T2: Tax Planning for Corporations

tax planning strategies overview

• ultimately trying to reduce tax liability; common strategies used:

  • timing → when is income or loss recognized?

  • income-shifting → to whom/where is income or loss allocated?

  • estimated payments & avoidance of underpayment penalties → eliminating unnecessary penalty payments

timing strategies (when)

type of tax planning that pertains to when income must be recognized, when a deduction or loss can be taken, or when a tax credit is allowed

• timing strategies rely heavily on the concept of the time value of money

before tax income - tax costs = after-tax income

before tax deduction - tax savings = after-tax deduction

formula used to solve timing strategy problems

pretax income x marginal rate = tax costs x discount factor = PV of tax costs

pretax deduction x marginal rate = tax savings x discount factor = PV of tax davings

discount factor formula

discount factor = 1/(1+r)ⁿ

r = rate of return on other investments

n = number of pds in years 

utilizing NOL & cap loss carryovers

to maximize tax savings associated w/ cap losses, corporations should opt to receive an immediate refund for any cap loss that can be carried back & then carry forward any remainder 

change in tax rate

• tax rates constant or decreasing → accelerate deductions, defer income

• taxes rate increasing → corps should consider whether the increase in the tax rate is large enough that it changes the previous guidance 

income-shifting strategies

• work by changing where income, deduction, or loss is recognized as well as who recognizes the income, deduction, or loss

• these strategies work by exploiting differences in tax rates across jurisdictions & entities

transactions between jurisdictions

as a general rule, effective tax planning entails recognizing income in jurisdictions w/ lower tax rates 

• laws have eliminated most income-shifting opportunities but some still exist as many states have different tax rates

transactions between corporations & their owners

in general:

• the taxpayer w/ the lowest marginal tax rate should recognize income

• for corps, common strategies include paying a salary to corporate SH-employees as it often allows the corp to circumvent double taxation & realize a deduction for compensation 

risks of effective tax planning

• these types of transactions can create adverse tax consequences by generating unexpected tax liability for the SH & corp

• in the case of contributions of appreciated noncash property:

  • contributing SH must recognize a gain if 80% control requirement for Sec 351 nontaxable transfers to a corp isn’t met

• in the case of non-liquidating distributions of appreciated non-cash property to SHs:

  • corp must recognize a gain on the property distributed to the SH

estimated tax payment requirements & underpayment penalties

• payment due dates: April 15, June 15, Sep 15, Dec 15

• each payment = 25% of the corporation’s annual requirement payment

• minimum annual required payment is the lowest of the following:

  • 100% of tax liability in current yr

  • 100% of tax liability on prior yr return (1st quarter only)

  • 100% of estimated tax liability in current yr by using the method of annualizing quarterly taxable income 

annualizing quarterly taxable income

estimates the tax that would be due if the corporation continued earning income @ the same rate for the remainer of the year 

Due date	Months	Annualization factor	Payment required
April 15	Jan-Mar	12/3	25% of annualized tax
June 15	Jan-Mar	12/3	50% of annualized tax
Sep 15	Jan-June	12/6	75% of annualized tax
Dec 15	Jan-Sep	12/9	100% of annualized tax

judicial doctrines

certain judicial doctrines limit the ability of effective tax planning

• constructive receipt doctrine → limits effectiveness of timing strategies; states that income must be recognized the earlier of when it’s received or “constructively received”