Corporation Income & Expenses

Gains and losses from property transactions are handled in the same manner. IRC §1221 makes no distinction between corporation and noncorporation taxpayers in determining whether a gain or loss is capital or ordinary. However, IRC §291(a) does cause a corporation to have more depreciation recapture on Section 1250 property.

Corporations and individuals are similar in the areas of like-kind exchanges [IRC §1031], and involuntary conversions of property [IRC §1033].

The nonrecognition of gain provision dealing with the sale of a personal residence does not apply to corporations [IRC §121].

Corporation business deductions also parallel those of an individual. Ordinary and necessary rules of IRC §162(a) apply for both. Many tax credits are also available to both individuals and corporations. The following covers some of the basic rules for income and expenses of corporations that are dissimilar to those of individual taxpayers.

The dividends received deduction is meant to reduce the negative effects of the double tax on C corporation profits distributed to corporation shareholders as dividends.

A corporation may deduct (subject to certain limitations) 70% of the dividends received from another domestic corporation if the receiving corporation owns less than 20% of the distributing corporation. If a corporation owns 20% or more of the corporation distributing dividends, the receiving corporation may deduct 80% of the dividends received. Exceptions:

• Certain dividends from Federal Home Loan Banks.
• Capital gain dividends from a regulated investment company or real estate investment trust, and return of capital distributions do not qualify.
• Small business investment companies may deduct 100% of the dividends received from taxable domestic corporations.
• Members of an affiliated group of corporations may elect, if certain conditions are met, to deduct 100% of the dividends received from a member of the same affiliated group. [IRC §243]
• Certain limitations apply to regulated investment company dividends received.
• Special rules apply to dividends received from foreign corporations. [IRC §245]
• No deduction is allowed for dividends received from:
1) Real estate investment trusts.
2) Corporations exempt from tax.
3) A corporation, to the extent the receiving corporation is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property.
4) A corporation whose stock has been held by the receiving corporation for 45 days or less (90 days or less if the stock has preference as to dividends and the dividends received are attributable to a period or periods totaling more than 366 days). Effective for dividends paid or accrued after September 5, 1997.

The total deduction for corporation dividends received or accrued is limited to:

1) 80% of the difference between taxable income and the 100% deduction for dividends received from affiliated corporations, for dividends received or accrued from 20%-owned corporations, and
2) 70% of the difference between taxable income and the 100% deduction for dividends received from affiliated corporations, for dividends received or accrued from less than 20%-owned corporations (reducing taxable income by the total dividends received from 20%-owned corporations).

The above limits are figured without regard to corporation net operating loss deductions, dividends received deductions, nontaxable portion of an extraordinary dividend, or capital loss carrybacks.

When a corporation sustains a net operating loss, the above 80% or 70% limitation of taxable income does not apply.

Corporation Charitable Contributions

C corporations are allowed to deduct charitable contributions as a business expense. No deduction is allowed if any of the net earnings of the receiving organization are used for the benefit of any private corporation shareholder or individual. The contribution deduction is limited to 10% of the corporation’s taxable income.

Taxable income for limitation purposes is calculated without taking into account:

• Deduction for corporation charitable contributions.
• Dividends-received and dividends-paid deduction.
• NOL carrybacks.
• Capital loss carrybacks.

Unused corporation contributions because of this limitation can be carried forward for up to 5 years.

Corporation Contributions Of Inventory

The deduction for a charitable contribution of inventory or other ordinary income producing property is generally limited to the adjusted basis of the property.

A provision in the Tax Code allows a C corporation (not an S corporation) to donate inventory to charity, then deduct up to one-half of fair market value above cost as a charitable contribution [IRC §170(e)(3) and Reg. §1.170A-4A]. For purposes of this provision, depreciable property under IRC §1221(2) also qualifies for the deduction.

The following rules must be met:

1) Charity must be a Section 501(c)(3) organization,
2) Charity must use the donated property solely for the care of the ill, the needy, or infants,
3) Charity cannot exchange the donated property for money, other property, or services,
4) Corporation must be given a written statement from the charity that says it will follow rules (2) and (3) above,
5) If the donated property is subject to the regulations of the Federal Food, Drug, and Cosmetic Act, then all such regulations must be satisfied, and
6) Use of the donated property must be related to the purpose or function that gives the charity its exempt status.

The corporation charitable deduction is computed by taking the fair market value of the donated property at the time of contribution, and then subtracting one-half the gain that would not have been long-term capital gain if the property had been sold at its FMV. The deduction is further limited to twice the basis of the donated property.

If the donated property has any potential recapture of ordinary income under Sections 617, 1245, 1250, or 1252 (depreciation recapture), then the FMV for the above computation purposes must first be reduced by the recapture amount before making the above charitable deduction computation.

Corporation Contributions Of Computer Technology And Equipment

Under the Taxpayer Relief Act of 1997, contributions of computer technology and equipment by a C corporation are treated similarly to contributions of inventory. To qualify, the property must be donated within two years of the date of purchase, and must be donated to an education organization for use by students in grades K–12. If the conditions are met, the corporation can deduct the property’s basis plus one-half the amount of ordinary income that would result if the property were sold at FMV. Effective for contributions made in tax years beginning after 1997 and before January 1, 2001. [IRC §170(e)(6)]

Corporation Gains And Losses

• Gains or losses from the sale or exchange of corporation capital assets are reported on Schedule D, Form 1120.
• Sales or exchanges of corporation property other than capital assets are reported on Form 4797.
• If corporation property is involuntarily converted because of a casualty or theft, use Form 4684, Casualties and Thefts.
• If a like-kind exchange occurs, complete Form 8824.
• Installment sales are reported on Form 6252.
• Use Form 6198 if the property was used in an activity to which the at-risk rules apply.
• See instructions for Schedule D, Form 1120 for special rules on the treatment of certain corporation gains and losses.

Corporation Capital Assets 
All property held by a corporation is a capital asset except:

• Inventory or other property held mainly for sale to customers.
• Depreciable or real property used in a trade or business.
• Certain copyrights, literary, musical, or artistic compositions, letters or memorandums, or similar property.
• Accounts or notes receivable acquired in the ordinary course of business for services rendered or from the sale of inventory.
• U.S. government publications.

Corporation Capital Gains

C corporations pay tax on capital gains at the same tax rate as ordinary income. The maximum tax rate on net capital gains is 35%. [IRC §1201]

Corporation Capital Losses

Capital losses are allowed only to the extent of capital gains. A current year deduction for a net capital loss is not allowed. A net capital loss may be carried back 3 years and forward 5 years as a short-term capital loss. Carry back a capital loss to the extent it does not increase or produce a net operating loss in the tax year to which it is carried. Foreign expropriation capital losses may not be carried back, but may be carried forward 10 years. A net capital loss for a regulated investment company may be carried forward 8 years.

Corporation Like-Kind Exchanges

If a corporation engages in a §1031 like-kind exchange with a related party, and either party disposes of the property within two years, nonrecognition treatment may be nullified. 

A corporation is not subject to the adjustments required for individual taxpayers when calculating a net operating loss. The corporation does not adjust its tax loss for the year when a capital loss occurs because corporations are not allowed to currently deduct net capital losses. Also, there is no adjustment for nonbusiness deductions. For corporation tax years beginning after August 5, 1997, a net operating loss may be carried back 2 years, or carried forward 20 years. Under prior law the carryover periods were back 3 years and forward 15 years.

Election to Forego Carryback Period: An election is available to carry an NOL forward without the carryback period. To make the election, check the box on line 14 of Schedule K, Form 1120. The election must be made on a timely filed return (including extensions) and is irrevocable.