Chapter 11 - The Corporate Taxpayer

Chapter11
QuestionsandProblemsforDiscussion
1.

Individualswhoperformprofessionalservicesforclients(doctors,attorneys,CPAs,etc.)cannot
avoidliabilityformalpracticebyoperatingasshareholder/employeesofacorporation.These
individualsremainpersonallyresponsiblefortheiractionsandcanbesuedfornegligenceor
misconduct.

2.

a. Theshareholdersofapubliclyheldcorporationelectaboardofdirectorstomanagethe
corporationontheirbehalf.Theboardofdirectorsisresponsibleforhiringthecorporateofficers
andotherkeyemployees.Underthiscentralizedstructure,theownersofthebusiness(the
shareholders)donotparticipateinmanagementdecisions.
b. Incontrast,theshareholdersofacloselyheldcorporationusuallyserveastheboardofdirectors
andaretypicallyemployedtomanagethecorporatebusiness.Inthiscase,managementisnot
centralizedbutisretainedbythebusinessowners.

3.

a. Equitystockinpubliclyheldcorporationsisahighlyliquidassetthatcanbefreelyboughtorsold
throughestablishedsecuritymarkets.Thesepublicmarketsdeterminethepriceatwhichthe
stockistraded.
b. Equitystockincloselyheldcorporationsisboughtorsoldthroughprivatemarkets.Transfersof
stockmaybeinfrequent,andthestocksvalueisnotdeterminedbythemarketbutbyreference
totheunderlyingvalueofthecorporateassets.Suchstocktypicallyissubjecttobuysell
restrictionsthatpreventtheownersfromtransferringstockunlesstheothershareholdersagree.
Consequently,thestockmaynotbefreelytransferableatall.

4.

Thethreefamilycorporationsformabrothersistercontrolledgroup,butnotanaffiliatedgroup.
Consequently,thethreecorporationsareineligibletofileaconsolidatedreturn.

5.

AlthoughRPlegallycontrolsQV,its59percentownershipfallsfarshortofthe80percentrequiredto
formanaffiliatedgroup.Consequently,RPandQVareineligibletofileaconsolidatedreturn.

6.

Librettomaywanttoisolatetheriskassociatedwiththemusicvideobusinessbyoperatingthe
venturethroughawhollyownedsubsidiary.Thesubsidiarycanhaveauniquemanagement
structureanditsowncorporateofficerswhoaresolelyresponsibleforthesuccessofthe
subsidiarysspecializedbusiness.

7.

Thedividendsreceiveddeductionwasenactedtomitigatethedoubletaxthatwouldoccurwhenone
corporationsubjecttofederaltaxdistributesaftertaxincomeasadividendtoasecondcorporation
alsosubjecttofederaltax.Ifthedistributingcorporationisaforeigncorporationnotsubjecttofederal
tax,theproblemofdoubletaxationbytheUnitedStatesgovernmentdoesntarise,andthe
dividendsreceiveddeductionisunnecessary.

8.

Congressenactstaxpreferencesasincentivesforallcorporationstoengageincertainbehaviors.
WhileCongresswantstheseincentivestoworkonamacroeconomiclevel,itdoesnotwantanyone
corporationtobenefittoomuchfrompreferences.Consequently,theAMTpenalizesoverindulgence
inpreferencesatthemicroeconomiclevel.

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Chapter 11 - The Corporate Taxpayer

9.

Becausethe20percentAMTrateissomuchlessthanthe34or35percentregularcorporatetax
rate,AMTImustbesignificantlygreaterthantaxableincomebeforeacorporationowesanAMT.
Evidently,CorporationVroutinelyhasinsignificantAMTadjustmentsandpreferences,butnot
enoughtotriggertheAMT.

10. Acorporationismerelyaforminwhichpeople(owners,employees,suppliers,customers)
participateinabusinessactivity.Anytaxleviedontheactivitynecessarilyreducestheaftertax
valueoftheactivitytosomegroupofparticipants.
ApplicationProblems
1.

AlphaistheparentcorporationofanaffiliatedgroupconsistingofAlphaandBeta.

