Corporations

• Author: Jack Zuckerman
• Pages: 82-131

¾FACT PATTERN FOR

PROFESSIONA L CORPORATION

Ledger & Post, an accountancy corporation, con-

sists of two shareholders. It is a C Corporation that

pays a salary to its ofc er/shareholders. The sala ry

is usually deter mined such that no taxable inc ome

is reported by the corporation.

¾FACT PATTERN FOR A

CORPORATION INVOLVED IN

WHOLESALE DISTRIBUTION

OF PRODUCT S

Fashion Apparel, Inc. is a C Corporation owned

by Ms. Anderson. She draws a minimal salary.

Though protable in 2008, the corporation has

had a history of losses.

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 distribution of prots from the

corporation.

¾OVERVIEW OF “C”

CORPOR ATE TAXATION

With the exception of the S Corporation, wh ich is

treated like a partnership, cor porations generally

pay income tax on ear nings and are often referred

to as C Corporations. (The overview of the S

Corporation appears in the following section.)

Unlike the other predominant types of business

tax returns, the C Corporation’s owners may be

subject to double taxation. Earnings are taxed at

the corporate level, and if t hese same earnings are

distributed as dividends, they are taxed again at

the individual level.

The corporation tax return consists 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 nancial statement

income (also known as book inc ome). As a result,

82

PART THREE:

CORPORATIONS

Form 1120:

U.S. Corporation

Income Tax Return

a very thorough nancial overview of a business

or practice is usu ally available from the tax return

itself.

All Forms 1120 contain pages one through ve

plus as many supporting schedules as requ ired to

supplement and explain entries 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 comprised of questions regarding

dividends rec eived from other corporations. Page

3 contains thr ee sections. The rst sec tion reects

the calculation of the corporate income tax. The

second section reects the income tax payments

the corporation has made. While the third sec-

tion, Schedule K, is used to describe the nature

of the business and its accounting method, i.e.,

cash, accrual or otherwise the next part of page

2. Schedule K continue s on page 3 with questions

regarding the stock ownership of the corpora-

tion and various other questions that 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 reported on page 5 are the reconciliation of

taxable income to book income, and the recon-

ciliation of the beginning and ending retained

earnings.

Additional supporting schedules are required

to report other corporation 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 section.

¾OVERVIEW OF “S”

CORPOR ATE TAXATION

An S Corporation is a corporation in which tax-

able income and losses are passed th rough to the

individual shareholders. In effect, it is a corpo-

ration that is treated like a partnership 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 deciding 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

circumstances. 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 that taxable income, deductions, and

credits are pa ssed through to the individual sh are-

holders for reporting on their individual income

tax returns. In other words, shareholders of the

corporation are treated like partners for tax pur-

poses only. In all other respects, the corporation

retains the same 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 reconciliation format within the return is used

to denote differences between taxable income

and nancial statement income (also known as

book income). As a result, a very thorough nan-

cial overview of a business or practice 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 inform shareholders of their

allocation of income, deductions and credits.

Income from a trade or business is reported

on the rst page. Page 2 is used to report infor-

mation concerning the nature of the corporate

activity and its ownership characteristics. 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 summarized

on this page. Page 4 contai ns comparative balance

sheets for the current and prior year-ends. The

reconciliation of taxable income to book income,

PART THREE: CORPORATIONS / 83

and the reconciliation of the beginning and end-

ing “Accumulated Adjustment Account,” the S

Corporation’s equivalent of retained earnings is

reported on page 5. The “Accumulated Adjust-

ment Account” is used to calculate the taxability

of distributions to shareholders. A more detailed

explanation of this concept is presented in the

analysis of page 5.

Additional supporting schedules are required

to report other corporation activity. The most

common of these schedules are Schedule D for

Form 1120S, where capital gains and losses are

reported, and Form 4562, the depreciation detail

summar y. Examples of Schedule D and Form 4562

are included in th e hypothetical t ax returns at the

end of this section.

S Corporations, like pa rtnerships, contain K-1s

for each of the shareholders that reect the tax-

able income and deductible expenses al locable to

each. Complete disc ussion and explanation is pre-

sented later in this section after the section on C

Corporations.

Page 1—U.S. Corporation Return

of Income (C Corporation)

Most corporations may report on a calendar or

scal year or otherwise, depending on the nature

of the underlying business activity. Generally,

professional practices and other personal ser-

vice corporations must report on a calendar-year

basis unless the corporation can establish a busi-

ness purpose for adopting another scal year.

Nonservice-type corporations may elect a scal

year-end other than December 31 when the alter-

native year-end coincides with 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 income, loss, or cash

ow is derived from activitie s of a corporation that

reports on a scal year other than December 31.

This complexity a rises because salar y or dividends

from a corporation is reected on the personal

income tax return on a calendar-year basis.

To illustrate, let us assume a corporation with

a January 31, 2014 year-end that is 100% owned

by the ofcer/spouse. The corporate income tax

return will reect income for eleven months of

2013 and one month of 2014. Further, assume

that 100% of the ofcer’s scal year salary is

paid in the form of a $100,000 bonus paid in

January 2014. Under these circumstances, the

ofcer receives a 2013 W-2 that does not con-

tain this $100,000 bonus because it was received

in 2014. If one were to look only at the personal

return for 2013, it would appear to indicate that

cash ow from wages for 2013 would not be the

same as the salary shown on the corporation’s

tax return unless the ofcer/spouse received the

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 required in order to asc ertain

the accurate amount of income to the ofcer 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:Corporate tax returns for consolidated

entities and corporations that are personal hold-

ing companies need to check the boxes in this

area. Box 3 requires d isclosure if the business is a

personal service corporation. A personal service

corporation is one in which 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 sources. An additional tax of

15 percent is imposed on t he undistributed income

from such corporations. The r ules governing these

tax entities are intricately dened in the Internal

Revenue Code. Because of the high 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 in family law cases.

 84 / TH E BUSINESS TAX RETURN H ANDBOOK, FOURTH EDITION