder Tax Consequences a. No gain or loss recognized if two condition exists: i. 80% control ii. Boot not involved (received): Cash, Cancellation of Debt (NBV ± Liabilities = Excess liability = Boot (gain)) b. Basis of common stock ( to shareholder) i. Cash ± amount contributed ii. Property ± adjusted basis (NBV) 1. It is reduced by any debt 2. Add: taxable boot, debt > basis ± to bring stock basis to zero iii. Service ± FMV (Taxable)

Operation:
3. Charitable Contribution a. 10% of Adjusted Taxable Income Limitation b. Before the deduction of i. Charitable contribution deduction ii. The DRD iii. NOL Carry back iv. Capital loss carry back v. UP production activities deduction 4. Business losses or casualty losses related to business a. Ordinary loss or capital loss i. Partially destroyed: lesser of 1. Decline in value of the property or 2. Adjusted basis of property immediately before the casualty ii. Fully Destroyed (NBV): loss amount is adjusted basis of property 5. Organizational Expenditures and Start-up Costs a. Deduct up to $5K of organizational expense AND $5000 of start up costs. b. Each is reduced by the amount which the organizational expense or start up costs exceeds $50K, respectively. c. Excess is amortized over 180 months 6. Purchased Goodwill: amortized on SL over 15 years 7. Capital Gain or Losses a. Capital losses deduction not allowed: no $3K deduction like individual. It only used to offset capital gain b. Carryover: 3back/5foward c. Taxed as ordinary income 8. NOL: 2back/20forward 9. General Business Credit a. Formula: net income tax less the greater of

i. 25% of regular tax liability above $25K or ii. Tentative Minimum Tax for the year. 10. Dividend Received Deduction: formula a. Gross Income (includes Dividend income) b. <Deductions>: not included for charity deduction and DRD) c. A d. <Charity>: max is 10% of A, not gifts, not political, 5 year carry forward e. B f. DRD: (1st corp. is taxed, owned 45 days before or after. Income: 100% (80% ~ 100%), 80% (20% ~ 80), 70% (under 20%). Limited to % of B (smaller of the two). Exception: if taking the full % of dividend income will create or adds to a loss, then take the bigger half instead) g. Taxable income of Loss h. Entity which DRD doesn¶t apply i. PSC ii. PHC iii. S Corp 11. Depreciation a. MACRS: Real Estate i. Residential Rental Property: 27.5 years SL: apartments, duplex rental homes. ii. Non-Residential Real Property: 39 year SL: office buildings and warehouses iii. Mid-Month convention: ½ month is taken in the month the property is placed in service. ½ month is taken for the month in which the property is disposed of. b. Mid Quarter: placed in service during last quarter of the year (if more than 40% of depreciable property placed during last quarter) c. Half-year: placed in service other than last quarter of the year (applies to personal property) d. Expense Deduction of Section 179 i. May deduct fixed amount of depreciation ii. Limit is$250K of new or used property that is acquired during the year iii. Max amount is reduced dollar for dollar if the amount placed in service during the year exceeds $800K iv. Deduction not allowed if it creates a loss v. SUVs: expense up to $25K. 12. Summary of Section 1231, 1245, and 1250 Assets a. Section 1231: comprised of depreciable personal and real property used in trade or business and held over 12 months i. Capital Gain Treatment: Long-Term Capital Gain ii. Ordinary Loss Treatment: ALL LOSSES ARE SECTION 1231 LOSS TREATED AS ORDINARY LOSS b. Section 1245 ( M&E Gains Only) i. Personal properties used in a trade or business for over 12 month (cars) ii. Recapture all Accumulated Depre 1. Less of a. Gain recognized or b. All accumulated depre recaptured as ordinary income 2. Any remaining gain is Section 1231 Gain (long Term Capital Gain) c. Section 1250 (Buildings Gains Only)

i. Real properties used in trade or business over 12 month (warehouse) ii. Recapture difference between SL and Depreciation taken: When depre taken > SL Depre -> gain is treated as ordinary iii. SL Depreciate Taken: amount taken results in the overall gain being taxed at 25% iv. Excess Gain is Section 1231 Gain: any gain in excess of original cost less SL Depre would be allowed section 1231 long term capital gain