2.

Grommet,Staple,andBinderareeligibletofileaconsolidatedreturn.

3.

a.

CorporationPs
SeparateReturn
Ordinaryoperatingincome(loss)
Capitalgain
Section1231gain(loss)
Capitalloss(deductibletoextentof
capitalandSection1231gain
Taxableincome(NOL)

Ordinaryoperatingincome
Capitalgain
NetSection1231gain
Deductiblecapitalloss
Taxableincome

$(200,000)
6,000
5,000

0
$499,000

0
$(189,000)

$300,000
6,000
4,000
(8,300)
$301,700

NapaCorporationsdividendsreceiveddeductionis$158,500.
KLPdividend$55,000 70%
Gammadividend$120,000 100%

5.

$500,000
0
(1,000)

Consolidated
Return

b.

4.

CorporationTs
SeparateReturn

$38,500
120,000
$158,500

GHJsdividendsreceiveddeductionis$76,750.
BPdividend$17,300 70%
MNdividend$80,800 80%

$12,110
64,640
$76,750

GHJisnotentitledtoadividendsreceiveddeductionfortheABdividendbecauseABisaforeign
corporation.
6.

BecauseCamcohadanNOLforitsfirstyear,itcouldnotdeductanyofits$5,000contributionbut
couldonlycarrythecontributionforwardtoitssecondyear.Inthesecondyear,Camcoscharitable

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Chapter 11 - The Corporate Taxpayer

contributiondeductionislimitedto10percentoftaxableincomeaftertheNOLcarryforward
deduction.Consequently,Camcoisallowedan$11,860charitablecontributiondeduction($10,000
currentyearcontribution+$1,860carryforward),anditstaxableincomeis$106,740.
Incomefromoperations
NOLcarryforwarddeduction
Taxableincomebeforecharitablecontribution
Charitablecontributiondeduction
Taxableincome
7.

$210,600
(92,000)
118,600
(11,860)
$106,740

a. The$100,000charitablecontributionhasanaftertaxcostof$66,000($100,000$34,000tax
savingsfromcurrentdeductionat34percent).
b. Figcandeduct$49,000ofthecontributionthisyearand$51,000asacontributioncarryforward
nextyear.Theaftertaxcostofthecontributionis$66,988.
Contribution
$(100,000)
Currenttaxsavings($49,00034%)
16,660
Taxsavingsnextyear
([$51,00034%] .943discountfactor
16,352
$(66,988

)
c.

Figcandeduct$19,000ofthecontributionthisyearand$13,000ineachofthenextfiveyears.
Theremaining$16,000contributioncarryforwardexpires.Theaftertaxcostofthecontributionis
$71,235.
Contribution
$(100,000)
Currenttaxsavings($19,00039%)
7,410
NPVoffuturetaxsavings
([$13,00039%] 4.212discountfactor) 21,355
$(71,235

8.

a. Domesticproductionactivitiesdeduction=$12,000($200,000*6%)
2007taxableincome=$438,000($450,000$12,000)
2007taxliability=$148,920
b. $153,000
c.

9.

Potentialtaxsavings=$4,080.Thistaxsavingsmaybeinsufficienttocausethecompanyto
shiftfutureproductionactivitiesfromCanadatotheU.S.,unlessothercostfactorsalsofavor
domesticproduction.

a. NetincomefromU.S.productionactivity
U.S.productionactivitiesdeduction
($429,000 3%)
NetincomefromCanadianproductionactivity
Investmentincome
Hallickstaxableincome

$429,000

b. NetincomefromU.S.productionactivity
NetlossfromCanadianproductionactivity
Investmentincome
Taxableincomebeforededuction

$429,000
(112,700)
39,400
$355,700

113

(12,870)
343,000
39,400
$798,530

Chapter 11 - The Corporate Taxpayer

U.S.productionactivitiesdeduction
($355,700 3%)
Hallickstaxableincome

(10,671)
$345,029

10. a. Allowablerehabcredit=$800,000(20%*$4,000,000)
Aftertaxpurchasepriceofhistoricbuildingis$6,200,000($3,000,000purchaseprice+
$4,000,000rehabcosts$800,000credit)
b. Landovershouldacquirethehistoricbuilding,becauseitsaftertaxcostof$6,200,000isless
thanthe$6,500,000costofthenewbuilding.
c.

