Tax Saving Opportunities for C Corporations
Retention of Corporate Earnings
The present 35-percent top rate for individuals may exceed the marginal tax rate of your corporation. In this case, it may be desirable to retain corporate income by deferring compensation to employee shareholders.
Caution: A corporation that accumulates E&P beyond its reasonable business needs may be subject to an additional 15-percent tax on its accumulated taxable income. However, up to $250,000 in E&P may generally be accumulated before this tax applies. Special rules pertain to holding, investment, and personal service corporations.
Personal Service Corporations
PSCs are denied the benefit of the lower corporate tax brackets and are taxed at a flat 35-percent rate. A PSC is a corporation that performs services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting and also meets certain stock ownership tests.
PSCs and certain small businesses on an accrual method of accounting are permitted to eliminate from accrued service income an amount that, based upon experience, will not be collected.
Caution: A PSC that elected a fiscal year is subject to a “minimum distribution” requirement. Such a PSC must monitor the level of payments (compensation, rent, etc..) to employee-shareholders to avoid postponing part or all of the deduction for these payments. Therefore, if your top individual tax rate exceeds the top rate of tax applicable to your corporation, it may be advisable to terminate a fiscal-year election, if you have not done so already.
Corporate Stock and Stock Options
A corporation may obtain a deduction by the issuance of its stock or stock options to pay otherwise deductible expenses. For example, stock issued to employees or independent contractors constitutes deductible compensation to the issuer at the time the stock is unconditionally vested. In the case of options, the deduction is generally available when the option is exercised.
Caution: The issuer is only allowed a deduction if the employee or independent contractor includes the same amount of the deduction in income. This requirement is deemed satisfied if the issuer timely files a Form W–2, in the case of an employee, or a Form 1099, in the case of an independent contractor.
New reporting requirements also went into effect in 2010 for certain transfers of incentive stock options (“ISOs”) and options granted under a qualifying employee stock purchase plan (“ESPP”). The new reporting requirements are Forms 3921, Exercise of an Incentive Stock Option Under Section 422(b), and 3922, Transfer of Stock Acquired Through An Employee Stock Purchase Plan Under Section 423(c), and must be filed for options exercised and stock purchased in 2010 not later than January 31, 2011.
Disqualifying dispositions of incentive stock options (“ISOs”) by employees during the year will also result in compensation deductions for the employer. Companies that have issued ISOs to their employees should determine whether there have been any disqualifying dispositions of the underlying stock during the year.
Stock or stock options (including warrants) issued to a lender could also result in deductible “original issue discount” as the result of allocating a portion of the issue price away from the debt instrument. Your BDO or Alliance firm client service professional can be consulted for further information regarding ISOs and nonqualified stock options. Also see our discussion of stock options in our 2010 Tax Letter for Individuals.
Planning Suggestion: For stock vested upon transfer (which includes the exercise of a stock option), fiscal-year corporations may take the deduction in the taxable year such stock is transferred to the employee or independent contractor, rather than waiting until the next taxable year in which the employee’s or independent contractor’s taxable year ends. This acceleration opportunity may be affected by filing an application for a change in method of accounting (Form 3115) not later than the last day of the taxable year of the change.
Corporate estimated tax payments may significantly affect your business’s cash flow. Accordingly, planning for the lowest required payment is essential. The requirements differ for small and large corporations.
A small corporation is one that had taxable income of less than $1 million for each of the three preceding taxable years. Conversely, a large corporation is one that had taxable income of $1 million or more for any of the three preceding taxable years. Taxable income, for this purpose, is computed without net operating and capital loss carryovers and carrybacks.
A small corporation may base its estimated tax payments on the preceding year’s tax liability. However, a large corporation may base only its first estimated tax payment on the preceding year’s tax liability. For either type of corporation, an estimate may be based on the preceding year’s tax only if the preceding taxable year consisted of 12 months and the preceding year’s return showed a tax liability.
