Important Changes
for 2002
Accounting methods. For tax years
ending on or after December 31, 2001, a qualifying small business taxpayer can choose to
use the cash method of accounting for an eligible business and not account for
inventories. A qualifying small business taxpayer is any taxpayer with average annual
gross receipts of $10,000,000 or less that is not prohibited from using the cash method of
accounting under section 448 of the Internal Revenue Code. Certain other requirements must
be met. For more information, see Revenue Procedure 2002-28 in Internal Revenue Bulletin
2002-18. Taxpayers with average annual gross receipts of $1,000,000 or less can use the
cash method of accounting under Revenue Procedure 2001-10. For more information on the
cash method of accounting and accounting for inventories, see Publication 538, Accounting
Periods and Methods.
Tax schedules for corporations. If a corporation's total receipts
for the tax year and its total assets at the end of the tax year are less than $250,000,
it is generally no longer required to complete Form 1120 Schedules L, M-1, and M-2 (Parts
III and IV of Form 1120-A). For more information, see the Instructions for Forms 1120
and 1120-A.
Important Change
for 2003
Reportable transactions. New
disclosure rules require corporations to file Form 8886, Reportable Transaction
Disclosure Statement to report certain transactions entered into after 2002.
For more information, see the tax shelter disclosure statement discussion in the Form 1120
instructions under Other Forms, Returns, and Statements That May Be Required.
Important Reminder
Photographs of missing children. The Internal Revenue Service is a
proud partner with the National Center for Missing and Exploited Children. Photographs of
missing children selected by the Center may appear in this publication on pages that would
otherwise be blank. You can help bring these children home by looking at the photographs
and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.
Introduction
This publication discusses the general tax laws that apply to ordinary domestic
corporations. It explains the tax law in plain language so it will be easier to
understand. However, the information given does not cover every situation and is not
intended to replace the law or change its meaning.
Some corporations may meet the qualifications for electing to be S corporations. For
information on S corporations, see the instructions for Form 1120S, U.S. Income Tax
Return for an S Corporation.
Comments and suggestions. We
welcome your comments about this publication and your suggestions for future editions.
You can e-mail us while visiting our web site at www.irs.gov.
You can write to us at the following address:
Internal Revenue Service
Tax Forms and Publications
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1111 Constitution Ave. NW
Washington, DC 20224
We respond to many letters by telephone. Therefore, it would be helpful if you would
include your daytime phone number, including the area code, in your correspondence.
Useful Items
You may want to see:
Publication
- 535 Business Expenses
- 538 Accounting Periods and Methods
- 544 Sales and Other Dispositions of Assets
- 925 Passive Activity and At-Risk Rules
Form (and Instructions)
- 1096 Annual Summary and Transmittal of U.S. Information Returns
- 1099-DIV Dividends and Distributions
- 1120 U.S. Corporation Income Tax
Return
- 1120-A U.S. Corporation Short-Form Income Tax Return
- 1120-W (WORKSHEET) Estimated Tax for Corporations
- 1120X Amended U.S. Corporation
Income Tax Return
- 1138 Extension of Time for Payment of Taxes by a Corporation Expecting a Net
Operating Loss Carryback
- 1139 Corporation Application for
Tentative Refund
- 2220 Underpayment of Estimated Tax by Corporations
- 3800 General Business Credit
- 4466 Corporation Application for Quick
Refund of Overpayment of
Estimated Tax
- 4562 Depreciation and Amortization
- 4626 Alternative Minimum Tax - Corporations
- 5452 Corporate Report of Nondividend Distributions
- 7004 Application for Automatic
Extension of Time To File
Corporation Income Tax Return
- 8109 Federal Tax Deposit Coupon
- 8582-CR Passive Activity Credit
Limitations
- 8832 Entity Classification Election
See How To Get Tax Help near the end of this publication for information about
getting publications and forms.
Business Taxed as a Corporation
The rules you must use to determine whether a business is taxed as a
corporation changed for businesses formed after 1996.
Business formed before 1997. A business formed before 1997 and taxed
as a corporation under the old rules will generally continue to be taxed as a corporation.
Business formed after 1996. The following businesses formed after
1996 are taxed as corporations.
- A business formed under a federal or state law that refers to it as a corporation, body
corporate, or body politic.
