Corporate tax in the United States is a tax on the taxable income of a C corporation or an entity taxed as a C corporation. The corporate tax is the default tax levied on a business entity unless the entity qualifies to be taxed under different tax rules such as those for non-profit organizations and S corporations. The corporation is taxed under 26 U.S.C. § 11 and Subchapter C (26 U.S.C. § 301 et seq.) of Chapter 1 of the Internal Revenue Code.
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GENERAL TAX PRINCIPLES
When advising clients, the advisor should be mindful of various principles underlying the IRC and all tax matters.
1. Separate Taxable Entity. Generally, legal entities are respected and treated as a separate and independent taxpayer. Individuals, head of households, those married (whether filing joint or separate returns) and legally organized trusts or estates are considered legal entities for tax purposes. § 1. Unless disregarded due to S election or by applying other tax principles or doctrines (e.g., sham entity), corporations are legal entities. § 11. A partnership is also considered a separate entity, even though partnerships are not taxable under the Code. § 701. A corporation, partnership or trust will be respected if it has a legitimate business purpose and engages in that business purpose. Judicial Doctrines (defined below under Section II.G) should be considered as well.
2. Maximizing Economic Gain; Prevention of Tax Attribute Shifting. The underlying assumption in applicable tax law is that each legal entity has an objective of maximizing economic gain relative to other involved taxpayers. As a result, it is expected that each entity will enter into transactions at a fair price or at fair market value. Obviously this assumption is not always true. For example, family owned entities or common controlled entities do not operate always under this premise. As expected, tax attributes (e.g., gross income, deductions, taxable income, credits and tax) have a tendency to be shifted among legal entities in a manner that reduces tax liabilities. Because of this limitation to the separate entity principle, statutory exceptions have been enacted to prevent abusive tax shifting. For example, § 482 is designed to prevent shifting across entities controlled by the same taxpayers. See also § 267. In addition to statutory exceptions, Judicial Doctrines (as defined below) have evolved over the years, and in certain cases have been enacted and promulgated to prevent abuse.
3. Realization; Capital v. Ordinary Character. The primary assumption in whether a transaction results in tax recognition is whether a realization event for the taxpayer has occurred, which depends on the amount, character, and timing of income or deduction. Realization is expressly contemplated in the Regulations under § 1001 as relating to an identifiable event. The following are examples of different transactions where realization becomes an issue.
a. Property Subject to Forfeiture. If the property "received" in exchange for services is subject to a substantial risk of forfeiture and is not freely transferable, then there is not a realization event. In such instances, the property is not deemed transferred for tax purpose. § 83. As the property vests, the difference between the fair market value (at such time) and amount already paid or recognized is considered income. To avoid this result, a person can make an § 83(b) election (although limited to 30 days from the initial "receipt" of property). The election treats the property as fully transferred despite the risk of forfeiture.
b. Property subject to Liability. Subjecting property to a liability (mortgage) is generally not considered a taxable event. However, at the time of disposition of property, the recourse or non-recourse debt is factored into the adjusted basis, impacting the amount realized.
c. Discharge of Indebtedness. Taxpayers receiving discharge of indebtedness realize income, although in certain instances the IRC excludes the discharge from income (e.g., insolvency under §108). Note that if a shareholder cancels debt owed by the corporation, then the cancellation usually gets treated as a capital contribution.
4. Recognition. In addition to realization, to be subject to tax income must also be recognized. Usually realization and recognition occur together. However, Congress has (for policy reasons) created non-recognition provisions even though there has been a realization event (e.g., reorganizations). Non-recognition usually results in tax deferral rather than tax-free.
5. Clearly Reflect Income Accounting. The assumption with income tax is the accounting method used must clearly reflect income. The most typical methods are cash and accrual methods. Regulations do not specifically indicate what it means for a method of accounting to clearly reflect income. Taxpayers should treat all items of gross income and expense consistently from year to year. The general preference is to match a taxpayer's revenue with its expenses, particularly in the case of accrual method taxpayers.
6. Other Principles. Numerous other principles permeate throughout the IRC. In particular, taxpayers are afforded the opportunity to negotiate and bargain for good deals. In such cases, getting a good price for property does not result in recognition to a buyer, even if realization may have occurred for the buyer. This principle is tempered by the Judicial Doctrines described below. Another principle is the preference to defer to taxpayers on the valuation methods for various transactions, as well as to presume in certain cases that transactions are arm's-length. See Principle 2 above. However, criteria have been established and methodologies have been judicially defined in the context of valuing closely-held businesses through use of fair market value. These criteria, unfortunately, create some uncertainty in entity formation.
© 2008 Jay Bettinger, Esq. All Rights Reserved.
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