Ifthecreditcannotbeusedimmediately,itsvalueislessthan$800,000.Dependingonthe
lengthoftimeuntilLandoverexpectstobeprofitable,iftheNPVofthecreditdropsbelow
$500,000,thedecisionwouldchange.

11. a. Bookincome
Less:DRD
Less:excesstaxdepreciation
Less:munibondinterest
Plus:excesscapitalloss
Plus:federalincometax

$500,000
(10,500)
(15,000)
(5,000)
2,000
249,000

Taxableincome

$720,500

Taxliability

$244,970

b. ScheduleM1:

12. a. EFGsnetincomeperbooks
U.S.productionactivitiesdeduction
($314,800 6%)
Taxexemptincome
Baddebtexpenseperbooks
$3,700
Baddebtdeduction(writeoffs)
(4,400)
Nondeductiblefine
Bookdepreciationexpense
MACRSdepreciation

$479,900
(18,888)
(10,700)
(700)
6,000

$44,200
(31,000)
13,200

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Chapter 11 - The Corporate Taxpayer

Capitallosscarryforwarddeduction
Amortizationoforganizationalcosts
Federaltaxexpenseperbooks
EFGstaxableincome
Taxrate
EFGsregulartax

(8,800)
(460)
241,589
$701,141
.34
$238,388

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Chapter 11 - The Corporate Taxpayer

b. ScheduleM1:

13. a. CorporationABstaxsavingsis$750($5,000 15%),andCorporationYZstaxsavingsare

$1,750($5,000 35%)
b. Thetaxsavingsofa$5,000credittobothcorporationsis$5,000.
14. a. $45,650($22,250+[39%$60,000])
b. $56,000(35%$160,000)
c.

$1,329,400(34%$3,910,000)

d. $5,834,000($5,150,000+[38%$1,800,000])
e. $19,950,000(35%$57,000,000)
15. a. Marginaltaxrate39%;averagetaxrate28.53%
b. Marginaltaxrate35%;averagetaxrate35%.
c.

Marginaltaxrate34%;averagetaxrate34%.

d. Marginaltaxrate38%;averagetaxrate34.73%.
e. Marginaltaxrate35%;averagetaxrate35%.
16. MyamoisexemptfromtheAMTonlyfor2005(itsfirsttaxableyear).Myamosfirsttestyearis2006,
andthetestingperiodforthatyearis2005.BecauseMyamos2005grossreceiptsexceeded
$5,000,000,MyamoisnotexemptfromtheAMTfor2006oranysubsequenttaxableyear.
17. NorthupisexemptfromtheAMTfor2002(itsfirsttaxableyear)andfor2003,2004,and2005.
Northupsaverageannualgrossreceiptsforthe2003testingperiodwere$4,282,000,whichisless
thanthe$5,000,000limitforthefirsttestyear.
Northupsaverageannualgrossreceiptsforthe2004and2005testingperiodswere$6,350,000
([$4,282,000+$8,418,000] 2years)and$6,567,333([$4,282,000+$8,418,000+$7,002,000]
3years),whichwerelessthanthe$7,500,000limitforallsubsequenttestyears.

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Chapter 11 - The Corporate Taxpayer

Northupsaverageannualgrossreceiptsforthe2006testingperiodwere$8,362,667([$8,418,000+
$7,002,000+$9,668,000] 3years).Consequently,NorthupisnotexemptfromtheAMTfor2006
oranysubsequenttaxableyear.
18. Perkinstaxableincome
AMTadjustments
AMTtaxpreference
AMTIbeforeexemption
Exemption
($40,000[25% $17,000excessAMTI])