Taxation
1. Filing Requirements a. Extension Form 7004 for 6 month b. Accrual Basis vs. Cash Basis i. Cash Basis: individuals, qualified PSC, and taxpayers who average annual gross receipts DO NOT EXCEED $1M ii. Accrual Basis: purchases and sales of inventory, tax shelters, farming corporations, C corporations, partnerships have C Corp. provided has greater than $5M of average annual gross receipts for 3 year ending with tax year. 2. Estimated Payments of Corporate Tax: use annualized income method. Penalty assessed if amount owed on return is $500 or more. a. Small Corporations: lesser of i. 100% tax shown on the return for the current year or; ii. 100% tax show on the return for the preceding year. b. Large Corporations: whose taxable income was more than $1M can do in any of three ways: i. 100% on current statement ii. May not use preceding year¶s return. c. Corporate AMT: subject to minimum 20% on AMTI ± exemption amount ($40K). Same objective like individual. i. Regular Taxable Income: before NOL deduction ii. Adjustments (add back or minus) 1. Long Term contracts 2. Installment sale dealer 3. Excess depreciation (post 1986) iii. Preferences (add back) 1. Percentage depletion 2. Private activity ± issued post ¶86 tax exempt interest income 3. Pre ¶87 ACRS excess depr iv. Adjusted Current Earnings (ACE) (addback) 1. Muni interest income: tax exempt interest income 2. Increase CSV life insurance 3. Non S/L Depreciation: after 1989; excess over alt depre sys life 4. DRD: under 20% ownership v. <AMT NOL Deduction> vi. AMTI vii. <AMT Exemption>: $40K ± 25% of MTI over $150K viii. AMT ix. X 20% x. Gross AMT xi. <Foreign Tax Credit> xii. Tentative MT xiii. <Regular Tax Liability>

xiv. Alternative MT d. Accumulated Earnings Tax i. imposed on regular C crop for retained earning that excess of $250K ii. PSC is only $150K limit iii. Not on PHCs, tax-exempt corp, or passive foreign investment corp iv. Tax rate is 15% v. It is an IRS-assessed as a result in case of corporation audit e. Personal Holding Company Tax i. Formed by high tax bracket taxpayers to channel their investment income by the low normal tax (15% - 25%) ii. Defined as corp more than 50% owned by 5 or fewer individuals (directly or indirectly) and having 60% adjust ordinary gross income consisting of: 1. Net rent 2. Interest that is taxable 3. Royalties 4. Dividends from an unrelated domestic corp. iii. Additional Tax Assessed: 15% on PHC for net income not distributed iv. Not subject to Accumulated earnings tax v. Self Assessed Tax f. Personal Service Corporation: Flat 35% tax rate. Performing acctg, law, consulting, engineering, architecture Distribution 1. Dividends Defined: DO NOT NET THEM TOGETHER, TREAT SEPRATELY a. Current E&P (by Y/E) = taxable dividend (1st) b. Accumulated E&P (Dist. Date) = Taxable dividend (2nd) c. Return of Capital (No E&P) = tax free and reduces basis of common stock (3rd) d. Capital Gain Distribution (No E&P/ No Basis) = taxable income as a capital gain (4th) 2. Corporation Paying Dividend ± Taxable Amount a. Property dividend: i. Distributed appreciated property ii. Recognize gain as if the property had been sold ( FMV Property ± NBV = Gain (goes to E&P)) 3. Stock Redemption: corporation buys back from stock holders a. Proportional ± taxable dividend income (to shareholder-ordinary income) b. Disproportional (substantially disproportionate) ± sale by shareholder subject to taxable capital gain/loss to shareholder

Liquidation
1. If liquidated, transaction is subject to double taxation (corporate and shareholder level) 2. Corp sells assets and distributes cash to shareholders a. Recognize gains or losses: Sales price ± Basis = taxable gain/loss (1st tax) b. Shareholder recognize gain or loss to extent cash exceeds adjusted basis of stock: Proceeds ± stock basis = taxable gain/loss (2nd tax) 3. Corporation distributes assets to shareholder a. Corp recognize gains or loss as if it sold the assets for the FMV: FMV ± Basis = Taxable Gain/Loss (1st Tax) b. Shareholder recognize gain or loss to extent FMV of Assets received exceeds the adjusted basis of stock: FMV ± Stock Basis = Taxable Gain/Loss (2nd tax)