Estimated tax payments that cannot be based on the prior year’s tax can be based on 100 percent of the expected tax for the current year or tax calculated on the current year’s annualized income. The annualized income method provides a safe harbor from estimated tax penalties if the expected tax for the entire year is difficult to determine. If the annualized income method is used, payments are made as follows:
% of Tax to be Paid
||1st 3 months of taxable year
||1st 3 months of taxable year
||1st 6 months of taxable year
||1st 9 months of taxable year
Alternatively, a corporation may annually elect one of the following annualization periods:
Optional Annualization Period - I
Optional Annualization Period - II
||1st 2 months of taxable year
||1st 3 months of taxable year
||1st 4 months of taxable year
||1st 5 months of taxable year
||1st 7 months of taxable year
||1st 8 months of taxable year
||1st 10 months of taxable year
||1st 11 months of taxable year
Option I or II must be elected by the due date of the first quarterly installment for each year. Form 8842, Election to Use Different Annualization Periods for Corporation Estimated Tax, can be used to make the election.
In some cases, lower payments may be made under the adjusted seasonal installment method. No estimated taxes are required for a particular year if the tax shown on the return for that year is less than $500.
Estimated taxes also are required if there is an AMT liability for the current year.
Final regulations for corporate estimated tax payments, issued in August 2007, apply to taxable years beginning after September 6, 2007. These regulations provide a general rule that taxpayers using the annualized income method must annualize items incurred during the quarter, as well as special rules for specific deductions and extraordinary items.
Planning Suggestion: A corporation anticipating no 2010 tax should consider taking action to produce a small tax by reporting low taxable income so that estimated 2011 tax payments can be based on 2010 tax.
- X Corporation will have a $100 net operating loss and no tax for 2010. X must pay 2010 estimated taxes based on its 2011 regular or AMT income to avoid penalties.
- Y is a small corporation. Its 2010 return will show a $500 tax liability. Y will be able to pay only $500 as 2011 estimated taxes and avoid penalties, even though its actual 2011 tax may be much higher. If Y’s 2011 tax is $100,500, it would pay the $100,000 balance on March 15, 2012.
“Quick Refund” for Excess Estimated Tax
If estimated taxes paid exceed the expected annual tax, a corporation may apply for a “quick refund” (on Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax) of the excess tax before the tax return is filed, but only if this excess tax is at least $500 and ten percent of the expected annual tax. This quick refund may be requested after the close of the corporation’s taxable year, but no later than the 15th day of the third month following the end of the taxable year (the original due date of the corporation’s income tax return). The Service must act on this refund application within 45 days after it is filed.
Example: Z, a calendar-year corporation, paid $50,000 in estimated taxes for the first three quarters of 2010. In the fourth quarter of 2010, Z incurs a large loss so that the tax due for the year is expected to be only $10,000. Z may request a $40,000 refund after December 31, 2010, and by March 15, 2011. The Service must act on Z’s refund application within 45 days after it is filed.
Special Temporary Extended Net Operating Loss Carryback Periods
Generally, a taxpayer may carry back a net operating loss (“NOL”) for a taxable year only to the two immediately preceding taxable years. Temporary legislation enacted in 2009 allowed taxpayers to elect to carry an NOL back to the three, four, or five taxable years preceding the taxable year of the NOL. Under this provision, a taxpayer is required to choose one (and only one) taxable year that began or ended in 2008 or 2009. From this taxable year, the taxpayer is permitted to carry back an NOL for three, four, or five taxable years, at the taxpayer’s option. The taxpayer must elect which taxable year the NOL will be carried back from by the extended due date of the final year that is eligible for the five-year carryback. For example, a corporation with a June 30 year end could elect to apply the five-year carryback provision to any one of the years ended June 30, 2008, June 30, 2009, or June 30, 2010. The corporation must elect which year to carryback by March 15, 2011, the extended due date of the final eligible year. If no election is made by the due date, the ability to use the extended carryback is lost. The due date for this election is prescribed by statute, and may not be extended under traditional relief provisions available to taxpayers and the Service for “regulatory” elections.