$100,000
45,000
22,000
$167,000
(35,750)
$131,250
.20
$26,250
(22,250)
$4,000

AMTrate
Tentativeminimumtax
Regulartax
AMT
19. Raisestaxableincome
AMTadjustments
AMTtaxpreferences
AMTIbeforeexemption
Exemption
AMTrate
Tentativeminimumtax
Regulartax
AMT

$3,590,000
980,000
315,000
$4,885,000
0
$4,885,000
.20
$977,000
(1,220,600)
0

20. GrandstaxableincomebeforeNOLdeduction $1,250,000

AMTadjustments
0
AMTtaxpreferences
0
AMTIbeforeNOLdeductionandexemption
$1,250,000
Exemption
0
$1,250,000
NOLdeduction(90%AMTIbeforededuction)
(1,125,000)
$125,000
AMTrate
.20
Tentativeminimumtax
$25,000
Regulartax*
0
AMT
$25,000
*GrandhasnotaxableincomeaftertheNOLdeduction

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Chapter 11 - The Corporate Taxpayer

21. a.

b. Regulartaxableincome
AMTpreferences&adjustments
AMTI
Rate
Tentativeminimumtax
Regulartax
AMT
Finaltaxdue

$6,965,000
2,000,000
$8,965,000
20%
$1,793,000
$2,368,100
$0
$2,368,100

22.
MinimumTaxCredit
Generated
MinimumTaxCredit
Used
FinalTax
Liability
MinimumTaxCredit
Carryforward

Year1
$40,000

Year2
$0

Year3
$0

$0

$20,000

$20,000

$150,000

$130,000

$130,000

$40,000

$20,000

$0

23. a. Hallstaxfor2005was$200,000;for2006was$900,000(including$30,000AMT);andfor2007
was$1,820,000(including$320,000AMT).
b. Halls2008AMTI
AMTrate
Tentativeminimumtax
Regulartax($9,000,000 34%)
Minimumtaxcredit
Halls2008tax
c.

Halls2008AMTI
AMTrate
Tentativeminimumtax
Regulartax($9,000,000 34%)
Minimumtaxcredit(excessofregular
taxovertentativeminimumtax)

$11,000,000
.20
$2,200,000
$3,060,000
(350,000)
$2,710,000
$14,800,000
.20
$2,960,000
$3,060,000
(100,000)

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Chapter 11 - The Corporate Taxpayer

Halls2008tax

$2,960,000

24. a. Toavoidanunderpaymentpenalty,NBsrequiredinstallmentpaymentsof2008taxmustequal
orexceed$201,620($50,405perinstallment).Thetotalequals100percentofNBs2008tax.
b. Toavoidanunderpaymentpenalty,NBsrequiredinstallmentpaymentsof2008taxmustequal
orexceed$242,000($60,500perinstallment).Thetotalequals100percentofNBs2007tax.
c.

Toavoidanunderpaymentpenalty,NBsrequiredinstallmentpaymentsof2008taxmustequal
orexceed$476,000($119,000perinstallment).Thetotalequals100percentofNBs2008tax
becauseitisineligibletomakeasafeharborestimate.

25. a. Jamestaxonthe$100,000dividendis$15,000($100,00015%).
b. The$100,000dividendconsistsofaftertaxdollars.Consequently,JJhadtoearn$151,515of
beforetaxincometogeneratethe$100,000dividend($151,515[$151,515 34%]),andthe
corporatetaxwithrespecttothedividendis$51,515.Jamesmustrecognizea$151,515
grossedupdividendonwhichhisprecredittaxis$22,727($151,51515%).Becausehe
receivesacreditforthe$51,515corporatetax,hisindividualtaxonthedividendisreducedto
zero.
26. a. TheshareholderswhoownShinestockbeartheincidenceofthecorporatetaxincrease.
b. Inthiscase,Shinesemployeesbeartheincidenceofthecorporatetaxintheformofreduced
compensation(nomoreonsitedaycare).

IssueRecognitionProblems
1.

Wouldthefoundationsprofitsfromsalesofanewsletterbeunrelatedbusinessincomesubjectto
thecorporatetax?CanGreentownFoundationundertaketheforprofitnewsletteractivityand
maintainitstaxexemptstatus?