- A business formed under a state law that refers to it as a joint-stock company or
joint-stock association.
- An insurance company.
- Certain banks.
- A business wholly owned by a state or local government.
- A business specifically required to be taxed as a corporation by the Internal Revenue
Code (for example, certain publicly traded partnerships).
- Certain foreign businesses.
- Any other business that elects to be taxed as a corporation by filing Form 8832.
For more information, see the instructions for Form 8832.
Exchange of Property for Stock
If you transfer property (or money and property) to a corporation in
exchange for stock in that corporation (other than nonqualified preferred stock,
described later), and immediately afterward you are in control of the corporation, the
exchange is usually not taxable. This rule applies both to individuals and to groups who
transfer property to a corporation. It also applies whether the corporation is being
formed or is already operating. It does not apply in the following situations.
- The corporation is an investment company.
- The property is transferred in a bankruptcy or similar proceeding in exchange for stock
used to pay creditors.
- The stock is received in exchange for the corporation's debt (other than a security) or
for interest on the corporation's debt (including a security) that accrued while you held
the debt.
Both the
corporation and any person involved in a nontaxable exchange of property for stock must
attach to their income tax returns a complete statement of all facts pertinent to the
exchange. For more information, see section 1.351-3 of the regulations.
Control of a corporation. To be in control of a corporation, you or
your group of transferors must own, immediately after the exchange, at least 80% of the
total combined voting power of all classes of stock entitled to vote and at least 80% of
the outstanding shares of each class of nonvoting stock of the corporation.
Example 1. You and Bill Jones buy property for $100,000. You
both organize a corporation when the property has a fair market value of $300,000. You
transfer the property to the corporation for all its authorized capital stock, which has a
par value of $300,000. No gain is recognized by you, Bill, or the corporation.
Example 2. You and Bill transfer the property with a basis of
$100,000 to a corporation in exchange for stock with a fair market value of $300,000. This
represents only 75% of each class of stock of the corporation. The other 25% was already
issued to someone else. You and Bill recognize a taxable gain of $200,000 on the
transaction.
Services rendered. The term property does not
include services rendered or to be rendered to the issuing corporation. The value of stock
received for services is income to the recipient.
Example. You transfer property worth $35,000 and render services
valued at $3,000 to a corporation in exchange for stock valued at $38,000. Right after the
exchange you own 85% of the outstanding stock. No gain is recognized on the exchange of
property. However, you recognize ordinary income of $3,000 as payment for services you
rendered to the corporation.
Property of relatively small value. The term property does
not include property of a relatively small value when it is compared to the value of stock
and securities already owned or to be received for services by the transferor if the main
purpose of the transfer is to qualify for the nonrecognition of gain or loss by other
transferors.
Property transferred will not be considered to be of relatively small value if its fair
market value is at least 10% of the fair market value of the stock and securities already
owned or to be received for services by the transferor.
Stock received in disproportion to property transferred. If a group
of transferors exchange property for corporate stock, each transferor does not have to
receive stock in proportion to his or her interest in the property transferred. If a
disproportionate transfer takes place, it will be treated for tax purposes in accordance
with its true nature. It may be treated as if the stock were first received in proportion
and then some of it used to make gifts, pay compensation for services, or satisfy the
transferor's obligations.
Money or other property received. If, in an otherwise nontaxable
exchange, you also receive money or property other than stock, you may have to recognize
gain. You recognize gain only up to the amount of money plus the fair market value of the
other property you receive. The rules for figuring the recognized gain in this situation
generally follow those for a partially nontaxable exchange discussed in Publication 544
under Like-Kind Exchanges. If the property you exchange includes depreciable
property, the recognized gain may have to be reported as ordinary income from
depreciation. No loss is recognized. See chapter 3 of Publication 544.
Nonqualified preferred stock. Nonqualified preferred stock is
treated as property other than stock. Therefore, there could be gain. See Money or
other property received, earlier. Generally, it is preferred stock with any of the
following features.
- The holder has the right to require the issuer or a related person to redeem or buy the
stock.
- The issuer or a related person is required to redeem or buy the stock.
- The issuer or a related person has the right to redeem or buy the stock and, on the
issue date, it is more likely than not that the right will be exercised.
- The dividend rate on the stock varies with reference to interest rates, commodity
prices, or similar indices.
