Corporations
| Author | Jack Zuckerman |
| Pages | 82-131 |
¾FACT PATTERN FOR
PROFESSIONA L CORPORATION
Ledger & Post, an accountancy corporation, c on-
sists of two shareholders. It is a C Corporation that
pays a salary to its ofc er/shareholders. The sala ry
is usually deter mined such that no taxable inc ome
is reported by the c orporation.
¾FACT PATTERN FOR A
CORPORATION INVOLVED IN
WHOLESA LE DISTR IBUT ION
OF PRODUCT S
Fashion Apparel, Inc. is a C Corporation owne d
by Ms. Anderson. She draws a minimal salar y.
Though protable in 2008, the corporation has
had a history of loss es.
¾FACT PATTERN FOR S
CORPORATION INVOLVED IN
PROVIDING IMPORT SALES
Straight Edge, Inc. is an S Cor poration owned by
Mr. Collins. He draws a modest sala ry but enjoys
a sizable annual d istribution of prots from the
corporation.
¾OVERVIEW OF “C”
COR POR ATE TAX ATIO N
With the exception of the S Corporation, wh ich is
treated like a pa rtnership, cor porations generally
pay income tax on ear nings and are often referred
to as C Corporations. (The over view of the S
Corporation appears i n the following section.)
Unlike the other predom inant type s of business
tax returns, the C Corporation’s owners may be
subject to double taxation. Ear nings are taxe d at
the corporate level, and if t hese same earnings are
distributed as d ividends, they are t axed again at
the individual level.
The corporation ta x return consi sts of an
income stateme nt, balance she et, and information
statement for the corporation. A rec onciliation for-
mat within the ret urn is used to denote differe nces
between taxable income and nanc ial statement
income (also known as book inc ome). As a result,
82
PART T H REE :
CORPORATIONS
Form 1120:
U.S. Corporation
Income Tax Return
a very thorough nanci al overview of a busine ss
or practice is usu ally available from the tax return
its elf.
All Forms 1120 contain pages one through ve
plus as many supporting schedules as requ ired to
supplement and explain entr ies on the rst four
pages. Unlike the S Cor poration tax return, the C
Corporation does not includ e K-1s for each of the
shareholders becau se it is not a ow-through entity,
that is, income ta xes are paid at the corporate level.
Income from all sourc es is reported on the rst
page. Page 2 is comprise d of questions regarding
dividends rec eived from other corporations. Page
3 contains thr ee sections. The rst sec tion reects
the calculation of the c orporate income t ax. The
second section reects the income tax payments
the corporation has made. While the third sec -
tion, Schedule K, is us ed to describe the nature
of the business and its a ccounting method, i.e.,
cash, accr ual or otherwise the next part of page
2. Schedule K continue s on page 3 with questions
regarding the stock owner ship of the corpora-
tion and various other questions t hat provide the
IRS with important information about the cor-
poration’s activities. Page 5 contains comp arative
balance sheets for the cu rrent and prior year-ends.
Also reporte d on page 5 are the reconciliation of
taxable income to book i ncome, and the recon-
ciliation of the beg inning and e nding retaine d
earn ings.
Additional supporting schedules are required
to report other corp oration activity. The most
common of these schedules is Form 4562, the
depreciation detail summary. Examples of Form
4562 and other supporting corporation tax form s
are included in th e hypothetical t ax returns at the
end of this sect ion.
¾OVERVIEW OF “S”
COR POR ATE TAX ATIO N
An S Corporation is a corporation in which tax-
able income and losse s are passed th rough to the
individual sha reholders. In effect, it is a c orpo-
ration that is treated like a partnersh ip for tax
purposes. T he ability to recognize bu siness losses
on the individual t ax returns of shareholders is one
of the major considerations in de ciding to elect S
Corporation status. Th e avoidance of double taxa-
tion at the corporate level is anothe r consideration
for the S Corporation election.
The election is only available under speci c
circumst ances. In general, to qualify as an S
Corporation, a corporation must consist of 100
or fewer individual shareholders (none of whom
are nonresident aliens) and have only one class of
stock issued and outsta nding. Partnerships, corpo -
rations, and cert ain trusts cannot be shareholder s.
The S Corporation is a ow-through entity.
This means t hat taxable income, de ductions, and
credits are pa ssed through to the individual sh are-
holders for reporting on their i ndividual inc ome
tax return s. In other words, shareholders of the
corporation are treate d like partners for tax pur-
poses only. In all other resp ects, the cor poration
retains the sa me legal status as a C Cor poration.
The S Corporation ta x return, like the C Corpo-
ration, is a combination income st atement, balance
sheet, and information re port for the corporation.