2.

CanTKaccrueanddeductthe$375originalissuediscountasinterestexpenseoverthefiveyear
lifeofthebonds?

3.

CanBanderadeductthe$16,800feeasanordinaryandnecessarybusinessexpense?Isthe
consultingfeeconsideredpartofBanderasnondeductibledividendpayment?

4.

IsM&Mallowedadeductionforacharitablecontributionofitsowncommonstock?Istheamountof
thecontributionequaltothestocksFMVeventhoughM&Mhasnobasisinthestock?

5.

CanChemcodeductthe$950,000paymentasacharitablecontribution?WilltheIRSdisallowthe
deductionbecausethepaymentisinlieuofanondeductiblegovernmentfine?

6.

IsthedifferencebetweenthegainrealizedusingtheMACRSadjustedbasisandthegainrealized
usingtheAMTadjustedbasisanAMTadjustmentthisyear?IsFerrisentitledtoa$122,000negative
AMTadjustment(excessofgainrealizedforregulartaxpurposesoverAMTgainrealized)thisyear?

7.

WillthelimitationontheNOLcarryforwarddeductionforAMTpurposestriggeranAMTliabilityinthe
nextthreeyears?

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Chapter 11 - The Corporate Taxpayer

8.

WillWigginsoweanunderpaymentpenaltybecauseofthesubstantialunpaidtaxliabilitytriggered
bythesaleofthelandinthelastmonthoftheyear?CanWigginsavoidunderpaymentpenaltyonits
firstthreeinstallmentpaymentsbecausethesepaymentswerebasedoncorporateincomeearned
throughthedateofpayment?

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Chapter 11 - The Corporate Taxpayer

ResearchProblems
1

AccordingtoSection118(a),Connordidnotrecognizeincomeonreceiptofthelandbecause
AugustaCountycontributedthelandtocorporatecapital.AccordingtoSection362(c)(1),Connors
initialbasisinthecontributedlandwaszerobecauseAugustaCountywasnotashareholder.Connor
wasrequiredtocapitalizethe$17,560expenditureforthetitlesearch,survey,andwaterwellstothe
basisoftheland.(SeeReg.Sec.1.263(a)2(c),Wacker,TCMemo1968173,andTidwell,TCMemo
1961162).
Section165(a)andReg.Sec.1.1652allowataxpayertorecognizeanordinarylossonthe
abandonmentofnondepreciablebusinessproperty.Thedollaramountofthelossisthepropertys
adjustedbasis.Therefore,Connorrecognizeda$17,560ordinaryabandonmentlossin2008whenit
renouncedanylegalclaimtotheland.

2. Section170(a)(1)allowsadeductionforcharitablecontributionspaidwithinthetaxableyear.
However,Section170(a)(2)providesthataccrualbasiscorporationscanelecttotakeadeductionin
theyearinwhichtheboardofdirectorsauthorizesacharitablecontributionontheconditionthatthe
contributionispaidonorbeforethefifteenthdayofthethirdmonthfollowingthecloseoftheyear.
BecauseWilkiefailedtotransfertheGydostockbeforeMarch15,2006,itcannotelecttotakethe
deductionin2005butcantakeitonlyin2006.AccordingtoReg.Sec.1.170A1(c)(1),theamountof
acontributionofpropertyisthepropertysFMVatdateofcontribution.Thisamountisnotreduced
underSection170(e)(1)becausethesaleofthestockwouldhaveresultedinlongtermcapitalgainto
Wilkie.Consequently,Wilkiesdeductionequalsthe$100,000FMVofthedonatedshares.
3. AccordingtoSection311(b),ifacorporationdistributespropertytoashareholderasadividendand
theFMVofsuchpropertyexceedsthecorporationsadjustedintheproperty,thedistributing
corporationmustrecognizegainasifsuchpropertyweresoldtotheshareholderatFMV.Becauseof
thisrecognitionrule,EchoValleymustrecognizea$209,000gain($420,000FMV$211,000basis)
onthedistributionoftractD6toBarryandLynetteMajors.Ifitheldthelandasaninvestment,the
gainiscapitalgain.Ifitusedthelandinacorporatebusiness,thegainisaSection1231gain.
AccordingtoSection301(b)and(c),theamountofthecorporatedistributionequalstractD6s
$420,000FMV,andtheMajorsmustrecognizea$420,000dividend(assumingthatEchoValleyhas
sufficientearningsandprofits).AccordingtoSection301(d),thecouplesbasisinthetractisits
$420,000FMV.
4.