Special Temporary Extended General Business Credit Carryback and AMT Provisions
The Internal Revenue Code provides for a variety of “general business credits” which allow taxpayers a dollar-for-dollar reduction in their tax liability, subject to applicable limitations. These credits include the R&D Tax Credit, as described above. With certain exceptions, such credits may not reduce a taxpayer’s tax liability below the “tentative minimum tax” of the taxpayer, a key determinant of the taxpayer’s liability (if any) for the AMT. To the extent that the credits available to a taxpayer for a taxable year exceed the applicable limitation, the excess credits may be carried back one taxable year and carried forward 20 taxable years.
The Act provides two relief provisions for eligible small businesses, which are defined as taxpayers with average annual gross receipts not exceeding $50 million for the three immediately preceding taxable years. Certain special rules are provided for businesses conducted by S corporations and partnerships, for sole proprietorships, and for aggregating the gross receipts of certain related taxpayers.
Under the first relief provision, in the case of the eligible small business taxpayer’s first taxable year beginning after December 31, 2009, i.e., the 2010 taxable year, the general business credits may be carried back for five taxable years. Under the second relief provision, for the same taxpayers and for the same single taxable year, the general business credits are effectively permitted to offset both regular tax and AMT liability.
Postponing Tax Payments if Net Operating Loss Expected
Generally, a taxpayer cannot obtain an extension of time for paying a tax. However, if a corporation expects an NOL for the current year, it may extend the time for paying the tax for the immediately preceding taxable year. The postponement is available only for tax payments due after this extension is filed and applies to the extent that the NOL can be carried back to preceding taxable years. Although the tax payment is postponed, interest is still charged from the original due date of the tax payment until the original due date of the current year’s return.
Example: Q, a fiscal year corporation, determines that it will have an additional $30,000 tax to pay on December 15, 2010, for its taxable year ended September 30, 2010. Q also expects to have a $100,000 NOL for its year ending September 30, 2011, which may be carried back to one or more of its preceding taxable years. Q files Form 1138, Extension of Time For Payment of Taxes By a Corporation Expecting a Net Operating Loss Carryback, before December 15, 2010, to extend the time for paying the $30,000 tax otherwise due on December 15, 2010. Interest on the postponed tax payment will be charged from December 15, 2010, until December 15, 2011.
Expedited Refund Claim in Hardship Cases
If a corporation incurs an NOL in the current year, it may request a “quick refund” from a carryback of that NOL by filing Form 1139, Corporation Application for Tentative Refund, on or after the date of filing the tax return for the NOL year–but not later than one year after the end of the NOL year. Generally, the Service must act on this refund request within 90 days of its filing. If Form 1139 is not timely filed, the corporation must file an amended tax return (Form 1120X) for the prior year to carry back the NOL.
In extreme cases, where a corporation can demonstrate hardship if it has to wait even 90 days for the refund, the taxpayer also should file Form 911, Application for Taxpayer Assistance Order to Relieve Hardship. We have been successful in obtaining refunds within a week or two where a desperate need for the refund was demonstrated, such as the need to meet payroll.
Planning for Net Operating Losses
NOLs are a valuable corporate attribute. Even net operating losses that were not fully reported on a prior-year return can be carried forward. However, the ability to use an NOL carry forward may be limited where a loss corporation has experienced a change of stock ownership–for example, as a result of a merger or acquisition, the issuance of new stock, or the acquisition of outstanding stock by a five-percent shareholder. Your BDO or Alliance firm client service professional can assist you with the appropriate planning needed to preserve and maximize the use of NOLs by your corporate business.
Succession and Family Business Planning
Year-end is the traditional gift-giving season. This should also be a time to plan for your company’s succession and the transfer of your wealth to your heirs in a manner that minimizes transfer taxes. We urge you to consult with your BDO or Alliance firm client service professional for ideas to preserve your family wealth.