4. Tax- Free Reorganization a. Mergers of consolidation (typeA) b. Stock for Stock ( TypeB) c. Stock for assets (typeC) d. Dividing corp into separate operating corp (TypeD) e. Recapitalization (TypeE) f. Mere change in form, identity, place of organization (Type F) 5. Worthless Stock ± Section 1244 Stock (small business stock) a. When become worthless, original stockholder can be treated as a ORDINARY LOSS (FULLY TAX DEDUCTIBLE) , instead of a capital loss, up to $50K ($100K MFJ). Any excess will be capital loss to offset capital gain up to $3K b. 50% exclusion of Gain: holds qualified small business stock for more than 5 year, may exclude 50% of gain

Chapter 3: S Corporation
1. Eligibility a. Must be domestic corp b. S corp may own any interest (even 100%) in a C corp c. May not file consolidated return with C corp d. May create a sub S corp e. Two S can file as one entity 2. Eligible Shareholders a. Individual, estate, or certain types of trust b. C Corp and partnership are not allowed c. Only US people 3. Shareholder Limit a. No more than 100 shareholders b. Family members count as 1 4. One class of Stock a. May not have more than one class of stock outstanding b. Voting and non-voting are allowed 5. Electing S Crop a. By march 15 for the whole year b. Any other will be next year 6. S Corp Tax Year: GR 12/31 is year end. Form 1120S 7. No Tax on S Corp: all earnings are pass through shareholders 8. Corporate Level Taxes a. Life Recaptures b. Built-In Gain Tax i. An unrealized built-in gain results when: 1. A Corp elect S corp status 2. The FMV of corporate assets > adjusted basis of corporate assets on the election date 3. Amount of built-in gain recognized in any one year is limited to the net unrealized ³built-in´ gain less any ³built-in gain´ previously recognized ii. Exemptions from Recognition of Gain 1. S Crop was never a C corp 2. Sales or transfer does not occur within 10 years of the first day of the first year that the S election is made

3. S corp can demonstrate that the appreciation occurred after the S election iii. Tax Rate: 35% 9. Effect of S Corporation election on Shareholders a. Pass-through of income and/or losses (to shareholder/K-1) i. Report both separately and non-separately stated items of income and/ or loss ii. Allocated to shareholder is on a per-share, per-day basis iii. Losses are limited to shareholder¶s basis which also includes shareholder¶s loan made to S crop. Guarantees does not increase basis (different from partnership) 10. AAA ± Accumulated Adjustments Account a. The accumulated earnings since inception b. It is 0 at the inception of S Crop. c. AAA increased by separately and non-separately stated income d. AAA decreased by separately and non-separately stated expense and loss 11. Computing shareholder Basis in S Corp. Stock: B-A-S-E a. Initial basis + income + additional shareholder investment ± distribution ± loss or expenses = ending basis. b. Loss limitation = basis + direct shareholder loans ± distributions 12. Taxability of distributions to shareholders a. S Corp. with NO C corp. E&P i. To extent of basis in stock = return of capital (1st) ( not subject to tax) ii. In excess of basis of stock = capital gain distribution (2nd) (taxable as long term capital gain if held over a year) b. S Corp. with C Corp. E&P i. To extend of AAA = S Corp profits (already taxed) (1st) ii. To extend of C Corp E&P = Old C Corp taxable dividend (taxed as a dividend, doesn¶t reduce basis) (2nd) iii. To extent of basis in stock = return of capital (not subject to tax) (3rd) iv. In excess of basis in stock = capital gain distribution ( taxed as long-term capital gain) (4th) 13. Terminating the Election a. When S Corp Terminates i. Holders of a majority of the corporation¶s stock consent to a voluntary revocation ii. Corporation fail to meet the requirements as being a S Corp iii. More than 25% of the corporation¶s gross receipt come from passive investment for 3 consecutive years b. Re-Electing: 5 years of IRS¶s consent to earlier election.

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