Underthegeneralcomputationalrule,Prewerisentitledtoa$112,000dividendsreceiveddeduction
(70%$160,000)withrespecttoitsTKSdividend.However,Section246(b)(1)limitstheDRDto70
percentofPrewerstaxableincomebeforetheDRD.Thissubparagraphspecifiesthattaxable
incomeiscomputedwithoutregardtoanyNOLdeductionfortheyear.Consequently,PrewersDRD
andtaxableincomearecomputedasfollows.
Dividendincome
Operatingloss
TaxableincomebeforeDRDorNOLdeduction
LimitedDRD

$160,000
(43,500)
$116,500
.70
$81,550

TaxableincomebeforeDRDorNOLdeduction
DRD
NOLdeduction
Taxableincome

$116,500
(81,550)
(31,300)
$3,650

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Chapter 11 - The Corporate Taxpayer

TaxPlanningCases
1.

a. An$80,000deductionisworth$27,200($80,000 34%)toTMMCorporation.Becausethe
corporationsprecredittaxon$500,000incomeis$170,000,itcanuseitsentirecredit($80,000
50%)tosave$40,000intax.Therefore,TMMshouldelectthecredit.
b. TMMsprecredittaxon$70,000incomeis$12,500.Thecorporationcanreduceitscurrentyear
taxtozerobyelectingthecredit.Ifthecorporationdeductsthe$80,000costoftheprogram,it
hasa$10,000netoperatingloss,whichitcancarrybackorforwardasadeductionagainstpast
orfutureincome.Inthiscase,TMMhasnocurrentyeartaxplusavaluableNOLdeduction.
Therefore,TMMshoulddeducttheprogramscost.

2.

A&Zsbeforetaxandaftertaxcostofthenondeductibledividendpaymentsonthepreferredstock
wouldbe$28,000(5.6%$500,000).Thecorporationsaftertaxcostofthedebtwouldbe$29,700
($45,000beforetaxcost[9%$500,000]$15,300taxsavingsfrom$45,000interestdeduction).
Consequently,thepreferredstockoptionminimizesA&Zsaftertaxcostofnewcapital.

3.

Thecostofthe$129,300AMTpaymentinNPVtermsis$20,688.
2006AMTpayment
NPVof2009minimumtaxcredit
($129,300 .840discountfactorat6%)
NPV

$(129,300)
108,612
$(20,688

4. a. Becauseinterestfromthebondsisexemptfromregulartax,aftertaxcashflowequalsthe
$400,000beforetaxinterestreceived.
b. BecauseoftheDRD,only$120,000ofthedividendistaxed($400,000$280,000DRD[70%
$400,000]).Consequently,aftertaxcashflowis$359,200($400,000dividendreceived$40,800
regulartax[34%regularrate$120,000]).
c.

ThetaxexemptinterestisincludedinbookincomeandalsoinACE.WingosACEadjustment
increasesby$300,000(75%$400,000),anditsAMTincreasesby$60,000(20%AMTrate
$300,000).Consequently,aftertaxcashflowis$340,000($400,000interestreceived$60,000
AMT).

d. Wingosregulartaxwithrespecttothedividendis$40,800(seetheanswertob.).Theentire
dividendisincludedinbookincomeandalsoinACE.WingosACEadjustmentincreasesby
$210,000(75%$280,000DRD),anditsAMTincreasesby$42,000(20%AMTrate
$210,000).Consequently,aftertaxcashflowis$317,200($400,000dividendreceived$40,800
regulartax$42,000AMT).

1112