A reconcil iation format within the ret urn is use d
to denote differenc es between t axable income
and nancial st atement income (also known as
book income). As a result, a very thorough n an-
cial overview of a busi ness or practic e is usually
available from the tax retur n itself.
All Forms 1120S contain pages one through ve
plus as many supporting schedules as requ ired to
supplement and to explain entr ies on the rst ve
pages. In addition, K-1s for each of the sharehold-
ers are included to i nform shareholders of thei r
allocation of income, d eductions and cred its.
Income from a trade or business is r eporte d
on the rst page. Page 2 is use d to report infor-
mation concern ing the nature of the cor porate
activity and its ownership character istics. Page 3
contains in formation very much li ke a partnership
tax return page 3. The total of all K-1 items that
ow through to the shareholders is sum mariz ed
on this page. Page 4 contai ns comparative balance
sheets for the current and pr ior year-ends. The
reconcil iation of taxable income to book income,
PART THREE: CORPORATIONS / 83
and the reconci liation of the begin ning and end-
ing “Accumulate d Adjustment Account,” the S
Corporation’s equivalent of retained ear nings is
reported on page 5. The “Accumulated Adjust-
ment Account” is used to c alculate the taxability
of distributions to shareholders. A more detailed
explanation of this conc ept is presented i n the
analysis of page 5.
Additional supporting schedules are required
to report other corp oration activity. The most
common of these schedules are Sche dule D for
Form 1120S, where capital gai ns and losses are
reported, and Form 4562, the deprec iation detail
summar y. Examples of Schedule D and Form 4562
are included in th e hypothetical t ax returns at the
end of this sect ion.
S Corporations, like pa rtnerships, contain K-1s
for each of the shareholders that reect the tax-
able income and deductible expenses al locable to
each. Complete disc ussion and explanation is pre-
sented later in th is section aft er the section on C
Corporation s.
Page 1—U.S. Corporation Retu rn
of Income (C Corporation)
Most corporations may report on a calendar or
scal year or other wise, depe nding on the nature
of the underlying business activity. General ly,
professional practices and other persona l ser-
vice corp orations must report on a calendar-year
basis unless the corporation can establish a busi-
ness purpose for adopting another scal yea r.
Nonservice -type cor porations may elect a scal
year-end other than Dec ember 31 when the alter-
native year-end coincides w ith the corporation’s
business cycle. Gr eater complexity in the prepara-
tion of income analyse s for support is more likely
to exist where substantial i ncome, loss, or cash
ow is derived from activitie s of a corporation that
reports on a scal year other than Dec ember 31.
This complexity a rises because salar y or dividends
from a corporation is reect ed on the personal
income tax return on a calendar-year basis.
To illustrate, let us assume a cor poration with
a January 31, 2014 year-end that is 100% owned
by the ofcer/spouse. The corporate income tax
return wi ll reect income for eleven months of
2013 and one month of 2014. Further, assume
that 100% of the ofcer’s scal year salar y is
paid in the form of a $100,000 bonus paid in
January 2014. Under these circumstanc es, the
ofcer receives a 2013 W-2 that does not con-
tain this $100,000 bonus bec ause it was received
in 2014. If one were to look only at the personal
return for 2013, it would appear to ind icate that
cash ow from wages for 2013 would not be the
same as the sala ry shown on the corporation’s
tax return unless the ofcer/spouse received t he
same exact $100,000 bonus in January of 2013
(that was reported on the 2012 corporate tax
return). Careful review of month ly activity with in
the corporation is requ ired in order to asc ertain
the accurate a mount of income to the ofcer for
the calendar year i n question. Errors result from
overlooking the timing problems associated w ith
non-calendar scal year corporations perceived
earning ability.
LINE A: Corp orate tax retur ns for consolidated
entities and corporations that are persona l hold-
ing companies ne ed to check the boxes in t his
area. Box 3 requires d isclosure if the business is a
personal ser vice cor poration. A personal service
corporation is one in wh ich the major source of
revenue is not the sale or manufacture or a product.
Corporations that own interests in other corpo-
rations or that are part of a group of corporations
with common shareholder ownership may le on a
consolidated basis.
Generally, a personal holdi ng company is a cor-
poration that receives most of its revenue from
investment income sour ces. An additiona l tax of
15 percent is imposed on t he undistributed income
from such corporations. The r ules governing these
tax entities are i ntricately dene d in the Interna l
Revenue Code. Because of the h igh rate of tax
imposed on such corporations, the appearance
of this typ e of return i n family law matter s is rare.
Schedule M-3 is a form required of larger cor-
porations that rarely appear i n family law case s.
84 / TH E BUSINESS TAX RETURN H ANDBOOK, FOURTH EDITION
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