For a detailed definition of nonqualified preferred stock, see section 351(g)(2) of the
Internal Revenue Code.
Liabilities. If the corporation assumes your liabilities, the
exchange is generally not treated as if you received money or other property. There are
two exceptions to this treatment.
- If the liabilities the corporation assumes are more than your adjusted basis in the
property you transfer, gain is recognized up to the difference. However, if the
liabilities assumed give rise to a deduction when paid, such as a trade account payable or
interest, no gain is recognized.
- If there is no good business reason for the corporation to assume your liabilities, or
if your main purpose in the exchange is to avoid federal income tax, the assumption is
treated as if you received money in the amount of the liabilities.
For more information on the assumption of liabilities, see section 357(d) of the
Internal Revenue Code.
Example. You transfer property to a corporation for stock.
Immediately after the transfer you control the corporation. You also receive $10,000 in
the exchange. Your adjusted basis in the transferred property is $20,000. The stock you
receive has a fair market value of $16,000. The corporation also assumes a $5,000 mortgage
on the property for which you are personally liable. Gain is recognized as follows.
Fair market value of stock received |
$16,000 |
Cash received |
10,000 |
Liability assumed by corporation |
5,000 |
Total received |
$31,000 |
Minus: Adjusted basis of property transferred |
20,000 |
Realized gain |
$11,000 |
Recognized gain |
$10,000 |
The liability assumed is not treated as money or other property. The recognized gain is
limited to $10,000, the amount of cash received.
Loss on exchange. If you have a loss from an exchange and own,
directly or indirectly, more than 50% of the corporation's stock, you cannot deduct the
loss. For more information, see Nondeductible Loss under Sales and Exchanges
Between Related Persons in chapter 2 of Publication 544.
Basis of stock or other property received. The basis of the stock
you receive is generally the adjusted basis of the property you transfer. Increase this
amount by any amount treated as a dividend, plus any gain recognized on the exchange.
Decrease this amount by any cash you received, the fair market value of any other property
you received, and any loss recognized on the exchange. Also decrease this amount by the
amount of any liability the corporation or another party to the exchange assumed from you,
unless payment of the liability gives rise to a deduction when paid.
Further decreases may be required when the corporation or another party to the exchange
assumes from you a liability that gives rise to a deduction when paid after October 18,
1999, if the basis of the stock would otherwise be higher than its fair market value on
the date of the exchange. This rule does not apply if the entity assuming the liability
acquired either substantially all of the assets or the trade or business with which the
liability is associated.
The basis of any other property you receive is its fair market value on the date of the
trade.
Basis of property transferred. A corporation that receives property
from you in exchange for its stock generally has the same basis you had in the property,
increased by any gain you recognized on the exchange. However, the increase for the gain
recognized may be limited. For more information, see section 362 of the Internal Revenue
Code.
Capital Contributions
This section explains the tax treatment of contributions from
shareholders and nonshareholders.
Paid-in capital. Contributions to
the capital of a corporation, whether or not by shareholders, are paid-in capital.
These contributions are not taxable to the corporation.
Basis. The corporation's basis of property contributed to capital by
a shareholder is the same as the basis the shareholder had in the property, increased by
any gain the shareholder recognized on the exchange. However, the increase for the gain
recognized may be limited. For more information, see section 362 of the Internal Revenue
Code.
The basis of property contributed to capital by a person other than a shareholder is
zero.
If a corporation receives a cash contribution from a person other than a shareholder,
the corporation must reduce the basis of any property acquired with the contribution
during the 12-month period beginning on the day it received the contribution by the amount
of the contribution. If the amount contributed is more than the cost of the property
acquired, then reduce, but not below zero, the basis of the other properties held by the
corporation on the last day of the 12-month period in the following order.
- Depreciable property.
- Amortizable property.
- Property subject to cost depletion but not to percentage depletion.
- All other remaining properties.
Reduce the basis of property in each category to zero before going on to the next
category.
There may be more than one piece of property in each category. Base the reduction of
the basis of each property on the ratio of the basis of each piece of property to the
total bases of all property in that category. If the corporation wishes to make this
adjustment in some other way, it must get IRS approval. The corporation files a request
for approval with its income tax return for the tax year in which it receives the
contribution.
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